Before signing off on any business loans, including small business loans, you’re going to want to know a thing or two about the different types of loans out there so you can determine which one is the right fit for you.
No one knows better than small business owners how precious time is, so let’s dive right in!
The two main categories of business loans available, no matter the lender, are secured and unsecured business loans. You might be able to draw some assumptions about what each entails based on the names alone, but we never want to trust assumptions alone!
To clarify, secured business loans put the risk on the borrower while unsecured business loans put the burden of risk on the lender. In other words, in a secured loan if the borrower cannot pay their debt for whatever reason, the lender will have an extra layer of security in place to help repay the debt, like collateral or a personal guarantee from the borrower.
An unsecured business loan, on the other hand, does not require the borrower to sign off on anything “extra,” putting more risk on the lender in case the borrower cannot pay for whatever reason.
Not every borrower is eligible for an unsecured loan and not every borrower is eligible for a secured loan. Every lender has its own criteria to determine who qualifies for what, but it will usually depend on a combination of elements such as credit score, collateral, and how long you’ve been in business, among other things.
This article will focus on everything there is to know about unsecured business loans, so you don’t end up clueless at the bank!
What is an unsecured business loan?
Unsecured business loans do not require a borrower to pledge their valuable assets as collateral to the lender. Collateral, which is required for secured business loans, includes anything that the business or business owner, well, owns. Collateral can include things like real estate, equipment, or personal finances.
The collateral is then promised to the lender in return for funding. You might be asking yourself why a lender would ever approve an unsecured business loan given the potential risks. Unsecured business loans are useful for small businesses or startups that haven’t been in the game long enough to have collateral, but are looking to expand.
But don’t get it twisted, lenders are not just handing out free money to every Joe Schmoe applying for an unsecured business loan. There is still a vetting process, and unless your personal credit score can prove you are trustworthy, the chances of you getting approved for an unsecured loan are beyond slim.
Business owners will also have to provide other documents like proof of revenue and a business plan. If you’re thinking, “okay, even if I have immaculate personal credit and a great business plan, the borrower is still at risk here,” you’re not wrong. So, what’s the catch?
Unsecured business loans tend to have more strict terms than secured business loans to help make up for some of this risk. Unsecured business loan interest rates will be higher than secured loans. The sum of money you can receive from an unsecured business loan will also generally be smaller than with a secured loan.
Something else to consider is that the timeframe in which you must pay back the loan might be shorter with an unsecured loan than with a secured loan.
Some lenders will also require a personal guarantee from the business owner before granting an unsecured business loan.
A personal guarantee makes it the responsibility of the individual to pay back the business loan in case the business fails or cannot repay the debt for whatever reason.
A personal guarantee is not the same as collateral, because it is not restricted to business assets. Personal guarantees allow the lender to sue the borrower for personal property or finances to repay the debt.
Types of unsecured business loans
There are a few different types of unsecured business loans that are popular. It is important to learn about each before you decide which one is right for you. Unsecured small business loans are available in various forms, each with its own set of terms and conditions.
A business line of credit
A business line of credit is just like a credit card, for your business. Maintaining good business credit is crucial for accessing a business line of credit, as it demonstrates your business’s financial responsibility to lenders. A business line of credit is when the lender gives you a limited amount of funding to use, the amount will be decided upon in advance.
A business line of credit is a great option when it comes to businesses that aren’t sure exactly how much money they need. With this type of loan, you will usually only have to pay interest on the money you actually spend. That said, these interest rates are usually pretty high so that is something to take into consideration.
Term loans
Term loans are probably what people typically think of when they think business loan. With a term loan, the lender will loan your business a set amount of money that you will repay monthly over a set period of time (plus interest, of course). Lenders often require a minimum credit score to qualify for term loans, with thresholds varying depending on the lender and loan type.
Most lenders including banks, and online lenders usually offer term loans of some kind. Both long and short term loans fit under the term loan umbrella and can be used for whatever your needs may be. For example, businesses looking to expand can benefit from long term loans. Businesses that need a little extra boost to pay for expenses might benefit from short term loans.
Again, if you are taking out an unsecured term loan, chances are the interest rates are very likely going to be high. Until you pay off your term loan in full, you will be racking up costs with these rates so you should take this into serious consideration.
Getting a large sum of money fast can be tempting, but businesses can get roped into risky terms with unsecured term loans, so make sure you understand what you are signing off on before committing.
Merchant cash advance
With merchant cash advances, the lender will give your business a lump sum of money in exchange for a percentage of future sales. This is a good option if you need cash fast and might feel like a good way to lower the amount of future debt your business has. However, figuring out the exact amount of money your business will have to repay the lender can be tricky. In this case, your business will need to repay the original amount plus, you guessed it, interest. The percentage may end up being a larger chunk than you expected, especially with high interest rates.
SBA loans
Small Business Administration, or SBA, loans are a very popular small business loan option amongst small businesses because of their desirable terms, like low interest rates and longer repayment windows than other loans. SBA loans are usually secured business loans, but in some cases they do not require collateral. Even in the cases that collateral is not requested, a personal guarantee will more than likely be necessary for your business to even be considered for an SBA loan. Now, you might have guessed that due to popular demand, it isn’t easy to get an SBA loan, especially an unsecured SBA loan. But never say never! Your business just might be among the lucky ones, but you will need to discuss this directly with the lender to find out.
Personal loans
Personal loans don’t exactly qualify as business loans, but if your business is brand new, you might not have what it takes to be eligible for a business loan, secured or unsecured, just yet. If you need a loan to get your business off the ground, a personal loan might just be the best option. That said, measuring the risks of taking out a personal loan is crucial. After all, you’re putting your own assets and money on the line here. But you know what they say, the greater the risk the greater the reward.
Unsecured business loans for bad credit
Nobody is perfect, but if you have bad credit or a history of bad credit, it might be difficult for you to get approved for an unsecured loan from a bank or other lenders. But don’t lose hope just yet. There are a number of alternative lenders that offer unsecured business loans to people who might not have the best credit.
These lenders will generally disregard credit score and focus on other areas of your business like revenue and business plans.
The process of getting approved for unsecured business loans when you have bad credit can take longer because the lenders might request additional documentation. As with any unsecured business loan, unsecured business loans for bad credit will usually include terms like higher interest rates and shorter repayment times. When searching for the best unsecured business loans, it’s important to compare various lenders and their offerings to find the most favorable terms for your situation.
Advantages and disadvantages of unsecured business loans
Not every entrepreneur feels comfortable putting up their personal assets for collateral, which is why unsecured business loans are attractive to businesses without the assets traditional lenders look for when granting business loans. Another advantage of unsecured business loans is that they can actually take less time to be approved than secured business loans.
Unsecured business loans are heavily credit score based, so where secured business loans require more documentation and paperwork, unsecured loans can be approved after checking fewer parameters.
The disadvantages of unsecured business loans are the terms; the high interest rates and repayment windows in the previous section. You don’t want to end up biting off more than you can chew when it comes to interest rates! Whether you decide to pursue an unsecured business loan or a secured business loan, be aware of the pros and cons of each. You can guarantee that no lender is giving out free money, so to avoid any unpleasant surprises you want to educate yourself to protect yourself and your business.
