You can consider an unsecured business loan if your business needs to borrow money but doesn’t have much by way of collateral. Unsecured small business loans aren’t backed by any assets — such as land or equipment — that can be liquidated in the event of default. As such, they carry a higher risk for lenders than secured loans, which are backed by property that can be seized in the event of nonpayment.
Here’s what you need to know about unsecured loans for businesses.
Advantages and Disadvantages of Collateral-Free Cash for Businesses
Unsecured loans carry both advantages and disadvantages. No-collateral loans might be easier to apply for, but they can often be harder to get. Unsecured loans might also cost more than secured loans. Here’s a look at the major pros and cons of unsecured business loans as a means of small business financing.
Advantages of Unsecured Business Loans
Here are the benefits of getting an unsecured business loan:
The most obvious advantage of an unsecured loan is that you don’t have to put up any collateral. Not only does that offer your business financial flexibility, it also protects you from losing additional assets in case you end up defaulting on the loan.
Higher Credit Limits
When you take out a secured business loan, the amount of your loan is typically limited to a percentage of the collateral you offer. An unsecured loan is only limited by the willingness of the lender to extend credit, meaning you might be able to get a much larger loan.
Easy Application Process
With an unsecured loan, you don’t have to itemize assets used for collateral, nor does the lender have to value that collateral. The application process is similar to applying for a credit card — which is also an unsecured loan — and can often be performed online.
Although no company plans on going bankrupt, sometimes things go sour. In some situations, you can be personally liable for the debts of your business. Unsecured loans can usually be discharged in bankruptcy, unlike secured loans.
Traditional loans, including secured business loans or SBA-guaranteed loans, can take one month or more to be approved. You can often get an online unsecured loan application approved in 24 hours or less.
An unsecured loan is essentially a handshake agreement between a borrower and a lender. If you can borrow money — and pay it back — with nothing but your and your company’s word backing it up, you are building trust with a lender. This can lead to easier financing, and perhaps better terms, in the future.
Learn: How to Get a Business Loan
Disadvantages of Unsecured Business Loans
Before you commit to getting your small business financed with this kind of funding, know the drawbacks of this financial strategy. Here are the disadvantages of unsecured business loans:
Higher Interest Rates
Because your business doesn’t provide any physical backing for the loan, the lender takes on more risk in extending you a loan. To compensate for this risk, interest rates on unsecured loans are often higher than on secured loans.
Good Credit Required
Lenders have no recourse if you can’t pay back your unsecured loan. Because banks and other lending institutions aren’t in the business of losing money, they might not extend your business a loan unless you can demonstrate having a good credit history.
Lenders make money on the interest they charge you for a loan. The longer your loan period, the more interest they stand to earn. Thus, some lenders will not allow you to prepay a loan; those that do permit prepayments might charge additional fees to offset the cost of lost interest.
Might Not Be as Flexible as SBA Loans
Loans from the Small Business Administration can be approved with collateral shortfalls and can offer extended terms of up to 10 years. These options can give a business more flexibility than a conventional loan, which typically has a term of three to five years.
Equity Funding Can Be Better
If your business can raise money from friends, family, angel investors or venture capital firms, it might be in a better financial position than taking out an unsecured loan. Although you’ll have to give up shares in your business to get equity funding, you won’t have a loan that you’re required to pay back.
Might Require Personal Guarantee
In some cases, a lender might require you to make a personal guarantee to back up your unsecured business loan. Although not technically collateral, a personal guarantee could put your financial assets, such as your home, at risk.
Qualifying for an Unsecured Business Loan
All banks are different in terms of their requirements for getting a business loan. Generally, your business will have to show a history of generating revenue so that the lender knows it can get paid back. Bank of America, for example, needs to see at least $100,000 in annual revenue generated under the same ownership team for at least two years before you can apply for an unsecured business loan. As with any loan, the greater your ability to make your payments, the more likely you are to be approved for small business funding of any type, including an unsecured business loan.
Also See: 7 Best Business Lines of Credit
Flexibility at a Possibly Higher Cost
An unsecured business loan can be easier to obtain than a secured loan, and it might offer more flexibility of terms and larger loan amounts. These features can appeal to businesses that need a simple and clean transaction. The downside is that an unsecured loan might put your personal assets at risk and come at a higher cost. For businesses that are unwilling or unable to put up collateral, however, an unsecured loan might still be the best option.