Is a small business loan secured or unsecured?
A small business loan can be either secured or unsecured, but not both. Many of the loan options that small businesses funding experts most highly recommend are secured. Other funding routes for which a greater number of small business owners might qualify are often unsecured. The differences between these two types of loans – and what lenders often do to account for these differences – can explain why.
What is a secured small business loan?
Secured business loans are any type of funding you must back with collateral. That collateral could be property, equipment, or virtually any other asset. The total value of all items you put up as collateral must be equal to at least the loan amount.
Securing loans allows lenders to offer lower interest rates. That’s because secured loans give lenders something to recoup and sell if you can’t repay your loan. As such, lenders don’t have to earn as much interest on these loans.
What is an unsecured small business loan?
Unsecured loans are any type of money you borrow without putting up collateral. Qualification for unsecured loans is typically based on your creditworthiness. These loans also leave lenders unprotected if you default. That’s why lenders often charge higher interest rates on them: They’re riskier for lenders, and collecting more interest helps to offset that risk.
Given the high risk that lenders face with unsecured loans, new businesses rarely qualify for them. Loan amounts are often low too, hovering around $50,000 at most.
Are your assets safe with unsecured small business loans?
Notably, some unsecured small business loans can still put your assets in peril. These loans require you to sign one of two clauses that give lenders recourse if you default on your loan. Below are explanations of those two causes.
- Blanket lien. If you must sign a blanket lien to obtain an unsecured loan, you might wind up in a worse place than if you’d declared collateral. That’s because a blanket lien gives a lender the right to seize any of your business assets if you default on the loan. All your property, equipment, inventory, and accounts receivable could be on the line. Collateral, on the other hand, permits lenders to seize solely a handful of items.
- Personal guarantee. A personal guarantee is basically a blanket lien for your personal assets. When you sign a personal guarantee, you give the lender the right to seize your personal property, bank account, and more. Notably, since this provision concerns your personal, not business, assets, the liability protections of corporations and limited liability companies (LLCs) don’t apply.
Pros and cons of a secured business loan
A secured business loan can seem intimidating since you risk ownership of certain assets when you take out such loans. But there are plenty of reasons these loans are common. In fact, minus the potential for asset forfeiture, these loans are often the better choice. Below are some pros and cons to consider.
Pros of a secured business loan
- Lower interest rates and longer repayment terms. Small business owners looking for smaller monthly payments and low rates should turn to secured loans. In fact, if you compare several secured loans, you’ll probably notice consistently low interest rates and long repayment periods. That’s how you wind up with small monthly payments for which you can easily budget.
- Larger loan amounts. Since secured business loans are less risky for lenders, you can typically find them in larger amounts. In fact, for large purchases such as commercial real estate, secured business loans might be your only option.
- Clearly defined collateral. The business liens and personal guarantees that sometimes accompany unsecured loans aren’t part of secured loans. Instead, only the items that you list as collateral in your loan agreement are open to seizure. Sure, the prospect of losing those items can be worrisome, but at least you know you’ll lose only them.