3 Factors To Consider When Deciding Between A Secured And Unsecured Business Loan

A business owner can apply for two categories of business loans, namely unsecured business loans and secured business loans.

Secured business loans are loans awarded to a business upon providing property or business assets as collateral to back up the loan. On the other hand, unsecured business loans do not require any collateral but rely on the history and performance of the business.

Most business owners consider unsecured loans a better option than secured loans because they do not have to provide collateral. However, unsecured loans are much harder to come by because lenders consider them to have a higher risk of default.

Thus, before deciding on whether to opt for an unsecured or secured business loan, here are three comparison points you need to consider.  

1. The Amount Required 

Before applying for a business loan, you should know the loan amount you need. However, it is up to lenders to determine whether or not you qualify for the amount requested.

It is easy to get the total amount you want to borrow when applying for a secured loan, provided your collateral meets the required loan-to-value ratio (LVT). The loan-to-value ratio is expressed as a percentage of the total value of the collateral that a lender is willing to loan you. However, the percentage varies between lenders, and thus you need to compare and contrast the LVTs of different lenders to find an ideal ratio.

For unsecured business loans, it can be challenging to get the total loan amount you require considering you do not have any collateral. In most cases, these factors determine the amount you get for an unsecured business loan:

  • The credit score of the business
  • Past loan repayment history
  • Nature of the business
  • Past and projected income for the business
  • Your business plan

If any of the above factors doesn't appeal to a lender, they will not be willing to provide a large sum of money as an unsecured business loan.

Therefore, if you are looking for a large amount of money as a loan, your best bet is to apply for a secured business loan rather than an unsecured one.

2. The Urgency of the Business Loan

How soon you need the business loan also determines which type of business loan is ideal.  

From a lender's perspective, providing an unsecured business loan is quite risky because if you default on the loan, the lender has no collateral to fall back on. As a result, lenders will put you through a lengthy and stringent application and qualification process before they feel comfortable enough to trust you with an unsecured business loan.

For one, they have to audit your entire business to determine its creditworthiness. Secondly, lenders also have to run background checks on you and your business's history to determine if you risk defaulting on the business loan. All these processes could take up to several months, and thus if you need a business loan urgently, getting an unsecured business loan may not be ideal.

However, applying and qualifying for a secured business loan is less stringent and thus takes up less time. In most cases, lenders only need to have the assets or properties listed as collateral appraised to determine the loan-to-value ratio. Thus, qualifying for a secured business loan takes a fraction of the time an unsecured business loan takes.  

Therefore, if you need a business loan promptly, applying for a secured loan is the fastest option available.

3. The Interest Rates 

Lenders use several factors to determine the interest rates on a business loan. Some of the factors include:

  • Credit score
  • Loan duration
  • Business income
  • Risk of defaulting

Though all the above factors are essential, the risk of defaulting takes preference when determining interest rates.

Secured business loans are less risky because even if you default on the loan, a lender can use your collateral to recover their money. However, because unsecured business loans have no collateral, lenders risk having a bad debt in their books if you default.

As a result, lenders place higher interest rates on unsecured business loans than on secured business loans. Therefore, if you want favorable interest rates on a business loan, it is advisable to opt for a secured business loan instead of an unsecured business loan.