There are two basic kinds of business loans that could help you raise your business capital. Discover the key differences between them to decide which one is best for your needs.
Facebook.
Google.
Walt Disney.
These brands have so many things in common.
And one of them is the fact that they were all built by their owners using business loans.
So, if your business ends up needing more money than what you can raise through a line of credit…
May it be to expand to a new location or just to meet next month’s payroll, securing the right loan or financing option is crucial for accessing the necessary funds.
Taking out a loan might just be the way to go. Business loans are one of several financial solutions available to help businesses access funds for business growth.
But before you sign on that dotted line, make sure you’ve done your due diligence. After all, not all business loans are created equal.
For starters, you should be familiar with the two basic types of bank loans:
Secured business loans and unsecured business loans. Choosing the right loan for your business needs is essential to ensure you select the best financing option for your goals.
In this article, we’ll explain four key differences to distinguish secured loan vs unsecured loan. This can help you decide which business loan is right for you.
Secured Loan vs Unsecured Loan: 4 Key Differences
It doesn’t matter who you are and what industry you’re in.
If you ask us to choose which between these two types of loans is better for you, there will only be one answer:
It depends.
The type of loan you should get depends on your asset profile, your risk appetite, and the loan repayment structure you’re eyeing. Your individual circumstances, such as your business’s growth rate, funding needs, and repayment preferences, play a key role in making the right business lending decision.
There are two main types of business lending options: secured and unsecured loans. The main difference between a secured and unsecured loan is that a secured loan requires collateral or security, while an unsecured loan is based on your creditworthiness and cash flow.
As such, it’s crucial to take note of the key differences between secured and unsecured loans so you can assess the variables yourself. Understanding the features of each secured and unsecured loan is an important part of the business lending process.
Difference #1: Need for Collateral
The most important factor in distinguishing secured loan vs unsecured loan is the need for collateral.
Secured loans are called such because they’re backed up with some kind of security that’s typically called a collateral.
A collateral is something you pledge to signify your intent to pay back the loan in good faith. Your collateral may come in the form of a pre-existing property, or even the exact property or equipment you’re purchasing with the proceeds from your secured loan. Businesses may also use accounts receivable as a type of asset to provide security for a secured loan. The importance of asset security in the lending process cannot be overstated, as it directly affects loan terms and approval.
When obtaining a secured loan, businesses may need to provide assets as security, such as property, inventory, or receivables, to meet the lender’s collateral requirements.
In the event that you default on the loan, the lender will claim ownership of your collateral to cover for the money you haven’t paid. Bear in mind that this happens automatically and without the need for a court order.
On the other hand, unsecured business loans do not require you to put up anything as collateral. This means you won’t be at risk of having your assets seized if you end up defaulting on the loan.
Still, this is without prejudice to any legal action the bank may pursue against you if you do default on an unsecured loan. They may hire a collection agency, ask the court to seize your assets anyway, or even sell your outstanding debt to a third party.
In any case, it is the lender that takes on a bigger risk of not getting paid back when they offer unsecured loans. So, the lender will undoubtedly try to make up for this higher risk by charging higher rates on the loan, which provides its own kind of protection.
And that brings us to our next point…
Difference #2: Interest Rates
Since secured business loans burden lenders with lower risk of default, they are usually offered at lower interest rates. Collateral reduces the lender’s risk, which allows them to provide a lower interest rate, more flexible terms, and easier approval processes. Securing a loan with assets can also benefit the borrower by increasing borrowing limits and improving approval chances.
Conversely, unsecured loans typically come with higher interest rates. Without collateral, lenders evaluate the borrower’s financial strength and cash flow to determine creditworthiness, which often results in stricter application processes and higher rates.
For some entrepreneurs, the higher interest rate is a red flag.
Indeed, this is a major drawback that might make you think twice about unsecured business loans.
But there may be instances where you’re more concerned about keeping your assets intact while you weather a storm Which is why you might be fine with paying a higher interest rate on the loan.
Difference #3: Maximum Loan Amount
Many business owners think they can get bigger loan amounts on secured loans compared to unsecured loans. That assumption might generally hold true, but it’s not always as simple as that.
It’s true that lenders are typically more inclined to let you borrow more if you’ll put up your assets as security for the loan. Secured loans often come with higher borrowing limits, as the amount you can access is based on the value of the collateral you provide, making them suitable for significant investments and growth initiatives. However, the loan amount will still depend on the value and nature of the property or other asset you’ll be offering as collateral. Traditional lenders, such as banks, may also have stricter requirements for secured loans compared to non-bank lenders.
So, if you want to borrow more than any of your assets’ worth, you might have a better chance with an unsecured loan. Provided that you have a rock-solid credit rating.
Still, you’ve got to manage your expectations when it comes to the maximum loan amount you can get from an unsecured loan.
If you default on a secured loan, the lender may use the collateral to settle the outstanding balance, including any interest or fees owed.
Difference #4: Repayment Periods
Another typical drawback of unsecured loans is that they come with shorter repayment periods compared to secured business loans. The loan term can vary significantly between secured and unsecured loans, with secured loans often offering longer loan terms that may better suit certain business needs.
On the other hand, secured loans will normally afford you longer repayment terms. Whether you consider this an advantage or a disadvantage depends on your priorities. After all, having longer repayment terms means you will be in debt longer.
Bear in mind that you can’t just cut short the tenor you are given on a loan. Some loans have a fixed term, which can affect your early repayment options, potentially resulting in interest discounts or penalties depending on the lender’s policy.
…at least without paying a hefty fee.
Understanding Loan Agreements and Terms
When seeking financing for your business, it’s vital to have a clear understanding of the loan agreements and terms that come with both secured and unsecured loans. A loan agreement is a legally binding contract between you and your lender, spelling out the specifics of your business loan—including the interest rate, repayment schedule, and any fees that may apply. Whether you’re considering secured and unsecured loans, knowing exactly what you’re agreeing to can help you avoid surprises down the track and ensure the loan truly supports your business goals. Taking the time to review and understand your loan agreement is a crucial step in the business financing process, no matter which loan type you choose.
What to Expect in Your Loan Contract
A business loan contract, whether for a secured or unsecured loan, will outline all the essential details you need to know before committing. For secured loans, expect to see requirements for collateral—this could be commercial property, residential property, or even business equipment. The contract will specify what assets are being used as security and what happens if you default. Unsecured loans, in contrast, won’t require you to provide collateral, but you’ll likely see higher interest rates and more stringent credit history checks. Both loan types will clearly state the loan amount, interest rates, repayment schedule, and any additional fees. It’s important to pay close attention to these details, as they directly impact your business’s financial obligations and long-term planning.
Key Clauses to Watch Out For
As you review your loan contract, keep an eye out for several key clauses that can significantly affect your business. The interest rate is a major factor, as it determines the overall cost of your loan. Repayment terms—such as the length of the loan and payment frequency—should align with your business’s cash flow. For secured loans, carefully review the collateral terms, including how the lender assesses the value of your assets and under what conditions they can claim them. Some lenders may also require a personal guarantee, putting your personal assets on the line if your business can’t repay the loan. Unsecured loans often come with stricter lending criteria, requiring additional proof of strong cash flow and a solid credit history. Understanding these clauses will help you avoid unexpected risks and ensure you’re choosing the right financial solution for your business.
How Terms Differ Between Secured and Unsecured Loans
The terms you’ll encounter with secured and unsecured loans can vary widely, and understanding these differences is key to making the best choice for your business financing needs. Secured loans generally offer lower interest rates and more flexible repayment options, thanks to the reduced risk for the lender provided by collateral. However, this means your assets are at risk if you default. Unsecured loans, while not requiring collateral, typically come with higher interest rates and stricter repayment terms, reflecting the higher risk for the lender. When comparing loan types, consider your business goals, financial situation, and risk tolerance. By carefully evaluating the terms and conditions of each option, you can select a business loan that supports your growth while managing your exposure to risk.
Apply for an Unsecured Business Loan Today
In our experience, many businesses—both small and big—find value in taking out unsecured loans. Unsecured lending is especially popular among small businesses seeking quick access to funding for their immediate needs.
For smaller, newer businesses, it is a way to get access to more business capital even without any assets that can be offered as collateral. Business overdraft is another financial product that can help manage working capital and support business growth alongside unsecured loans.
On the other hand, established businesses are not always keen on putting their headquarters or family homes at risk of getting seized.
In both these scenarios, taking out an unsecured business loan will be the best option. Funds from unsecured loans can be used for a variety of business purposes, including working capital, expansion, equipment purchase, and other needs that drive business growth.
If you are in a similar position where you don’t have a large asset pool for a secured loan…
We at Unsecured Finance Australia can help by offering the best unsecured loans for your business.
Apply online and get approval within the next 24 hours!
