Are you looking for a business loan?
Do you know the difference between a secured and unsecured loan?
In this article, I will outline the difference between the two types of loans to make it easier for you to decide which type of business loan is right for you.
Unsecured business loans don’t need any form of collateral.
If your business loan is unsecured, it means you do not have to use any collateral such as your home, personal property or any other personal or business asset as security for the loan. Instead, if you fail to repay the loan, the lender will use this asset will be used to pay off the debt.
The majority of credit cards and small business loans are unsecured loans and are relatively simple to get. Most banks and non-bank lenders will use your past credit score or credit history to determine your risk profile and if you’re suitable for this small unsecured business loan.
Secured business loans use collateral as security.
When a business loan is secured, banks and non-bank lenders such as us at Sparrow Loans will use this collateral, such as your home or other significant secured assets, as a guarantee to pay the loan back. If the business goes bad and you’re unable to repay the loan, they will use this asset to repay the debt, which is why in some cases, a secured loan can be risky, especially if it’s a business loan.
What are the advantages of secured business loans?
Secured loans are a lot less risky for the lender as they have your home as security; a physical asset that these non-bank lenders can sell to recover their money.
For this reason, secured loans are generally:
- Easier to qualify for as the lender has a considerable asset as a guarantee
- Attract lower interest rates
- You can take the business loan for a more extended period as the lender is less nervous about recouping their debt as they have security.
- For larger amounts of money. In our case at Sparrow Loans, we generally lend up to $2.5 million for secured loans for more significant amounts of money.
Most lenders will take a close look at your past credit history, but if the loan is secured against an asset, you can generally have the secured business loan in about 48 hours. So, if you need cash for a business loan fast ( and it’s a large amount of money ), then a secured loan is the best option.
What are the disadvantages of secured loans?
If you’re a nervous type of person, then a secured loan will keep you up at night. Just imagine having your family home used as collateral for this loan. You’ll be stressing hard, and in uncertain economic times, as we have now in 2021 with COVID, anything could happen. Just imagine another lockdown or something insane like that happening, and your business cash flows dry up. Then you just might have to sell your home. It’s a disaster. Uncertainty for many small businesses is the obvious downside of having a secured loan which is why you MUST plan ahead and be confident that the next business cycle will allow you the extra cash to repay the loan.
Another disadvantage is the paperwork and formalities involved in setting up a secured business loan, especially if you decide to use one of the large Australian banks. These guys will demand lots of paperwork, and the horrible part is handing over your title deeds to the family home. In addition, they will credit histories, get your home valued and other necessary formalities. All this adds up to extra set-up fees, which you have to pay upfront.
Disadvantages of unsecured loans
There are a certain number of risks involved in having an unsecured business loan.
First, because they tend to be riskier for the lender, interest rates are generally higher, meaning you will be paying more over the loan term.
Unsecured business loans are generally for shorter periods, so expect to repay more monthly fees. Plus, loan amounts will be more negligible, so you cannot buy large, expensive equipment or property. And, if you want a quick unsecured loan and have a poor credit history, this may affect your borrowing capacity.
Which business loan should you choose?
For loans over a short period for smaller amounts of money, go with an unsecured loan. They are far less risky ( as you don’t have to put up any collateral), and you can rest easy at night knowing that the banks don’t have the title deeds of your house in case you default. Also, while the interest rates may be higher, the loan is for a shorter period, so you end up paying less. Conversely, as the lender is taking a more significant risk, they will want to see solid credit history. If there have been any glitches or mishaps, this will go against your unsecured borrowing ability.
To learn more about your credit history go to the Money Smart website.
If you have a business that’s trading well and your confidence that you will maintain positive cash flow for the future, then go for the secured loan. With cheaper interest rates and smaller monthly repayments, you’ll be able to use the money to buy that factory, warehouse, or office equipment.
I have clearly outlined the difference between secured and unsecured loans. However, if you are still unsure which option is best for your business and what’s suitable for your financial circumstances, please give me a call or shoot me an email, and I’ll be more than happy to help.