The Pros and Cons of Unsecured Small Business Loans

ByTop10 StaffFeb. 28, 2019
The pros and cons of unsecured small business loans
Unsecured business loans require no personal or business assets as collateral, however they may require the borrower to have good credit and can have higher rates and shorter terms than collateral-based loans. Take a look at this breakdown of the pros and cons.

Pros of Unsecured Business Loans

Many successful companies rely on unsecured commercial financing because it offers significant advantages. The highlight, of course, is that you don't need to use your business as collateral to secure your loan, which means there's no risk of losing business assets if you can't repay your debts. Here are some other advantages to business loans without collateral: 

1. Less loan processing time

Secured loans can take weeks to get approved for because of the asset evaluation of your collateral. Applying for an unsecured term loan or line of credit can take as little as 24 hours. You'll need to submit your revenues, credit score, time in business, and any other financial statements in order to get approved. 

2. More flexibility

There are many more types of unsecured business loans than there are secured loans. This means that in addition to classic term loans of 2, 5 or 10 years, you can take out money in the form of a line of credit or invoice factoring, among other options. Some loans will allow you to withdraw partial funds now and pay interest only on the money you've withdrawn. Unsecured loans cover a variety of options and you can choose the one that works best for your business. 

3. Less personal risk

As with any loan, you do need to repay your debts at the time allotted.  Because of the nature of unsecured loans, you do not run the risk of losing your business or personal assets, such as your house, should you have trouble paying on time. Unexpected financial strain can impact the most well-run businesses, and you'll be able to contact your lender to discuss deferment, forbearance or refinancing without impacting your ownership rights to any collateral. Inability to pay your debt will impact your business credit and possibly your personal credit score as well for future borrowing. 

4. Fewer restrictions

There are usually fewer restrictions on how your company can utilize the borrowed money, which gives you more choices in how you spend the funds. This leaves your business budget at your own discretion and allows you to choose if the money should be spent on payroll, invoices, inventory or rent. Often secured loans have very specific qualifications and purposes for the money. This is similar to how a car loan secured to ownership rights of your car cannot be spent on a vacation, college tuition, or home construction.

It can be helpful to look at the above advantages as a business loan checklist. Make a note of how many advantages are important to you. While you only need one strong reason to choose this method of financing, it is not unusual for business owners to find more solid benefits that make unsecured loans the best choice.

Cons of Unsecured Business Loans

In any business decision, it is prudent to examine the potential disadvantages. As with most loans, the first noticeable disadvantage is the rates: unsecured loans will almost always have higher rates than loans with collateral, because the lender will consider it a more risky transaction. This is especially true with larger amounts of money, such as equipment financing or construction loans. If your business can show stable revenues, good credit,  and has been active for some time, the rates can be reasonable. Here are some other disadvantages to consider:

1. Shorter loan terms

Medium and short-term business loans are often accessible without collateral, while long-term loans can be inaccessible to borrowers looking for an unsecured loan unless the business has excellent credit and revenues, or is able to pay very high interest rates. Many unsecured loans are due for repayment in only a few months, with some options for 2- to 5-year terms. If you're looking for a 10-year term loan (or longer), most lenders will require collateral, such as business ownership or personal property.

2. Less funding

Unsecured loans frequently pay out smaller amounts. Unsecured business financing might not be available for larger commercial loans. While this may not matter if you're covering your stock for this month, it will exclude your needs if you're looking for funding for large-scale projects or growth. 

3. Credit Score and revenues matter

Credit scores and creditworthiness are much more important for unsecured loans than for secured ones. Without collateral, lenders will usually look at credit factors more closely, which can make it difficult to qualify for an unsecured loan if you've missed payments in the past or defaulted on a loan. This can also impact newer businesses and startups, which have not yet built up credit or significant revenues to prove reliability with. 

The Bottom Line: What Is Best for Your Business?

For your business and personal circumstances, do the pros outweigh the cons? If you’re not sure, don’t hesitate to ask for a second opinion from your accountant and other financial experts. Make sure you tell them what you need funding for and how quickly you want to secure the financing. Ask them what your realistic choices are.

Once you have reviewed the pros and cons of unsecured commercial financing for your business, one of the best ways to put everything into perspective is to discuss a “real-life example” with one or more prospective lenders. Consider your required loan term, amount of money, and how soon you need the money, as well as how much your business will qualify for based on credit and revenues. By talking to a representative, you can discover what is possible for your specific business, including how much you can borrow, how quickly you can get your funding, and what the repayment terms will be. Before you apply for a loan for your small business, prepare yourself by using a business loan checklist to help you understand what you need and to ensure that you get your funding as soon as possible.