For some small business owners in need of working capital an unsecured business loan is more desirable than a traditional business loan. An unsecured business loan is not guaranteed by collateral which means the business owner will not be forced to use real estate, equipment, or other items of value to the lender in the event that the loan cannot be repaid.
According to the Small Business Credit Survey, 40% of small businesses applied for financing in 2017. Most of those businesses sought under $100,000 in funds. The majority of firms reported profitability and a growth in revenues. These positive outlooks from the survey indicate many successful aspects of small business financing in recent years.
While unsecured loans carry a higher interest rate than secured business loans because there’s a higher risk associated with them given the lack of collateral, the length of time it takes to become approved and receive the loan can be faster.
What is an unsecured business loan?
Providing collateral with a secured loan is the safest way for a lender to guarantee its repayment. A small business owner uses his or her assets to show a promise to repay borrowed funds with items of similar value to the loan. An unsecured loan does not have assets or property to guarantee repayment of the debt.
An unsecured loan may sometimes require a personal guarantee from the borrower. A personal guarantee means that the small business owner will be required to repay the small business loan with personal assets (which is money from a personal checking or savings account, car, home, etc.).
What are the main advantages of an unsecured loan?
For lenders who do not require a personal guarantee, an unsecured business loan is a low-risk financing option for small businesses because they do not require collateral like a traditional business loan. This means that small business owners who do not have collateral to guarantee their loan can still get the financing they need for their businesses.
And for those who are worried about the risk of debt, with an unsecured loan, they do not have to worry about losing equipment or other forms of liquidity in the event that they’re unable to repay the unsecured loan.
There are a few other advantages of an unsecured loan. Unsecured loans also do not have any restrictions on what they’re used for in your business. Many other types of small business loans have specific expenses they target like equipment, inventory, vehicles, etc. With an unsecured small business loan you can choose where the funds are allocated for your venture.
Unsecured business loans can be more easily dismissed in the event of bankruptcy and they often come with shorter loan terms. Both of these factors make them appealing to small business owners.
The downside is, unsecured business loans are a much higher annual interest rate than traditional small business loans. And, as mentioned previously, the shorter repayment term could be a disadvantage or an advantage depending on your finances.
Small business owners should consider if they’re able to repay the loan within the timeframe allotted and if the high interest rates are feasible for them.
Choosing the Best Unsecured Business Loan
Since every business and budget is different, it’s best to explore the types of unsecured business loan options prior to choosing one. If you’re set on an unsecured business loan, many of these loans are up to $50,000 with a term of one to three years. Some may require a personal guarantee, while others may not. It depends on the lender.
According to the Small Business Administration (SBA), an unsecured business credit line is another good option for small business owners. It’s similar to a business credit card, but the interest rates are lower and there are no fees for cash advances like a credit card.
Revenue-based loans are another option. Lenders look at your business financial records and then create a loan based on your revenue. In all three types of unsecured business loans, once you’re approved you’ll receive your funds in a few days.What happens if you default on an unsecured loan?
Lenders will always try to collect debt whether a loan is secure or unsecured. However, with an unsecured loan, lenders are assuming a level of risk with their borrowers because there’s no valuable asset to seize in the event of non-repayment. Lenders will rely on the small business owner’s ability to repay the loan without collateral.
Are unsecured loans safe?
An unsecured business loan is considered “safe” in that you will not lose your collateral if your business fails and you’re unable to repay your loan. However, taking out any kind of loan is inherently a risk because of interest rates. You’ll pay interest rates no matter which type of loan you choose, whether the loan is safe for you or not depends on your ability to make payments on time and grow your business with the financing help you receive.
When deciding if you need to take out a loan or not, business owners must weigh the types of risks they want to take with the potential benefits for their businesses. If you have a good credit score and you believe your business will profit from the investment you’re making with financing, then a loan is a safe bet.
However, if you have a bad credit score, business is rocky, and you’re unsure if you’ll be able to repay your small business loan, it may not be safe to take a financial risk.
Do unsecured loans improve business credit?
When you establish yourself as a business and use your business name for your phone lines, vendors, facility rent or mortgage, and business financing, you will begin to develop a business credit score.
Making payments on time and using trade lines with accounts for office supplies or other vendors can also help. Working on your personal credit can also improve your overall credit-worthiness.
Paying down personal debts, making payments on time, and not opening to many credit accounts can all positively influence your personal credit score. The same rules apply for your business credit. The more you have a record of timely payments, and less debt, the better.
How to apply for an unsecured business loan
When you’re ready to apply for an unsecured business loan you’ll need your tax information, identification, business financial history, and credit score. You’ll need a solid plan for repayment and to fill out your application accurately. If approved, be sure to make your payments on time so you do not incur a higher interest rate or fees.