Advantages and disadvantages of unsecured business loans
The main points
Unsecured loans can be funded faster than conventional or secured loans because they do not require collateral documents or appraisals.
The interest rates on unsecured loans can be higher than other types of business loans because lenders consider them too risky.
You may have to sign a personal guarantee, which makes you personally responsible for repaying the loan if your business defaults.
If you're a business owner, taking out a loan can give you a financial boost when you're ready to expand or need more cash flow. Unsecured business loans are a popular choice because they do not require collateral. However, the pros and cons of unsecured business loans should be considered before applying for financing.
If approved, this type of loan can help you with everything from covering unexpected expenses or expanding your business, but you'll likely need to sign a personal guarantee.
Learn more about unsecured business loans, including the overhead costs and requirements associated with this type of loan.
Advantages of unsecured business loans
There are two key reasons why unsecured business loans are popular.
No business collateral required
The biggest advantage of unsecured small business loans is that no collateral is required. With secured loans, you need valuable assets to help secure the loan. Lenders often require these assets to carry the same value that you want to borrow. Not every company has enough assets to serve as effective collateral.
Using assets as collateral can be risky for some companies. If you fail to repay the loan as agreed, the lender has the right to take the property you used to secure the loan. If you have no way of securing the loan or don't want the added risk of saving valuable assets, an unsecured loan is a good option.
It can offer faster financing
Many unsecured loans offer faster approval and financing. You do not need to provide any documents showing your business as collateral or wait for the lender to research and estimate the value of the collateral.
The fastest business loans come from online lenders that specialize in streamlined application processes and speedy approvals. With these lenders, it is possible to obtain financing within one to three days, which can be much faster than with loans from banks and credit unions.
Disadvantages of unsecured business loans
Here is a look at the drawbacks that can make unsecured business loan alternatives more attractive.
More expensive
Unsecured business loans cause greater risk to lenders than secured loans. If you fail to make payments on a secured loan, the lender might seize the collateral to recoup losses. about an unsecured loan, the lender is more concerned about your business reputation and credentials. Lenders compensate for this higher risk through higher loan interest rates and fees.
Even the best unsecured business loans have higher rates than secured loans. But the types of loans for companies with bad credit are often the most expensive. This is because unsecured options such as invoice financing or trade cash advances are considered high-risk loans that are usually offered to companies that are in financial difficulty or have cash flow problems.
Listick Tip
Subprime loans available to business owners with bad credit may show the value of an unsecured loan using a factor rate rather than an interest rate or APR. Make sure you know how to convert the factor rate into an annual interest rate to help you compare offers from different lenders.
There may be strict eligibility requirements
Another method lenders compensate for the higher risk of providing unsecured loans is to impose rigorous qualifying restrictions for specific types of unsecured business loans. This includes term loans and lines of credit with the best rates, higher loan amounts, lower loan fees and longer repayment periods. These loans are often reserved for established companies with good credit, two or more years in business and high annual returns.
Unsecured loans are available to startups and business owners with bad credit but the terms are inconsistent. This includes a lower loan amount and a shorter repayment period.
Funding may take time
Not all lenders provide fast unsecured business loans. If you apply for an unsecured loan from a bank or credit union, it can take days to get approved and a week or more to see the money. If you need quick cash, online lenders are the way to go. Offers a lot of financing the next day.
A personal guarantee may be required
Many secured and unsecured loan lenders will require a personal guarantee before a loan is approved. If you default on a loan, it puts your personal assets at risk.
Personal guarantees are usually required for anyone who owns a certain percentage of a business. For example, many lenders will want anyone with 20 to 25 percent ownership to sign a personal guarantee and be personally responsible for repaying the loan.
Unsecured business loan alternatives
Unsecured business loans are just one source of financing your business can consider. There are many other ways to get financing or borrow money for your business. Some have easier eligibility requirements, let you borrow more money in one go, or cost less.
Some alternatives to consider include:
Secured Loans and Lines of Credit: They require you to provide collateral against the loan, such as a piece of property or a certificate of deposit. They may have a cheaper interest rate than an unsecured loan due to the collateral.
SBA Loans: Backed by the US Small Business Administration and available from a variety of lenders, they have higher interest rates, making them affordable for many small businesses.
Business credit cards: These cards work like personal credit cards. You can use a revolving line of credit as a short-term loan to pay off projects and suppliers. Although business credit cards usually have lower credit limits than loans, you won't pay interest if your balance is paid off in full each month.
Business Grants: Grants do not have to be repaid, which makes them attractive. They are available from public and private sources but can be competitive and have lengthy application processes.
Crowdfunding: Crowdfunding campaigns let friends, family, and complete strangers to invest in your business. Often this is in exchange for a reward or fairness, but it can also depend on a donation.
Peer-to-peer (P2P) lending. This type of loan often has the same requirements as a traditional loan but is funded by a group of investors or a corporation, which makes it less formal.
Bottom Line
Unsecured business loans can be a good source of financing for your business. Their costs can be high and they require strong credit and business financing, but they allow you to borrow without risking your company's assets. They also provide straightforward application processes and quick funding.
Consider whether an unsecured loan is right for your business. Make sure to shop around and compare offers from several lenders to get the best deal. Your cheapest option is to make managing your debt and business easier.
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