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Finance & Accounting, Financial Management, Small Business Loans

The Pros and Cons of Unsecured Loans

Unsecured Loan

Updated on August 25th, 2017

Could your business use an unsecured loan or unsecured line of credit? When you decided to start a small business instead of working for someone else, you knew that you were taking a brave, but risky step. Not only did you have to start at the proverbial ground zero, but you also may have started with little experience in running a business, and definitely didn’t have a consistent cash flow. But those are all risks that you were willing to take. It truly does take some time for a business to begin to generate some income, for the ups and downs to stabilize, and for you to analyze the ebb and flow of income. There is never any guarantee that a profit will be obtained or that your business will ever make a name for itself. If you are starting a business or planning to, and are looking towards securing a loan, you should be familiar with the pros and cons of obtaining an unsecured business loan vs. a secured loan.

What is secured loan and unsecured loan?

Do you need to make business purchase, increase working capital or just need a line of credit as a safety net? As the owner of a brand new or growing your business, you will have many loan options available for your business financing needs. There are two main types of business loans, loans that are secured (by your assets) and ones that are unsecured. Lenders who offer unsecured business loans won’t require your business to put up any assets as collateral to obtain the loan. That means there’s no risk to existing assets like a home, vehicles, other commercial property, or long-term assets like a 401k or IRA. However, you must still meet income and credit requirements. Unsecured business loans can range from $5,000 to more than $500,000, depending on the size of the business and its credit rating. Some lenders may also offer businesses a revolving line of unsecured credit.

The small business loan will be based mainly on the credit history of the applicant. Sometimes these loans are also known as ‘signature loans’ because the bank has nothing but your credit history and your signature. Plus your personal assets cannot be repossessed, a great advantage for you for this kind of loan.

An unsecured small business loan can be both a blessing and a curse. If you can get your loan from a reputable lender, your business is likely in good financial shape. But, don’t abide by the terms of your loan, and the debt you incur can end up hurting your business and credit in the long run.

Pros of an Unsecured Loan

  • Unsecured financing can offer you higher loan amounts, yes; you read that correctly – higher loan amounts. Secured business funding is often limited by a percentage of value of the assets used to secure it. Unsecured business funding does not have this limitation, thus the funding amounts can be higher. An unsecured loan is also funded faster. Secured business funding usually requires an appraisal of the assets used to secure the funding. Unsecured business funding skips this appraisal step thus can often fund faster. In fact, with some lenders funding can often be obtained within 72 hours of application. And, believe it or not, unsecured financing can be easier to obtain. It may sounds like an oxymoron, but it truly is easier to get. This type of loan requires less paperwork, less documentation, and causes fewer headaches than secured business funding.
  • Unsecured lines of credit can offer a business additional flexibility. Could you imagine having extra cash on hand when you need it? Especially when that cash that is not leveraged against your assets? How great would that be! This offers almost unlimited flexibility for a growing business. You can use that extra money to purchase that new server you need, cover payroll in a slow month, pay your accounts receivable or make improvements to your property that will bring more customers in the door. The most effective type of unsecured loan is a working capital line of credit. With a line of credit, you can borrow money when times are tight, pay it back in the big months, and then borrow it again as you need it. It can provide you flexibility for the life your loan!
  • Unsecured loans can help you build a relationship with a lender. Every business would like to have a lender on their side, knowing that if they need a loan, this lender would be willing to give them one. In business, a solid relationship with a lender will always make it easier to obtain financing down the line. Often times businesses are granted these loans either because you already have a strong history with that lender or your business has a good reputation and strong financial position. If you are working off reputation, you can really make a good impression on the lender by properly handling your unsecured debt. Do this and you can find future financing requests pushed through more quickly and easily.

Cons of an Unsecured Loan

  • On the con side is liability. Even though your loan is not leveraged against your assets, it is still a liability. This means you have to make your payments each month without fail. Since you do not have collateral to back up the loan, the lender will be on top of you if you miss a payment. You may not get many “chances” if you start to become slow or delinquent on your payments. If you don’t pay, the bank doesn’t get anything in return, so it is likely to find a quick and easy way to drop your business as a client, and send you to collections for the rest.
  • Damaging your (and your businesses) good name is a risk. It is the flip side of building a good reputation with a lender. While properly handling your loan can build a strong reputation with your lender, mishandling it can cause your business irreparable harm. If you become delinquent, especially after the bank has shown its faith in you by granting you an unsecured financing, you will find it very difficult to obtain future financing. Additionally, if your lender decides to develop a strategy to drop you, it is highly unlikely you will be able to obtain unsecured financing with any another lender. If you don’t have the assets to offer as collateral, you may not be able to obtain the financing you need, putting your business in a bad financial position. You must really run through this scenario a few times before entering into a loan agreement. This really could be a worst case scenario.
  • There are additional costs to using an unsecured loan. While unsecured financing can be quick, provides your business flexibility and higher loan amounts, it does come with an additional price tag. Because an unsecured loan is secured only by trust, this type of loan is definitely more of a risk for the lender. The higher the risk is for the lender, the higher the costs are to you to borrow. Lenders will charge higher interest rates to mitigate risk, borrowers with bad credit or borrowing larger amounts will face high interest rates on a loan. Luckily, if you have a good credit rating you will still see rates above typical bank rates, but not by too much.
  • There could be a lack of flexibility. Unsecured financing can also offer flexibility to your business, but not to you when it comes to repaying the loan. When you take out this type of loan you agree to pay it back in installments over a given period of time. For example you agree to pay $200 a month for 5 years, you will not be able to adjust to a lower payment or be able to pay the loan off sooner without being hit with early repayment fines.
  • You can also expect lower or shorter loan terms. While secured loans can have terms up to 30 years, unsecured financing isn’t as generous. This goes hand in hand with the general restriction on the amounts given for unsecured business loans. Term limits of five years or less will be common; some lenders may offer as many as ten years. Lower terms, of course equate to higher monthly payments.
  • And just because the loan is unsecured, don’t think the lender won’t come after you if you don’t pay. This is especially true if you obtained a type of unsecured business loan with a personal guarantee. This type of loan at first requires the business to be responsible for repayment, unless the business defaults. If this happens, the individual guarantor becomes responsible for repayment. The lender will still have the right to come after your assets (for example: your paycheck, stocks you own, or property you own). Read your loan agreement carefully before signing.

Other Small Business Financing Options

Aside from loans, cash advances and lines of credit are also viable options for financing. Businesses owners often turn to an unsecured cash advance loan. Like a loan, an unsecured cash advance is money that is secured on nothing. The benefit of business cash advances is that collateral is not needed, making it unsecured. Business cash advances are usually given out based on your past credit history, existing business volume, and also repayment potential.

An unsecured cash advance makes getting money easier and more accessible. The process of approval does not take as long. Credit score, however, is the most important factor that lenders consider when offering loans to businesses. The higher the credit score, the higher amount of money may be available to you with a lower interest rate. Business cash advances can be borrowed from many financial institutions. A business owner may choose to borrow money from an institution online or in a banking facility.

Many people are under the impression that business cash advances are high interest scams or confuse them with street corner pay day loans. But this is not the case. True business cash advances and unsecured cash advances are really the same in principle as business loans. Business cash advances come with the responsibility of repaying back the loan amount according to the predetermined schedule. If you are extended a line of credit, what may be different is that you only repay the money that you withdraw, unlike a loan where you are given the lump sum up front. The repercussions are all the same, if you do not repay the borrowed amount; you are in danger of completely losing the financing. Not to mention what will happen to your business and credit score.

Companies like Kabbage offer similar services called lines of credit to certain types of businesses. Kabbage can provide fast, flexible funding to business that need it. For businesses looking for funds to get in on an amazing deal on inventory, or needing to ramp up personnel for an upcoming promotion, lines of credit can make things happen. That new piece of equipment to make your business more efficient can be a reality with a Kabbage line of credit. With Kabbage, businesses can do the thing they need to do to grow.

There is also a relatively new type of financing available in the unsecured financing market. Although it is not completely unsecured, it may provide the best of both worlds for both lenders and borrowers alike. The alternative option available is a partially secured business loan. A growing number of lenders now offer partially-secured loans for business, and for many entrepreneurs and lenders, this really could be the most attractive option available. This type of business loan provides borrowers the ability to be approved for a business loan without having to put up too much collateral. This tends to make lenders a little more willing to lend because they are still somewhat protected by the collateral that is secured. In addition, these loans are usually not forgiven by bankruptcy courts in their entirety, so lenders can feel more secure knowing that at least some, if not all of their money, is recoverable.

While an unsecured loan may not be right for every business, it may be a viable option for yours!

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Kabbage Team

The Kabbage Team is here to not only fund the small business loans you need, but to help you grow your business through free marketing tips, webinars, tools and more. Is there something you'd like us to cover or want to get your small business featured on our blog? Send us a note at content@kabbage.com.

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