Secured Or Unsecured Business Loans: Which Is the Right Option?
Understand the differences between business loans with and without collateral so you can take the first step in planning your business finances.
Starting a business requires two key components: competitive research and ample funds. Once you have decided what type of business you want to start, the size of your business and other basics, you can get an accurate estimate of your financial standing.
Depending on your requirements and if you can pledge any collateral, lenders give you the option to choose between a secured and unsecured business loan. Your loan obligation, including EMIs, impacts your cash flow and, hence, the overall financial planning. Understanding both types of business loans beforehand helps in making an informed decision
Purpose or Uses of a Business Loan
From startup financing to working capital, business loans can be used for any purpose. Before applying for a loan, you need to clarify how you are going to use the funds in the application. For this, you need to state how much money you need, how you are going to use it and how you plan to repay it.
These factors also play a key role in deciding whether you should apply for a secured or unsecured loan. Once this is clear, you can also look into the possible assets that you can pledge as collateral. This can be any commercial property, equipment, inventory, machinery, vehicle used for business, and accounts receivable, depending on the lender’s policies.
Difference Between a Secured and Unsecured Business Loan
The following parameters differentiate a secured business loan from an unsecured business loan.
- Collateral Requirement
The primary difference between the two financing options is the pledged collateral. If you borrow funds but provide a valuable asset to the financial institution, it is called a secured loan. This is because the lender can sell or seize your asset in case of default.
Similarly, if your credit score is good and if you showcase credibility through a good credit history, then you can borrow without any collateral.
- Interest Rates
Since secured loans are backed by collateral, the risk of lending is lower for the financial institution. This is why a collateral-free business loan may have higher interest rates compared to the alternative. This is something you must consider as it directly impacts your overall financial well-being.
- Loan Amount
By pledging collateral, you can provide a guarantee of repayment to the lender. This makes you eligible for a higher loan amount. This is why most financial institutions offer high-value business loans against collateral.
- Documents Required
In the case of secured loans, lenders evaluate the assets before processing the loan to ensure the asset pledged is valuable enough. On the contrary, an unsecured loan requires you to provide additional documents to prove your financial stability and repayment capacity.
- Approval Time
Secure loans may have a quicker approval time since lenders focus more on asset evaluation rather than solely on credit history. However, you can quicken the application process for collateral-free business loans by keeping all the documents ready and calculating your estimated business loan EMI.
- Eligibility Criteria
Applying for an unsecured loan comes with stricter eligibility criteria, especially when considering your credit score. If you apply with collateral, the lenders could be more lenient. So, even if your credit score is not up to the mark, you may still be eligible for the loan.
Benefits of a Secured Business Loan
Secured business loans come with several advantages that can help your business get the funding it needs. Here are some key benefits:
- Get a higher loan amount depending on the asset value
- Comparatively lower interest rate due to lower risk for the lender
- Option to choose a longer tenure for comfortable repayment with lower EMI
- Suitable for medium to large size enterprises with urgent fund requirement
- Approval may be faster if the collateral meets the lender’s requirements, even if the credit score is moderate
Benefits of an Unsecured Business Loan
These loans offer excellent benefits, especially for businesses that lack valuable assets to pledge. Here are some of the advantages:
- Zero risk of collateral loss under unfortunate circumstances
- Allows you to arrange funds even without any valuable assets available
- Interest rates for unsecured loans are primarily on the basis of credit history, which can influence affordability
- Simple application process without any complicated paperwork benefit of unsecured personal loan
- Quick disbursal suitable for any urgent business needs
Criteria for Choosing Secured or Unsecured Business Loan
Both financing options can be useful under different circumstances and financial requirements. When you don't have a valuable asset to pledge, then you can consider applying for an unsecured loan. The only condition is that you must have a good credit score to be eligible.
On the contrary, if you want to use business-related assets as collateral, then a secured business loan is a smart option to get a better loan offer. Make sure that you borrow only what is required so there is no risk of asset loss.
Understanding the differences between business loans with and without collateral is the first step in planning your business finances. For either option, you should use a business loan EMI calculator and decide on an amount that fits your repayment capacity. Considering these factors helps in effective financial planning and minimises risks associated with secured business loans.