An entrepreneur should ideally choose a loan as per the requirements of the business and his/her eligibility to get approval on the same. Eyeing the needs of small businesses across diverse industries, various forms of loans are available, which are fundamentally segmented into secured and unsecured. One of the primary factors that decide the type of a loan, is collateral, which refers to the business assets offered to guarantee a loan. Collateral is a valuable property or equipment owned by a business, which can be seized by the lender in case the borrower defaults. However, there are many other financing options that do not demand collateral for sanctioning a loan application. Therefore, small businesses must understand the difference between secured and unsecured business loans to make an informed and conducive business decision. 

Difference between Secured and Unsecured business loans:

Secured LoanUnsecured Loan
It requires guarantee, from the borrower, and hence ask for collateral in the form of business assets. It doesn’t require any collateral. Instead, the lenders might ask for a personal guarantee.
Lenders are more lenient with terms and requirements, as they get a guarantee. It comes with quite a few restrictions.
It comes with lower interest rates as the lender considers the investment less-risky. 

Some loans have interest rates as low as 2%.

Interest rates are higher as it is not guaranteed with collateral and hence the lender often considers it risky.

Some alternative lenders offer unsecured loans at interest rates as high as 100%. 

Personal guarantee is not needed.Personal guarantee might be needed as no other form of guarantee is given.
Credit score requirement is comparatively lenient.  Credit score requirement is high and stringent as the loan highly depends on the data in the credit report to make a decision.
Repayment terms are long. Repayment terms are quite short. 

      Mostly, secured loans are opted by new businesses or start-ups that require a substantial amount to cover operational costs. But, the borrower needs to scrutinize the expense of the added interest and decide if offering collateral is worth borrowing the amount. Secured loans are often considered convenient for businesses with no established credit, whereas, unsecured loans are ideal for business owners who have decent credit but no business asset to put up as collateral. When it comes to secured loans, the burden of risk mostly comes to the shoulders of the borrower, whereas, in the case of unsecured loans, the burden is more on the lender.

      Before opting for any of the above-mentioned loans, one needs to closely look at all options, considering the number of years the business has been operating and the amount of revenue it is currently fetching. For example, a business that has recently entered the market and is able to bring in revenue much less than the requirements of the lenders is less likely to qualify for unsecured loans. Hence, before applying, one must conduct research on traditional and alternative financing options and then select the most convenient loan for his/her business with favourable terms. Alternative financing options like Merchant Cash Advances (MCAs) offer unsecured loans. Now, what is MCA or Merchant Cash Advance? It is a type of loan that does not demand collateral and is often lenient with credit score requirements. MCA lenders only require data on the business transactions and profit statements of the last few months along with some other business documents. Sometimes, banks also sanction unsecured loans, but they are quite hard to get. 

      Application requirements for secured and unsecured business loans:

      • To apply for either secured or unsecured loans, one needs to provide identification, personal and contact information, credit score, financial statements, business plans and other documents.
      • If applying for a secured loan, one needs to provide additional information on collateral. In the case of unsecured loans, additional data on financial statements is required. This proves the eligibility of the business.

      Examples of Secured Loans:

      • Mortgages  Mortgages are loans secured with property.
      • Construction loans These are also secured with a property and help the borrower to build on the land owned by him/her.
      • Auto loans Secured with a vehicle, these help the borrower to make a major vehicle purchase.
      • Home equity line of credit It is a type of loan that can be secured with the borrower’s home.

      Examples of Unsecured Loans:

      Credit cards

      When a business owner uses a credit card, backed by a financial institution, to pay for something, fundamentally, he/she is using an unsecured loan, offered by the institution. In such a case, the creditworthiness of the business was determined when the card and the credit limit got sanctioned by the institution.

      Signature Loans

      Only those business owners get signature loans who are on good terms with banks. Here, instead of collateral, banks rely on the borrowers’ character and their promise to repay the amount.

      Alternative financing options like MCAs

      This is a kind of loan offered by MCA lenders at high-interest rates but with no requirement of collateral. However, some lenders ask for personal guarantees. In the case of MCAs, the borrower needs to pay a predetermined percentage of the future sales, on a daily or monthly basis, till the entire advance is repaid.