January 29, 2024 | 4 minute read
Answered by
Roderick Wilson
Small Business Lending Product Executive
Bank of America
A business loan can be a powerful tool for expanding your business or refinancing your debt in today’s fast-changing economy, and both secured and unsecured options can come in handy. Many small business owners, however, are not familiar with the difference between these types of business loans. Understanding what sets them apart can help you select the type that’s best for your business.
These are business loans backed by collateral, meaning an asset such as equipment, inventory or real estate owned by you or your business. The lender will place a lien on the collateral. Examples of secured loans include mortgages (which are secured by the actual property you are buying), construction loans (secured by the property where you are doing the construction), equipment and auto loans (secured by the car, truck or big machinery you might be buying) and a home equity line of credit (secured by the home).
Because you could lose property if you default, secured business loans are not without risk. However, in exchange for taking that risk, you will find secured loans may have lower interest rates than unsecured loans. Financing terms may also be better, meaning you might have more time to pay off the loan.
An unsecured business loan is not backed by collateral. Instead, it is based solely on how creditworthy you are, which rests on factors such as your personal and business credit history. Lenders tend to view unsecured loans as riskier than secured loans, so they usually require that borrowers have a satisfactory credit history and pay them back more quickly. Because the loan is not secured by a valuable asset, unsecured loans also may carry higher interest rates than secured loans. Uses for unsecured loans may include a one-time purchase of a large piece of equipment, expansion or updates to the location of your business.
Both secured and unsecured business loans can help you grow your business. If you own equity in a valuable asset such as commercial real estate, you may find that secured loans give you access to lower interest rates and longer payment terms, making them more affordable and putting less pressure on you as you repay your lender every month. However, if you don’t want to put up collateral or don’t have the type of asset that can be used as collateral, an unsecured loan can be a valuable tool, allowing you to access the funds you need quickly.
Before you consider either type of loan, review the terms and interest rates carefully. Create a cash flow budget to determine your ability to make payments over time or ask your CPA for guidance. Then talk with a lender or banker to evaluate collateral for a secured loan. If you are not comfortable putting up collateral (or don’t have any), an unsecured loan could be best.
As a business owner, it is important to consider both the risks and rewards of any loan. Any type of financing has both advantages and disadvantages, so it is important to consider your unique situation and ability to pay back the loan when deciding on the option that’s best for you.
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