What is a secured business loan?
This term refers to any credit that the borrower promises to pay, and an asset is put up as collateral against the loan. If the debtor defaults on the loan, the asset is used by the lender to repay the amount borrowed.
Examples of secured finance include property loans, bridging finance and secured small business loans.
What is an unsecured business loan?
Unsecured finance differs in that no collateral is put against the loan, so legal action must be taken to retrieve the amount borrowed if the debtor is unable to repay.
Examples of unsecured finance include crowdfunding and unsecured business loans.
6 Key Differences Between Secured and Unsecured Loans
There are some other key differences in the way these finance products work, which is explored below:
1. Collateral
Only recently in secured finance, this term refers to an asset with a value equal to or greater than the amount borrowed and forecast interest. Property and vehicles are often taken as collateral, and it is often required that these assets are insured, to ensure their value is preserved in case of damage within the terms of the loan.
When collateral is used to repay the loan, it may be sold in its entirety even if only a percentage of its value is required. This means that a debtor’s house may be sold to repay the remaining percentage of a mortgage.
2. Risk to lender
The risk for the lender is often higher in unsecured finance products than in secured ones, as legal action must be taken in the case of default. This can incur legal costs and the lawsuits can become quite protracted, depending on how the case unfolds.
The debtor has the most to lose in a secured business loan, as the lender receives their asset and associated funds if the loan is defaulted on. This reduces the lender’s risk in finance products of this type.
3. Interest rates
To offset the higher risk attached to unsecured loans, lenders are likely to charge higher interest.
4. Credit requirements
Similarly, more stringent requirements are in place for the borrower’s credit rating when looking for an unsecured finance product. This is because lender needs to ensure their debtors have a track record of repaying debts.
5. Debt-to-income ratio
Debt-to-income ratio is another metric by which lenders can gauge the likelihood of debtors repaying their debts in full and in a timely fashion. A more favourable ratio, i.e. a higher income relative to debt, will be required for unsecured finance.
6. Time and intended repayment schedule
For most unsecured finance solutions, the application process is usually shorter meaning funds can be made available more quickly. Repayment terms are often shorter too, which may potentially offset the costs presented by the higher interest rates mentioned earlier.
The overarching differences between secured and unsecured finance solutions, and the more granular differences between specific products (detailed in another article on our site), meaning that each is suited to different individuals and businesses.
In general, secured finance is best suited to those who are willing and able to put collateral against their loan. An individual or business with property or other high-value assets to put up will be able to apply for loans with more favourable interest rates through traditional secure finance channels.
Unsecured finance, on the other hand, is better suited to business owners who are not willing or able to put collateral, such as real estate, against their loan. Those with higher credit ratings, or demonstrably stable revenue, may also benefit from unsecured finance.
Specific needs that unsecured finance can help fulfil include plugging short-term funding gaps, borrowing when traditional collateral is unavailable, or borrowing when offering equity is not a preferable or viable option.
There are myriad factors to consider when seeking business finance, through both secured and unsecured channels. A less-than-ideal credit rating or gaps in a company’s finance will make it trickier to apply for loans but it does not make it impossible. At Funding Guru, we specialise in matching borrowers with the finance solution that best suits their specific needs and circumstances.
If you are looking for a business loan, we will work with you to understand your business, your vision and ambitions, and your past. With this information, we will be able to recommend the solution or solutions that match your circumstances.
