Secured loans and unsecured business loans – what's the difference?

'Which business loan is for me?' is something most owners have asked. To help you decide, here are the main differences between the two main types – secured and unsecured business loans.

By Bonnie Christian on 21/05/2019

Man considers if a secured or unsecured loan is right for him

There are many ways to fund a new business and raise money as it grows. A small business loan can be essential in helping you make those crucial next steps, but navigating all the different options can feel daunting. Whether it’s for staff wages, upgrading the cafe coffee machine or taking those first steps to getting a business off the ground, we’ve broken down the main differences between a secured and an unsecured business loan.

What is a secured business loan?

If you’re a homeowner, the chances are you’re familiar with the classic example of a secured loan: a mortgage. This type of loan gives the lender security by using an asset – whether it be machinery or a property – as collateral if the business owner fails to repay the loan.

“It involves the granting of some form of security to the lender,” explains director of FRP Advisory David Shambrook. “The effect of that security is to say that should the borrower become insolvent and unable to repay all of its debts in full and on time, the lending institution is the first to receive repayments over that secured asset.”

The main requirement for being granted a secured business loan is having something that can act as security. This means already owning an asset – such as a personal property – or borrowing against the asset you’re about to buy – such as the premises for your new clothing brand.

The amount that can be borrowed, the term, and the interest rate will vary depending on each business owners personal circumstances. In general, because that risk is lower for the lender it means they tend to be more willing to be flexible with the amount they lend and will allow for longer time periods over which repayments can be made.

Benefits of a secured business loan

  • Less risk for the lender tends to result in higher loans. “The risk profile is lower for the lender because they have greater control, more legal relevance and a higher ranking in an insolvency event,” says Shambrook. “So, in theory they should be willing to lend more money on a secured basis than they are on an unsecured basis.”
  • Less risk also tends to mean lower fixed monthly interest rates and a longer term for repayment options.
  • If a business has less than perfect credit history, having assets to secure a loan against can make it an effective route to getting funding.

Drawbacks of a secured business loan

  • If a business is relatively new and without assets a secured loan may not be a realistic option.
  • The risk for the borrower can be higher in the event they can’t make their repayments, which could mean losing the asset that has been borrowed against.
  • There may be some up front costs required, such as legal advice if the lender is applying for a first charge over a property.

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What is an unsecured business loan?

The main difference between secured and unsecured business loans is that there typically isn’t such a level of legal security for a lender, meaning the risk or exposure for them is much higher.

Providers of unsecured loans tend to mitigate this risk by lending business loans in smaller amounts over shorter periods of time. A seasonal business – such as a B&B with a focus on summer tourism – might seek an unsecured loan to cover gaps in their working capital (such as staff wages) in months when business is slow, knowing they can pay it back once things pick up in summer.

In most cases you'll need to provide a personal guarantee when taking out an unsecured loan. A lender will often offer an amount based on the business’ turnover, estimating the future success of the business based on its past performance.

Generally, it's also common for them provide a legal loan document, explains Shambrook. “This will typically say how much has been lent, what the interest is to be paid, the installments of repayments, and the terms if they default,” he says. Sometimes these loan documents will take the form of a debenture.

Benefits of an unsecured business loan

  • Having what is known as “free assets”, which have not been borrowed against, means the business can sell them as they please without seeking permission.
  • There tends to be fewer up front costs for unsecured loans in the absence of legal and valuation costs.
  • An unsecured loan is a good option for a relatively new business that does not yet have assets to offer as security and need more flexibility in the time it takes to repay them.

Drawbacks of an unsecured business loan

  • Unsecured loans carry more risk for the lender and therefore tend to have higher interest rates.
  • Many lenders will have a lower cap on the amount they loan to a business without security.
  • If a trading position of a business isn’t strong it can be more difficult to get funding through an unsecured loan.