Secured and Unsecured Loans Explained

Secured and Unsecured Loans Explained

What's the difference between secured and unsecured loans?

By Adam Pescod

Secured and unsecured loans

When looking to raise funding for your company, you’ll probably be given quotes for secured and unsecured loans. There are some significant differences between these two types of business finance, which many business owners will be unfamiliar with. So, how exactly do secured loans differ from unsecured loans, and what are the advantages and disadvantages of each?

What is a secured loan?

A secured loan is a viable option for businesses that need to borrow a large sum of money, typically anything above £200,000. This type of loan requires a business to offer something as security against the debt, which could either be company or personal assets, including property. Proceeds from the sale of these assets can then be used by a lender to pay off any outstanding debt, in the event of a business defaulting on the loan.

Advantages of secured loans

One of the main advantages of secured loans is that they enable businesses to access higher amounts of capital. Because the debt is secured against company or personal assets, secured business loans tend to be less risky for a lender, which might offer lower interest rates and longer repayment terms as a result.

Secured loans can also be a route to funding for companies with a less-than-perfect credit history, especially if they have valuable assets that can be offered as security against the loan.

Disadvantages of secured loans

A secured loan can be a riskier form of funding for borrowers, as it means putting their assets – and potentially the personal assets of directors – on the line.

While secured loans tend to come with lower interest rates, some lenders will ask for additional fees upfront, increasing the price of borrowing. A borrower may also need to foot the legal costs if a lender is applying for a first or second charge over a company’s property, for example.

By using a business loan calculator, you can work out the total cost of borrowing, including additional fees, for each quote you’ve received.

Is a secured loan right for your business?

If there are assets that you, or your shareholders, can put up as security, a secured loan might be a good option for your business. You may have to pay off the loan over a longer term, but you could be offered a favourable interest rate, reducing your monthly repayments and the overall cost of borrowing.

Secured loans can be used for a number of purposes, from the purchase of new property or machinery, to the extension or refurbishment of existing premises. They could also be used to fund the acquisition of a competitor.

Secured and unsecured loans
Secured and unsecured loans:

It's important to understand the differences between these two types of business funding

What is an unsecured loan?

As the name suggests, an unsecured loan is a loan that doesn’t require a company to put up any company collateral as security. Unsecured loans are suitable for businesses that are looking to borrow a smaller amount of capital, and that are unwilling, or unable, to secure the debt with company assets.

However, most unsecured loans will require a personal guarantee, which is a written promise from a business owner – and possibly its directors – guaranteeing payment of the loan if the business fails to keep up with repayments.

Advantages of unsecured loans

In theory, unsecured loans are a less risky borrowing option because there’s no danger of losing any assets if you can no longer repay the debt. They can also offer more flexibility than secured loans, with lenders tending to offer repayment terms of anything from one month to three years.

As it’s not secured against property or other collateral, many lenders will be happy to top up an unsecured loan once a company has made a certain number of successful repayments, and will also offer repayment holidays as an additional benefit.

Disadvantages of unsecured loans

Because they’re not backed up by any assets, unsecured loans are more of a risk for lenders. This means there’s a limit to how much you can borrow on an unsecured basis, with most lenders capping their unsecured loans at anywhere between £50,000 and £300,000. To mitigate the risk of unsecured lending, most lenders will also charge a higher interest rate on unsecured loans, with lower rates only available to companies and individuals with a strong credit history.

Is an unsecured loan right for your business?

An unsecured loan might be a good fit if you require a short-term injection of capital and your business and its shareholders have a relatively strong credit history. Unsecured loans are a popular solution for companies looking to manage their cashflow in periods when sales are usually slower, with some lenders offering a revenue-based repayment option, allowing business to repay at their own pace.

Unsecured loans may come with higher interest rates, but several lenders will let you repay early at no additional cost, and won’t charge any upfront fees. They’ll also offer flexibility on repayment terms, with the added benefits of top-ups and repayment holidays, which won’t normally impact any future borrowing.

Secured vs unsecured: making your mind up

Whether you’re considering a secured or unsecured loan, or another type of funding altogether, it’s essential to know exactly what you’re agreeing to before signing on the dotted line. Taking on debt is a risk, but with all of the right information to hand, you’ll be able to identify the best solution for your business.

 

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