Although taking out a loan to build your business might not be ideal, it’s often the reality for small business owners looking to take their business to the next level. For business owners with assets, a secured business loan can be the right funding solution. We’ll look at exactly how to get a secured business loan.
Before you dive in:
- Borrowers can use assets as collateral to obtain a secured business loan.
- If your business has assets, a secured business loan can help you alleviate short-term cash flow issues.
- Secured business loans often come with better interest rates and terms than unsecured loans.
- The risk is that you will lose the collateral if you default on the loan.
Do You Need Security for a Business Loan?
Collateral, or security, for a business loan is an asset that the borrower pledges to the loan. You might wish to explore how much collateral is needed for a business loan. If the borrower defaults, the lender can seize the asset and sell it to recoup their losses.
Not all business loans require security. See: Unsecured vs secured loans.
Secured business loans: Secured loans require collateral to grant the loan. When borrowers pledge collateral, that lowers the risk for the lender. So, secured business loans often come with more attractive interest rates.
Unsecured business loans: An unsecured business loan doesn’t require collateral. Instead, the lender grants the loan based on the borrower’s creditworthiness and ability to repay the loan.
As a business owner, tapping into the lower rates offered through secured loans is ideal. But if you don’t have assets to pledge as collateral, an unsecured business loan is a viable alternative.
Personal Guarantees and Blanket Liens
When taking out a business loan, a lender may require a personal guarantee or blanket lien to finalize the process. The goal of either is to protect the lender in the event of a default. But it’s important to understand the difference before pursuing a loan with either option.
Personal guarantee: A personal guarantee is typically associated with an unsecured business loan. The document states that you are personally responsible for the outstanding debt if your business defaults on the loan. So, the lender has the right to seize your personal assets if your business can’t repay the loan.
Blanket lien: A blanket lien on your business assets gives a lender the right to claim any of your business assets if you don’t repay the loan. With that, any of the assets owned by your business is fair game if you default on the loan.
How Do Secured Business Loans Work?
Asset-based lending, or a secured loan, is an option for businesses with tangible assets.
The lender will evaluate the assets of a business (as there are various types of collateral for loans) to determine a loan amount. Although most lenders won’t provide a loan for the entire value of your collateral, the lump sum loan amount can help you solve cash flow issues.
Loan-to-value ratio: The loan-to-value (LTV) ratio indicates how much of the value of the asset the lender is willing to provide. For example, an LTV ratio of 80% would mean that a lender is willing to lend $80,000 when a $100,000 asset is provided as collateral.
Loan-to-value varies based on the asset and the lender: In general, you can expect an 80% LTV on real estate, 50% LTV on inventory, and 70% on accounts receivable.
Asset appraisal: The lender will likely conduct an on-site appraisal to determine the value of physical assets. It can take several weeks for this process to unfold.
Reporting requirements: Most lenders will require a regular update on the collateral for the duration of your loan.
Examples of Secured Business Loans
So, you know how to get a secured loan. But what are some common examples of secured business loans? Here’s a closer look.
Mortgages: Let’s say that your business needs a physical space to operate within. A mortgage uses the property as collateral to secure the loan.
Construction loans: Do you own land or a building that needs improvements? The existing asset can serve as collateral for the loan required to undergo construction.
Auto loans: When you take out an auto loan for a company car, the vehicle will serve as collateral for the loan.
Home equity line of credit (HELOC): If you have built significant equity in your home, you can tap into that value through a HELOC. The home will serve as collateral for the new loan.
Examples of Collateral for a Secured Business Loan
The type of assets you can use will vary based on the lender. But here are some common examples of collateral used for business loans.
Real estate: Houses, land, and offices.
Valuable personal property: Cars, jewelry, collections, and other sizeable assets.
Financial property: Stocks, bonds, CDs, and cash in a savings account.
In general, lenders prefer assets with high liquidity. In other words, assets that can be easily converted into cash.
Pros and Cons of Secured Business Loans
Before jumping into a secured business loan, here are some advantages and disadvantages to consider.
Starting with the pros:
Lower interest rates: Collateral lowers the risk for lenders, which translates into lower interest rates.
Bigger loan amounts: The size of your asset can lead to higher loan amounts.
Longer repayment periods: You’ll often find longer loan terms with secured loans.
Poor credit isn’t a dealbreaker: The lender will focus on your asset’s value, not your credit score.
Now for the cons:
Potential loss of assets: If you use collateral to get a loan, you’ll lose the asset if you default on the loan.
Credit costs: These loans are reported on your business credit history. So, missed payments can negatively impact your score.
What Is an Unsecured Business Loan?
A secured business loan isn’t your only option. If you want to learn how to get a business loan without security, then an unsecured loan is a solution.
No collateral required: The major difference between an unsecured business loan is that collateral isn’t required.
Personal guarantees common: Many lenders will require a personal guarantee from the business owner for these types of loans.
Examples of Unsecured Business Loans
Here’s where you might encounter unsecured business loans:
Credit cards: If you don’t have to make a deposit, that’s an unsecured card.
Signature loans: In this case, the lender would make a loan decision based on your income and credit history.
Student loans: Student loans are unsecured because you don’t need any assets to obtain this loan.
Pros and Cons of Unsecured Business Loans
An unsecured business loan offers perks and drawbacks to consider.
Let’s start with the pros:
No collateral: You won’t need any existing assets or be purchasing a major asset to use as collateral.
No risk of losing collateral: A truly unsecured loan will come without risk of losing any particular asset.
Streamlined lending for small amounts: As a borrower, you can quickly obtain this type of funding.
But there are also cons to keep in mind:
Personal guarantee: Most lenders require a personal guarantee, which means that you are personally on the hook if your business defaults.
High interest rates: Without collateral, the lender is taking on more risk, which leads to higher interest rates.
Smaller loan amounts: Typically, you’ll find smaller loan limits for unsecured loans.
Shorter repayment terms: Most lenders require repayment within a shorter window.
Kinds of Financing
Secured loans and unsecured loans are broad categories for loan types. But there are many options for business owners to consider.
Small Business Administration (SBA) loans: The SBA backs loans to small business owners. You’ll need to have collateral if you are seeking a loan over $25,000.
Traditional bank loan: Most banks require collateral for small business loans.
Microloan: Microloans offer loan amounts from $500 to $50,000. But the average loan amount is $13,000.
Equipment loans: Suppliers often offer financing options for specific pieces of equipment.
Merchant Cash Advance: A merchant cash advance provides a loan based on your projected cash flow.
Inventory financing: With inventory financing, the inventory purchased will be the collateral for the loan.
Business line of credit: A business line of credit comes with a predetermined amount of money that you can borrow as needed.
Online lenders: You’ll find a wide range of financing options through online lenders. Quick approvals can get you the funding you need now.
Is the Application Process the Same for Secured and Unsecured Loans?
The application process for secured and unsecured loans has some differences.
Fill out an application: You’ll need to fill out an application for either type of loan.
Submit to an appraisal: If pursuing a secured loan, the lender will appraise your asset. In some cases, this requires a physical visit.
Reporting requirements: Once you have the loan, a secured loan may require regular reports on the collateral asset. But an unsecured loan won’t have this paperwork burden.
Things to Consider Before Applying for a Loan
Before you jump into any loan option, weigh out all of the factors.
Loan purpose: What do you plan to use the funds for. If you want to obtain an expensive piece of equipment or property, then a secured loan could unlock lower rates. But if you are upgrading technology or spending on market research, then an unsecured loan offers you the freedom to spend with fewer strings attached.
Amount of funds: Determine exactly how much you need for the next phase of your business. Asking for too much or too little could lead to problems.
Find the right lender: Not all lenders are created equally. Consider banks, non-banks, online lenders, and crowdsourcing options.
Gather your paperwork: When filling out an application, having all of your ducks in a row is critical.
What Do Lenders Look For?
When a lender is evaluating your loan application, here’s what they’ll look for.
Time in business: A longer term indicates more stability.
Credit scores: A high business and personal credit score unlock more opportunities.
Cash flow: Can your business support the loan payment?
Collateral: If applying for a secured loan, this is the most important part. Lenders will carefully appraise your assets.
Industry: Is the industry growing? If not, that could be a red flag.
The 5 Cs of Creditworthiness
Creditworthiness isn’t just defined by a credit score. Let’s explore the 5 Cs of creditworthiness.
Character: The business owner’s reputation matters. A strong personal credit score is also important.
Capacity: The cash flow of your business will determine your capacity to take on a loan.
Capital: Is the business owner personally invested in the business? If so, that’s a good sign.
Collateral: Does the business have assets to offer as security? High value assets will be a boost to your application.
Conditions: Do the market conditions suggest that your business will thrive? If not, the lender will be wary of moving forward.
Conclusion
When deciding between a secured business loan and an unsecured business loan, the details of your business matter. Asset-based lending can offer more affordable financing opportunities for some. But an unsecured loan is a better fit for those looking for the flexibility to spend the money as they see fit.
Before applying for a loan, explore the best small business loans available.