If you’re a business owner, you probably understand the importance of the right amount of funding at the right time. The funds may be needed to meet some sudden expenditure, for starting a new project, for hiring more labour, or for buying new equipment. And shelling out money from your savings is not really a wise idea.
Other options include borrowing from friends or family, getting a cash advance against credit card, or availing a traditional business loan from a financial institution. Now of course, the most preferred option is a business loan. And when it comes to business loans, you need to pick from two kinds- secured and unsecured business loans.
Understanding Secured and Unsecured Business Loans
A secured business loan, as the name suggests, requires the borrower to pledge an asset (generally an equipment or real estate) as collateral. The risk to the lender in this case is significantly less, because in case of default, the lender can use the asset to recover the loan value.
Unsecured loans, on the other hand, do not require you to pledge any collateral, and involve a high degree of risk to the lender.
Hence, lenders are a little picky when it comes to offering unsecured loans, and only offer such loans to those who have excellent credit scores and clean credit histories with a strong sales forecast. They want to be absolutely sure about the borrower’s repayment capability. These loans, therefore, command a slightly higher rate of interest than secured loans.
Both secured and unsecured loans fulfill business requirements. However, the terms of the loans are usually different and can have long-term implications for the financial health of your business. Therefore, one has to choose wisely, keeping their distinct business needs in mind.
Pros and Cons of Secured Loans
• It is easy to get a secured loan because the lender has to bear less risk.
• The interest rate is usually low, which means low EMI and easy repayment.
• You can get a secured loan even with a not-so-good credit score.
• Your business and personal assets are on the line and you may lose them if you default. This means, suffering a loss in your business can make you lose your home and other personal assets too.
• A lot of documentation is involved and approval may take more time because you need to provide additional documents for the collateral and lenders take time to assess the value of the property before deciding on the amount of loan to offer.
Pros and Cons of Unsecured Business Loans
• Even if you default, your personal and business assets are not at risk.
• Unsecured loans can be availed online from a number of financial institutions that facilitate quick and hassle-free processing and instant approvals.
• No lengthy documentation is involved. All you need to provide are KYC documents, financial statements of your business, and your business registration papers, to confirm its existence.
• The loan can be used for any purpose, be it for buying new equipment, funding your operational expenditure or handling a sudden crisis.
• The rate of interest is higher compared to secured loans, which means that you’ll end up paying heavily towards interest costs, in case the tenure is long.
• It is not easy to get unsecured loans as lenders want to be absolutely certain about your repayment capacity, and may demand a very high credit score with clean credit history.
• An unsecured loan, especially with a exchequer credit history, can sink you further in debt and ruin your chances of getting a loan in the future.
The comparison between secured and unsecured business loans shows that the key difference between the two is the collateral aspect. A secured loan is backed by collateral whereas an unsecured loan isn’t. Secured loan takes longer to process because it involves assessing the value of the collateral and only then the loan amount can be finalized. Unsecured loans on the other hand, have no such formality, and therefore, the process is a lot faster.
Therefore, if the requirement is an urgent one, it makes sense to go for unsecured business loans with a shorter tenure, so that you can pay it off quickly and become debt-free. Secured loans are best for established businesses with a lot of assets and those that need long term funding. This way, they can benefit from low interest rates and low monthly payments.
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All in all, like most other things in life, there are two sides to the coin of business loan. While unsecured loans are a good option for small businesses, they may not be that suitable for big businesses with long-term requirements. The best option for you depends on your requirement and circumstances. So, assess your financial condition, evaluate your requirements, and then take an informed decision, so you can benefit in the long run.