Should You Get an Unsecured Business Loan for Your Small Business?

What is an unsecured business loan?

When choosing a small business loan, your options may include secured and unsecured offerings. An unsecured business loan doesn’t require the borrower to provide business collateral against their borrowing amount. The lender doesn’t have an asset they can seize, such as a house or car, if you stop making payments. 

Jeff Fazio, business solutions analyst lead, RSA Archer at AmerisourceBergen, describes unsecured loans as backed only by the borrower’s creditworthiness. “Small businesses typically seek an unsecured loan when they either cannot qualify for a traditional loan or can’t negotiate better repayment terms with another lender,” Fazio explained. “The personal guarantee terms that are outlined within unsecured loans can be very generous for borrowers, but any default can have long-term ramifications that outweigh benefits, like negative effects to your business’s credit score.”

What are the benefits of unsecured business loans?

In some circumstances, an unsecured business loan can be just what your business needs. Unsecured loans offer the following benefits:

• Unsecured business loans don’t require collateral. Lenders typically ask borrowers to put up real estate, vehicles, or intangible assets like investment portfolios and business trademarks to back their loans. However, offering collateral may not be the best decision for you. For example, you may not want to attach your mortgage as collateral, knowing that if things go wrong, the lender can foreclose. Or your assets may already be committed as collateral to the maximum amount. An unsecured loan is only backed by your good creditworthiness, so no collateral is involved.
• You may receive your money faster with an unsecured loan. The lender doesn’t have to appraise assets with an unsecured loan, so the loan process may take less time. Some unsecured loans are approved and funded within 24 hours.
• Unsecured loans may be discharged in bankruptcy. If you file for bankruptcy, the unsecured loans may qualify for discharge. (Bankruptcy laws vary by state, so check the rules in your area.) In contrast, with secured loans, you may forfeit all assets you used to secure the loan.

What are the risks of unsecured small business loans?

An unsecured loan may seem like a fast cash flow strategy. However, unsecured business loans present the following risks and costs:  

• You may not be able to get an unsecured loan. Many local banks don’t offer unsecured loans. Lenders offering unsecured business loans expect solid credit scores, verifiable income, and a financial history showing you can repay the loan.
• Interest rates are higher with unsecured loans. The higher the risk lenders take, the higher the interest rate they charge. “Given a lender takes more of the risk involved in granting the unsecured loan, interest rates are high for borrowers,” Fazio noted. Interest rates on unsecured loans range from slightly higher than those on secured loans to rates so high it’s difficult to ever pay the loan back. “With unsecured business loans, we often find the borrower might default and not have the means to repay the loan,” Fazio warned.
• Unsecured loans tend to have shorter terms. Unsecured loans tend to be shorter-term and lead to a cycle of borrowing. Another way lenders alleviate their risk with unsecured loans is to expect repayment in a shorter period. If you don’t solve your cash flow problems, you may find yourself seeking another loan – and another – leading to an expensive cycle of borrowing and debt.
• Unsecured loans. You may not be able to borrow as much as you need with an unsecured business loan. Unsecured loans are often for smaller amounts. For example, you won’t get as large a loan as you would by taking out a home equity loan on your house.
• You can still lose your assets if you default on an unsecured loan. When you sign your personal guarantee for a loan, lenders can ultimately sue you if you don’t make your payments. If you default on the loan, it may take them longer to seize assets than with a secured loan, but don’t assume your assets are safe. Your business’s bank accounts can be garnished, and liens can be placed on your business’s assets – and all that can happen in months.

How do you choose a lender for an unsecured loan?

Here are some tips for choosing a lender for an unsecured loan: 

• Be wary of offers that are too good to be true. If you type “unsecured loan” in a search engine, you’ll find dozens of online lenders offering unsecured loans. However, be wary of online offers touting that anyone can qualify for a loan or advertising low teaser rates that may never materialize. Like any other financial institution, an unsecured loan lender should be an established business with a solid reputation. It shouldn’t make promises it can’t keep.
• Watch for predatory loans. Be especially wary of unsecured loans from payday lenders or businesses that target financially desperate people with low credit scores. One sign of a payday lender is that they may advertise “no credit check.” These businesses are known for offering easy cash at sky-high interest rates – up to 400 percent APR – for extremely short periods. If you need a payday loan, you can’t afford one. 
• Approach your bank or credit union. It’s worth asking your bank or credit union if they offer unsecured loans. However, traditional lenders rarely approve unsecured loans, according to Fazio. In fact, most of those kinds of lending agreements are approved by alternative lenders, which are typically financial technology firms. They operate online and can quickly determine if you qualify for a loan.

How can I qualify for an unsecured business loan?

Because of the high-risk nature of unsecured business loans, the qualifying bar tends to be set much higher. Consider the following unsecured business loan qualifications:

• Demonstrate a good credit history. To qualify for an unsecured business loan, Fazio says, your small business should be able to “show the lender a good credit rating, a solid financial history, and a cash flow forecast.” In other words, you must demonstrate a history of borrowing money and paying it back. You must also show the financial ability to repay the loan, generally from business income.
• Have a good credit score. While there’s no absolute minimum credit score you need to qualify, a lower credit score tells the lender that you may have a harder time paying back the loan. Save time by asking prospective lenders if they have a minimum credit score before you apply.

Understand the benefits and risks of unsecured business loans 

As a savvy business owner, you might balance the pros and cons of unsecured loans and decide it’s just what your business needs. If you shop around for the best terms and use the proceeds wisely, it may be to your advantage. 

On the other hand, if you can only qualify for an unsecured loan with very high interest rates and fees, or if you have any doubts about whether you can pay back the loan, look for other ways to keep your business going. It’s never a good idea to take on debt that could leave you in worse financial straits than before.

Andrew Martins contributed to this article source interviews were conducted for a previous version of this article.