One of the biggest decisions a business has to make when seeking finance is whether to choose a unsecured or a secured business loan. In simple terms, secured business loans are taken out against agreed collateral, with the lender holding a legal charge or debenture on a specific asset.
Should the loan not be repaid, the lender can then legally seize the asset in lieu of payment. In contrast, an unsecured loan does not involve a formal charge over any asset.
So which type of loan is likely to work best for your business? It’s fair to say that both have their advantages and drawbacks.
The main advantage of unsecured lending is that if your business struggles to keep up with repayments it is much harder for the lender to seize your assets. In the first instance, the lender would normally report the default to all the credit reporting bureaux, whilst remaining in contact to negotiate a repayment plan.
However, if the lender suspects the loan was taken out fraudulently, then a more vigorous approach can be taken to collection.
The main disadvantage, hardly surprisingly, is that lenders set more demanding criteria for unsecured business loans. Since the loan is effectively riskier, lenders will generally wish to see a strong and stable trading history before making an agreement.
Their decision will also be based on the reason for borrowing and they will often refuse to offer unsecured finance for debt consolidation, as this can indicate that a business is already financially stressed.
In some cases, the lender may only agree to an arrangement if the directors offer a personal guarantee. This means that if the business is in default, the lender can pursue the directors as individuals, placing their personal assets at risk. In this way, unsecured borrowing can actually be riskier than secured loans.
The biggest drawback of a secured business loan is fairly obvious: if you cannot keep up repayments, you can lose the asset used as security. However, there are also several key advantages to this type of borrowing.
First, the interest rate is likely to be lower due to the reduced risk. With an unsecured loan, the lender will factor the cost of defaults into the interest rate, meaning that responsible borrowers are effectively subsidising their less reliable counterparts.
Choose to take a secured business loan and you can make substantial savings over the life of the arrangement.
This brings us onto the second advantage: the loan term. Take a secured loan and you can generally negotiate a longer repayment period – sometimes several years longer.
Since there will be collateral to back the loan, the lender will be less anxious about securing repayment, giving you a higher level of flexibility and lower monthly outgoings.
In fact, factoring in both a longer term and a lower interest rate, monthly repayments can be vastly lower with a secured business loan. A lower monthly cost will increase your financial flexibility in other areas, which can prove extremely useful if you are adhering to a tight budget or dealing with an unexpected downturn in your cash flow.
Finally, you will be able to borrow a lot more if you choose the secured route. Unsecured business loans are based purely on your reputation and your credit score, and lenders are more sensitive to the risk of default.
With a secured business loan, you can borrow a substantial proportion of the value of your collateral, as lenders are confident that they can get their money back even if you run into financial difficulties and default.
Whilst secured and unsecured loans both have their benefits and drawbacks, secured lending is often the better choice for longer and larger loans.
You will be able to borrow more, over a longer period, at a more competitive interest rate, and lenders will place less emphasis on your trading history and cash flow, making you more likely to be accepted. Equally importantly, you are much less likely to be asked to provide a personal guarantee if you choose the secured route.
Every business has its own needs, and unsecured loans can be a useful weapon in a business’s financial armoury, but in most cases a secured business loan will offer more flexibility and significantly better value for money.