The Pros and Cons of an Unsecured Business Loan

The Pros and Cons of an Unsecured Business Loan

Starting or growing a business can be expensive, and finding financing may be necessary in order to survive the ups and downs. While searching for financing options, an option you may have encountered is an unsecured business loan.

So what exactly are unsecured loans? And are they a good fit for your business? Let’s take a look at the pros and cons of unsecured business loans and explore some financing alternatives.

Is a Small Business Loan Secured or Unsecured?

Small business loans can be secured or unsecured. Both types are common choices for small business owners who need financing. Choosing the right type of loan for your business depends on several factors, including your collateral.

Collateral is an asset, such as real estate or equipment, that a lender can take possession of if the borrower fails to make payments. An unsecured funding source may be a good option for small business owners without assets, because they don’t require the borrower to put up any collateral to secure the loan.

An unsecured loan is difficult to obtain because it isn’t secured with collateral — which means the lender takes on more risk if the borrower defaults on the loan.

Pros and Cons of Unsecured Business Loans

If you’re a small business owner looking for start-up loans without collateral or substantial revenue, an unsecured business loan may be a good option. We recommend working with a financial professional to determine the best loans and financing options for your business. For basic research purposes, here are a few pros and cons of unsecured business loans to help you get started.

Pro: No collateral required.

One of the biggest advantages of unsecured working capital loans is that you don’t need upfront collateral. This means you can access funding even if you don’t have valuable business assets. And you won’t have to put up your house, car, or other personal property as collateral.

Pro: Faster approval and funding.

A small business owner in need of an instant business loan — or one with a relatively quick turnaround — will appreciate this advantage: unsecured business loans are generally quicker to be approved and disbursed than secured loans. With no need for a collateral appraisal, the application and evaluation process is expedited, so you get the funds quicker.

Pro: Lower risk for the borrower.

With unsecured business loans, the lender assumes the risk of default. So if you can’t make loan payments, your business assets won’t be seized. While this does not absolve you of your responsibility to repay the loan, it does provide a bit of cushioning in the event of financial hardship.

Pro: The loan may be discharged in bankruptcy.

According to the Bureau of Labor Statistics, 50% of small businesses fail within their first five years. It’s often because the business runs out of money and can’t secure more. While bankruptcy laws vary by state, unsecured business loans may qualify for discharge, meaning the lender cannot attempt to collect the debt.

Con: Higher interest rates.

While it’s a big plus that these loans don’t require collateral, there’s often a downside. Because lenders assume a higher risk, they usually charge higher interest rates than secured business loans. This means you’ll likely pay more in interest over the life of the loan.

Con: Strict eligibility requirements.

An unsecured loan is difficult to obtain because it comes with strict eligibility requirements. Without collateral, it may be challenging to qualify, and the amount you can borrow may be insufficient for your business needs.

Con: Approval and funding may take longer.

While the approval window is often relatively quick due to the lack of collateral to appraise, it doesn’t mean there’s no waiting involved. If you apply for an unsecured loan from a traditional bank or credit union, the approval process could take several days, and it might be a week or even longer until you receive the funds.

That said, some online lenders have made the instant business loan possible by offering funding to business owners within hours.

Con: The loan may require a personal guarantee.

Lenders who offer unsecured business loans may request a personal guarantee. This legally-binding contract gives lenders an added layer of protection if you don’t make your loan payments. What happens if you default on an unsecured business loan? If you default on a loan with a personal guarantee, the lender could take you to court.

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5 Alternatives to Unsecured Business Loans

If you’ve determined that an unsecured business loan is not the best option for your small business, don’t worry. There are other ways to get funding. Take a look at these five alternatives to unsecured business loans.

1. Small business grants.

One plus with small business grants is that they don’t need to be repaid. The downside is that there’s a lot of competition for grants. Check out our guide to getting a small business grant to learn how to find the right grants and make your application stand out.

2. SBA 7(a) loan.

The SBA 7(a) loan program offers long repayment terms of up to ten years and low interest rates, making these loans a solid alternative to unsecured business loans. We’ve broken down the requirements and application process here.

3. Bad credit business loans.

If your credit score is less than stellar, you may still be able to secure financing through a bad credit business loan. These loans are designed specifically for businesses with poor credit ratings. Similarly, EIN-only loans don’t consider or factor in personal credit history, making them desirable for business owners who want to separate personal and business finances.

4. Small business crowdfunding.

Crowdfunding campaigns involve reaching out to others, typically through social media or crowdfunding platforms, to help fund your business efforts. Our guide to small business crowdfunding has tips to help you get started.

5. A secured business credit card.

If you can’t get approved for an unsecured or instant business loan, a secured business credit card may be an option to help you build credit. With a secured credit card, you put down a cash deposit, which becomes your credit limit. Sometimes your lender may increase your line of credit, giving you more access to funding.

Weighing the Pros and Cons

An unsecured business loan can be a lifeline for small business owners, but there are advantages and disadvantages. It’s best to carefully evaluate all your options so you can make the right financing decision for your business.

Susan Hamilton

I’ve always loved to write and have been lucky enough to make a career out of it. After many years in the corporate advertising world, I’m now a freelance writer—running my own show and contributing to Simply Business. Fun fact: I have three desks in my house, but I still do my best thinking walking in the woods.

Susan writes on a number of topics such as workplace safety, customer sales, and workers’ compensation insurance.