When you borrow money from a lender, they’ll understandably want some assurance that it will be paid back. Because even though borrowers have the best intentions, there’s always the risk that the business will struggle and the borrower will default.
With a secured loan, the borrower offers up collateral as a guarantee that the lender will not be left high and dry if the payments aren’t made. Common forms of collateral include boats, trucks, machinery, homes, cabins, real estate, or accounts receivable.
In many cases, the lender will seek collateral of equal value to the loan amount. Other times, they’ll require the collateral to have a higher value because it’s not always easy for a lender to convert collateral to cash.
For example, let’s say you used your potato farm in Idaho as collateral on a small business loan. Unforeseen challenges then arise, and you sadly are forced to default on the loan. After working to find a solution, it becomes clear that you’ll never be able to repay the loan and the lender takes possession of your farm. At this point, they would have their work cut out for them. First, they’d need to hire a real estate agent to list the farm. Then they’d have to wait for the farm to sell, assuming potatoes were a hot commodity at the time, before they’d see a dime.
While secured loans provide a safety net for lenders, they’re mutually beneficial. When you secure a loan with collateral and lower the risk for a lender, you’ll be rewarded with lower interest rates, higher loan amounts, and more favorable repayment terms. These 3 factors can easily save you thousands of dollars over the lifetime of a loan.
Nonetheless, some people understandably bristle at the idea of offering up their personal property as collateral. After all, your grandpa gave you that potato farm in Idaho, and he never intended for it to be handed over to a stranger.
If your business has been around for at least a couple of years and is bringing in more than $100,000 annually, you may qualify for an unsecured loan. Beyond the business’s finances, the lender will look closely at your savings, credit history, and other factors to decide whether or not to approve the loan.
If you are approved for an unsecured loan, you’ll find that the amounts rarely exceed $50,000. This smaller amount is to protect the lender. Likewise, the interest rate and repayment terms will be less favorable.
But there’s also some good news. Because of the limited nature of unsecured loans, the application process is much more streamlined and you’ll usually get your money faster.
It should be noted that unsecured loans don’t necessarily insulate you personally in the case of a default. A lender may still require a personal guarantee, meaning that if your business can’t fulfill its obligations, you will be on the hook for it.