What is an unsecured loan?

There are 2 possible outcomes when you borrow money from a lender. Either you will fulfill your obligation and pay back the loan, or you’ll default and not pay it back.

Lenders obviously prefer the former option, but they also want to protect themselves in case the latter occurs. They usually do this by “securing” the loan with collateral, which might include your house, vehicles, or real estate. This provision means that if you’re unable to repay the loan, the lender will take possession of the chosen collateral as compensation.

So what is an unsecured loan? It’s a loan that doesn’t require you to put up any collateral. The risk is much higher for the lender in this scenario, as there might not be a form of compensation in place should you default.

Qualifying for unsecured business loans is understandably difficult. Lenders will evaluate your credit history, income, savings, and employment history to make sure you’re a reasonably safe bet. Established companies are more likely to get the green light, as their track record can demonstrate a sustained ability to perform well financially. You usually need to have been in business for at least 2 years and bring in at least $100,000 a year to be in the running.

Even if you’re approved, an unsecured loan will rarely exceed $50,000. This moderate dollar amount helps to mitigate the risk for a lender. Additionally, the lender may require you to personally guarantee the loan, meaning you’d be responsible for the debt if your business were to default.

If you like the idea of an unsecured loan but don’t know if it’s a good fit for your situation, you may want to consider an unsecured business line of credit.

“An unsecured business line of credit is a great option if your business needs access to cash on demand,” says SBA.gov. “Business owners want access to funds—whenever they need it, at a competitive rate, and with flexible payment options. The National Federation of Independent Businesses says, ‘Think of it as an insurance policy that never needs to be paid until you need it.’”

Ultimately, it’s important to know the advantages and disadvantages associated with an unsecured loan. The obvious benefit is that it allows you to borrow money without putting your personal property at risk. This is particularly helpful if you lack the kind of property that could serve as collateral.

Additionally, unsecured loans can provide faster funding. Typically, the application process moves faster, which reduces the amount of time you need to wait for your funds.

On the flipside, unsecured loans are more difficult to qualify for. If you haven’t been in business for very long, it’s unlikely they are a viable option for you. And because the risks are higher for lenders, they will usually set the loan amounts lower, while also adding higher interest rates and shorter repayment terms.