Secured vs. Unsecured Loan: Pros & Cons of Each

Ashley KilroyUpdated August 4, 2021

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Owning a business can often be expensive. From raising capital to build inventory to finding funds to cover legal fees, owning a business involves a lot of financial responsibilities. In some cases, you may not have the funds on hand to meet an immediate financial need. That’s where applying for a business loan could be an option. But it’s important to understand that there are different types of loans to suit various needs. A significant factor that you should be aware of is whether a loan is secured or unsecured. To determine which option might work best for you and your small business, consider the key differences between secured versus unsecured loans.

What is a Secured Loan?

When you take out a secured business loan, you provide your lender with some form of collateral as security for your funding. Although the exact form of the collateral may vary, you might be asked to use specific asset types like property or business equipment. Having these assets as collateral helps reduce the lender’s risk of loss. If you default on the loan, your lender can take possession of the collateral to compensate for the unpaid money.Potential borrowers with bad credit or new businesses that need to build credit may find it easier to obtain a secured loan than an unsecured one. Banks typically prefer secured loans since they’re safer for the lender and they can fit the loan amount to the collateral value.There are loans that may or may not be secured and some funding that is always secured. Some examples of loan types that can be secured include:

Term loans (sometimes secured)
SBA loans (sometimes secured)
Equipment financing (secured by the equipment)
Invoice financing (secured by the invoices)
Inventory financing (secured by the inventory)

Pros and Cons of a Secured Loan

The very thing that makes a secured loan beneficial can also hurt you in the long run. By agreeing to back your loan with certain assets, you will probably be offered better loan terms. But you also run the risk of losing your valuables. Here are some of the main pros and cons to a secured business loan:Pros of secured business financing include:

Easier approval: Since the lender knows a failsafe is in place if you default on your payment, it isn’t as hard to get approval as it would be for an unsecured loan. Even if you have bad credit, many lenders may be willing to offer a secured loan to you since they can sell your assets to recoup any loss.
Better terms: The lower the risk of loss is, the more favorable the offer is likely to be. If you have a positive credit history, valuable assets to offer, and a steady stream of income, you’ll probably be able to shop around for the loan with the best terms, which may include low interest rates and longer repayment periods.
A larger amount: Typically, you can get a secured loan for more money than you can get with an unsecured loan. The amount you can borrow may increase with the collateral you offer.
Available if you have poor credit: Obtaining an unsecured loan with poor credit can be very difficult. However, secured loans come with collateral that can help counteract the lender’s risk. That’s why lenders are often more willing to give you a secured loan. Plus, taking out a secured loan and paying it back responsibly gives you the chance to build your credit.

Cons of secured business financing include:

Value shifting: The assets you agreed on may lose value over time. If that’s the case, your lender may require you to pledge additional assets to make up for the difference to keep the loan. Similarly, if you default and your lender sells the assets and the proceeds are less than what you owe, you’ll have to pay the difference.
Risk of losing collateral: Possibly the most significant downside to a secured loan is that you could lose the asset you pledged. In some situations, you could lose equity you’ve built up in that property.

What is an Unsecured Loan?

Of course, a business owner might not have the collateral a secured loan requires, though. If that’s your situation, you can apply for an unsecured small business loan. In this case, the bank or lender will rely on your credit history, meaning that it’s likely to accept only trustworthy applicants. The lender might still ask you for a personal guarantee (a written promise to pay back the loan yourself if your business cannot). Depending on your agreement, if your business defaults, the lender may still be able to seize your personal assets as compensation or take legal action. At the very least, your credit will probably be damaged. Any dent in your credit history could affect your ability to borrow funds down the road.Since an unsecured loan comes with greater risk to the lender, interest rates are usually higher than those you’d see with a secured business loan.Many kinds of loans can be unsecured. A few types that are often unsecured include:

Business credit cards
Business lines of credit
Construction loans

Pros and Cons of Unsecured Business Loans

Unsecured loans don’t require you to pledge your assets. However, they do have their drawbacks. Here are a few pros and cons to help you decide if an unsecured business loan suits you and your business needs.Pros of unsecured business financing include:

Fast funding: Typically, the applicant doesn’t have to go through the same vetting process that a secured business loan requires since there’s no collateral to assess. Therefore, you may be approved for financing more quickly.
Fewer limits on use: Unsecured business loans may come with more lenient rules about how you’re able to use the funds.
Safeguards assets: Even if you default, as long as the lender doesn’t have a court order, it can’t seize your business or personal property.

Cons of unsecured business financing include:

Higher interest rates: The risk in issuing an unsecured loan is higher for your lender, so the loan will usually come with a higher interest rate than a secured loan does.
May require personal assurance: Again, depending on the lender, you may have to provide a personal guarantee in case your business goes into bankruptcy. That can endanger your personal assets, even if they weren’t agreed on as collateral, since you’re personally responsible for paying back the loan.
A smaller amount: Due to the risk, lenders may not offer as much money as they might for secured loans.
Stricter approval requirements: These loans typically have more stringent eligibility requirements than secured loans since lenders want to minimize risk. Potential lenders may look at things like your business’s financial history and revenue.

Secured Versus Unsecured Loan: Key Differences

When you're comparing these two loan options the key variance is the collateral requirement for a secured business loan. However, that’s not the only factor that differentiates the two. Consider these other differences to figure out which loan type might better match your needs.Unsecured loans:

The loans don’t require collateral, although you may need to provide a personal guarantee.
The loan’s approval, conditions, and amount are determined based on the applicant’s creditworthiness.
The loans tend to come with shorter repayment terms and higher interest rates to mitigate risk.

Secured loans:

They do require collateral, which can include business or personal assets.
The loan’s amount is based on the offered collateral’s value.
They tend to have longer repayment terms and lower interest rates since the collateral reduces the risk to the lender.

When you look at a secured versus unsecured loan, most of the differences result from the higher risk that unsecured loans present for the lender. Thus unsecured loans come at a higher cost and with less favorable terms, and have stricter requirements for the borrower to help counteract that risk

Secured vs. Unsecured Loan: Which One Is Right For You?

Every business owner’s circumstance is different, so the answer depends on your individual situation. However, there are factors you can take into account to help you figure out which loan is right for you.For starters, determine your business's financial standing to identify what options you’re likely to have with financing. In particular, think about your credit history. If you’ve got a poor credit rating or no credit history, you may want to go the secured loan route since there are fewer approval requirements.Keep in mind that even if your credit isn’t great, you can still get start-up business loans with bad credit and no collateral, although that might involve a complex approval process. It may also help if you include your projected cash flow and how you intend to use the funds with your application.There are other ways to determine whether an unsecured or a secured loan would benefit you, beyond just eligibility. If you require a short-term loan and don’t have assets to offer as collateral (or if you want to avoid doing that), unsecured loans may be the right choice. In contrast, secured loans may provide financing at lower interest rates with longer repayment timelines. However, they do come at the cost of risking your assets if you go into bankruptcy. So how comfortable you are with risk can also be a factor that plays into your decision.

The Takeaway

Both secured and unsecured business loans provide financial funding that can help small businesses keep moving along. And while secure loans may transfer more risk to the borrower, if your business is successful and you manage your funds responsibly, you should be able to retain your collateral as well as build better credit for the future.Lantern Credit can make sifting through your business loan options easier. Whether you’re interested in obtaining SBA loans or online business loans or still debating on secured versus unsecured loans, you can fill out one simple form and get a range of financial solutions from our lending providers to compare right at your fingertips.

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About the Author

Ashley Kilroy

Ashley Kilroy is a personal finance expert with years of experience in radio, newspapers, magazines, and online content. Her work has appeared on websites including Forbes and Yahoo Finance. Ashley writes on a variety of personal finance topics for SoFi, including student loans, taxes, and insurance.

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