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If you need more working capital to grow your business, a secured business line of credit could be a good solution. Because it's backed by collateral, such as real estate or business equipment, a secured business line of credit can be easier to qualify for, and may offer better rates and terms than other, unsecured forms of business financing. Here’s a closer look at how secured business lines of credit work, their pros and cons, how they compare to secured business lines of credit, and how to go about getting one.
What Is a Secured Business Line of Credit?
A secured business line of credit is a flexible financing option that allows a business to borrow money when it needs it (up to a certain limit) and only pay interest on the amount they withdraw. Once you pay back the funds you’ve taken out, the full amount becomes available again.Unlike an unsecured business line of credit, a secured credit line requires putting up collateral. This is an asset of value (such as equipment, real estate, or intellectual property) that, should you become unable to repay the loan, the lender can seize and sell to recoup its losses.
How Do Secured Business Lines of Credit Work?
A secured business line of credit works in a similar way to a credit card. You get a credit limit for your business to tap into whenever you want or need the money. You only pay interest on the funds you draw, and once you repay them, your line of credit gets renewed to its original amount. A secured business line of credit is not available forever, however. Typically, you have to renew the credit line semi-annually or annually to get it extended.With a secured business line of credit, you must put a business asset on the line. Because this lowers the risk for the lender, secured lines of credit often come with favorable rates and terms. However, if you default on the loan, you risk losing that asset.
Pros and Cons of Secured Business Lines of Credit
A secured business line of credit has several advantages, but there are some disadvantages to keep in mind as well.
Pros
Cons
Only pay interest on your daily balance
Can lose your collateral if you cannot repay what you borrow
Can serve as an emergency fund
If you pay late or exceed your credit limit, you can get hit with high fees
Lower interest rate due to the collateral
By offering cash on demand, there is the potential for misuse
Unsecured vs Secured Business Lines of Credit
While unsecured and secured business lines of credit function in very similar ways, there are some key differences. Here’s a look at how they compare.
Unsecured
Secured
Risk to lender
Higher
Lower
Collateral required?
No
Yes
Credit limits
Typically lower
Typically higher
Interest rates
Typically higher
Typically lower
What Can Be Used to Secure a Business Line of Credit?
There are several types of assets you can use as collateral to secure a business line of credit. All the following items give reassurance to the lender that they will be repaid in some fashion, even if you default.
Real Estate
Real estate is one of the most common types of collateral used to secure a business line of credit. The reason is that property tends to have a lot of value and also hold its value over time. You can use any type of real estate that you or your business owns. However, you may want to think twice before using your primary residence as collateral for a business line of credit. Should you run into trouble repaying the debt, you could lose your home.
Cash
Cash savings in a bank account is a liquid asset, meaning it’s readily available. If you put cash up as collateral, a lender will feel confident that they won’t experience significant loss should you end up defaulting.
Equipment
Equipment or machinery owned by your business can also be used to secure a business line of credit, since these assets tend to be high in value. However, they also tend to lose value over time due to wear and tear. As a result you may not be able to get a high line of credit with equipment as your collateral.
Intellectual Property
Intellectual property, like trademarks, patents or copyrights, can have significant value. As a result, a lender will often accept this type of intangible asset as collateral for a business line of credit.
Inventory
You may be able to use your company’s inventory as collateral for a secured business line of credit. However, it may require an appraisal in order to be accepted by the lender.
Alternatives to Secured Business Lines of Credit
A secured business line of credit can be a great way to even out gaps in your cash flow or buoy your finances through an emergency. However, a credit line isn’t your only business financing option. Here are some others you may want to consider.
Business Loans
Unlike a business line of credit, a business loan provides you with a lump sum of capital that you pay back (plus interest) in regular installments. (One exception is a delayed draw term loan, which allows you to withdraw predefined amounts of a total pre-approved loan amount.) Business loans can be secured or unsecured, and may require making a down payment. A loan can be a good choice when you need financing for a specific project or major acquisition or investment that will help grow your business. Recommended: Business Line of Credit vs Business Loan
Merchant Cash Advances
With a merchant cash advance (MCA), a lender gives you an upfront sum of cash that you repay using a percentage of your debit and credit card sales, plus a fee. An MCA can come in handy if you’re in a pinch and need capital to cover a cash-flow shortage or short-term expense. However, MCAs tend to come with much higher interest rates than other types of business financing.
Invoice Financing
Invoice financing is when a lender gives you a cash advance on your outstanding customer invoices. Also known as accounts receivable financing, it uses your invoices as collateral. Invoice financing can be easier to get than a traditional business loan or business line of credit, but tends to come with higher interest rates.
Secured Business Line of Credit Application
When you apply for a business line of credit, you’ll have to determine how much credit you need. You’ll also want to check your eligibility, research and compare lenders, and gather the necessary documentation.
Where to Find a Secured Business Line of Credit
Secured business lines of credit are offered by traditional banks, credit unions, alternative online lenders, and the U.S. Small Business Administration (SBA). Rates and terms can vary widely from one lender to another, so it can be a good idea to shop around and compare offers.
Credit Requirements
You generally need to have a good credit profile for your personal and/or business credit score to qualify for a secured business line of credit. If your credit score is low, you may have a harder time receiving approval. It’s a good idea to check your personal and business credit score before applying.
Other Documents
When you submit your application for a secured business line of credit, you may be asked to submit a number of additional documents, including:
Business name, address, phone number and email address
Annual sales and/or revenue
Business and personal tax returns
Financial statements (such as your balance sheet and income statement)
Recent bank statements (business and personal)
Tax returns (personal and business)
Proof of collateral
A photo of your driver’s license
Articles of incorporations (is applicable)
Resume
Small Business Loans From Lantern
A secured business line of credit can provide your startup or small business with flexible financing and, because collateral lowers the lender's risk, may be easier to qualify for than other types of small business financing.Using a business asset (such as real estate or equipment) as collateral, however, poses some risk to you as a borrower. Should you become unable to make payments on the credit line, you could lose a valuable asset.If you’re interested in exploring financing options – both with and without collateral – to expedite your business growth, Lantern by SoFi can help. With our online loan comparison tool, you can access offers from multiple small business lenders with just one short application and without making any type of commitment.
Frequently Asked Questions
Do you have to use collateral for a business line of credit?
Can you get a secured business line of credit with a lower credit score?
What are the advantages of unsecured business lines of credit?
Photo credit: iStock/Six_Characters
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About the Author
Mike Zaccardi
Mike Zaccardi, CFA, CMT, is a finance expert and writer specializing in investments, markets, personal finance, and retirement planning. He enjoys putting a narrative to complex financial data and concepts; analyzing stock market sectors, ETFs, economic data, and broad market conditions; and producing snackable content for various audiences.
