What Are Unsecured Business Loans?
Unsecured business loans are a type of business financing that does not require the borrower to provide collateral in exchange for a loan. Just as there are several types of business loans, unsecured business loans come in many forms, each with its own characteristics and use. Common unsecured business loans include:
- Term loans. Term loans are what borrowers typically think of when they consider business loans—a bank lends a specific sum of money, with interest accruing over time and regular payments made over a set loan term. This type of financing is typically best for business owners who need to access a lump sum of cash rather than smaller amounts disbursed over several months or years.
- Business lines of credit. Unlike term loans, business lines of credit let borrowers access funds up to a certain limit on an as-needed basis. Interest only accrues on the outstanding balance—not the entire loan amount—and borrowers can access funds again once they’re paid off. This feature makes lines of credit an excellent option for business owners who need revolving access to funds to cover ongoing costs.
- Merchant cash advances. A merchant cash advance (MCA) occurs when a business borrows money from a credit card processor or other merchant services provider at a set factor rate (often 1.2 to 1.5) and in exchange for a portion of future transactions. Payments are made through automatic clearing house (ACH) payments daily or weekly until the balance is repaid. MCAs are usually best suited to businesses that need to access cash quickly and have a high volume of sales to cover payments.
- Invoice factoring. Invoice factoring is the process of selling outstanding invoices to a factoring company at a discount and receiving a portion of the invoice balance as an upfront payment. The factoring company then becomes responsible for collecting payment for the invoices.
How Unsecured Business Loans Work
As with unsecured personal loans, unsecured business loans do not require borrowers to secure the loan with collateral. Instead, lenders evaluate a borrower’s level of risk by looking at the business’ credit score or their personal creditworthiness.
For that reason, loans that don’t require collateral often require a personal guarantee—a legal agreement that the borrower will repay the debt obligation with their personal funds if the business fails to do so—from the business owner or other applicant.
In addition to looking at the borrower’s personal credit score, lenders typically evaluate the business’ financials and ability to make on-time payments. This may require submitting copies of personal and business bank statements, tax returns and documentation of other outstanding business loans. A business plan may also be necessary to demonstrate the likely future success of the business.
Once an unsecured business loan is disbursed, interest begins to accrue on the entire loan amount. Funds can be used for a range of business purposes, including startup costs, equipment purchases and everyday expenses. The borrower is then required to make regular payments throughout the entire loan term in accordance with the loan agreement. Business loans can be paid off early—though some lenders charge a prepayment penalty.
Where to Get Unsecured Business Loans
Unsecured business loans may be available through traditional banks and credit unions. However, this type of business financing is more often offered through online lenders and alternative lenders. This may include financial technology companies—fintechs—that base lending decisions on a wider range of qualification requirements.
When to Choose an Unsecured or Secured Business Loan
If you’re trying to get a business loan, you may want to consider an unsecured business loan if you don’t own any valuable assets to pledge as collateral or you want faster funding times than available with secured options. That said, unsecured loans often come with higher annual percentage rates (APRs) and less flexible terms, so opt for a secured loan if you qualify for competitive interest rates and have the means to secure the loan.
Pros and Cons of Unsecured Business Loans
As with other forms of business financing, unsecured business loans come with advantages and disadvantages—though these may vary by borrower and lender.
Pros of Unsecured Business Loans
- Collateral not required: Unsecured business loans don’t require borrowers to pledge any valuable collateral in exchange for funds. This makes unsecured loans an excellent financing option for newer businesses that don’t yet own real estate, equipment or other major assets.
- No risk of losing collateral: Because unsecured business loans don’t require borrowers to pledge collateral, there is a lower risk of a company losing its assets if it defaults on a loan. That said, lenders can still file a lawsuit to recover the unpaid balance, garnish revenue from the business or seize valuable assets like equipment and real estate.
- Faster application and approval: Due to the lack of collateral, lenders do not require an appraisal as part of the unsecured loan application process. This can translate into faster application and approval processes than available for secured options.
Cons of Unsecured Business Loans
- Smaller loan amounts: Unsecured loans pose more risk to lenders than secured alternatives. For that reason, lenders often offer lower borrowing limits on their unsecured financing options.
- Higher interest rates: Lenders can’t repossess collateral in the case of default, so unsecured business loans typically come with higher interest rates than their secured counterparts. In general, rates on unsecured business loans range anywhere from around 5% to 80% or higher.
- May be more difficult to qualify for: Because of the risk posed by unsecured loans, lenders may impose more demanding eligibility requirements than secured options. This means that it can be difficult to qualify for an unsecured loan if a business has bad credit, no credit or limited annual revenue.