Secured vs. unsecured business loans: How to decide

Whether you need to access funds to launch operations, scale your company or refinance existing debt, securing a business loan can play a defining role in your organization’s financial future. Business loans come in different forms, including secured or unsecured loans, and your best choice between the two will depend on your needs and financial goals.

In general, secured business loans require a form of collateral to back the funding, whereas unsecured business loans don’t—though lenders may still ask for a personal guarantee. Keep reading to learn more about the differences between these two types of business loans.

What you’ll learn:

• Secured business loans require collateral—like real estate or company equipment—to be pledged against the loan. But they typically come with lower costs and higher borrowing limits.

• While unsecured business loans can have higher costs and stricter approval guidelines, they don’t normally require collateral.

• When choosing between a secured and an unsecured loan, consider how much funding your business needs and whether you have assets you’re willing to pledge to secure the loan.

• There are also alternatives to secured and unsecured business loans, such as business credit cards, that may fit your company’s financial goals and needs.

A secured business loan is backed by collateral—an asset your business pledges as security to fund the loan. If you default on the loan, the lender could seize the pledged asset. 

Businesses can provide various items of value as collateral, including:

• Real estate

• Vehicles

• Equipment

• Inventory

• Accounts receivable 

Different lenders—including banks, credit unions and online lenders—can offer secured loans. These loans can also come in different forms, like term loans, SBA loans and business lines of credit.

Secured loans typically have lower interest rates and less-strict qualifying guidelines than unsecured loans. That’s because there’s less risk for the lender when collateral is pledged against the loan.

Here are some advantages of secured loans compared to unsecured loans:

• Lower costs: Secured loans tend to have lower interest rates than unsecured loans.

• Less-stringent guidelines: Lenders typically offer easier credit score and credit history requirements, and secured loans often have lower revenue thresholds for the borrower. 

• Higher borrowing limits: Secured loans frequently allow for larger borrowing amounts and longer repayment periods.

Here are some disadvantages of secured loans to consider:

• Pledged assets: Collateral is required to secure the loan, so the lender can seize the asset if you stop making payments. 

• Longer process: It can take longer to get approved and funded because the lender might require an appraisal of the pledged asset.

• Requirements around collateral: In addition to having the asset appraised, lenders may have other requirements. For example, if you use real estate as collateral, the lender might request regular inspections. Similarly, if your business’s equipment serves as the collateral, the lender may require proof of regular upkeep.

Unsecured loans aren’t backed by collateral. Instead, lenders often require a personal guarantee, which means you agree to repay the loan using personal assets if the business defaults. Unsecured loans can be provided by traditional lenders (such as banks) and nontraditional lenders (like online or fintech platforms). Like secured loans, unsecured loans can come in the form of term loans and business lines of credit, but they often offer a wider variety of financing options.

Unsecured loans can provide access to faster funding because no collateral is needed. But these loans tend to be riskier for the lender, so that’s why maximum loan amounts are often lower than with secured loans. Unsecured loans also typically come with higher interest rates and stricter qualifying criteria to make up for the lack of collateral. 

Here are some benefits of unsecured loans:

• No collateral requirement: You can access funding through an unsecured loan without having to pledge collateral. This means you’re not putting your business assets at risk. 

• The variety of financing options: There are several unsecured financing options available, like business lines of credit, term loans and merchant cash advances. 

• Potentially faster funding: Because collateral doesn’t need to be assessed, the approval and funding process can take less time.

Here are some drawbacks of unsecured loans:

• Higher costs: Compared to secured loans, unsecured loans tend to have higher interest rates, which can raise the overall cost of borrowing. 

• More-stringent eligibility guidelines: Without collateral backing the loan, lenders typically require higher credit scores, a stronger credit history and a higher income from borrowers. 

• Smaller loan sizes: Borrowing limits are generally lower with unsecured loans.

Here are a few actions worth taking when choosing between a secured and an unsecured business loan.

When you’re ready to start shopping for business loans, consider what you’ll be using the funds for and how much money you need. For example, if you’re using the loan for long-term financing needs, you might consider a secured loan, which typically will offer a longer borrowing term. On the other hand, if you’re using the funds for short-term working capital, you might lean toward an unsecured loan, which can offer faster funding.

Consider your assets and determine whether you’re able to pledge one against a loan. Secured loans can be less expensive because they often come with lower interest rates and longer borrowing terms, which could lower your monthly payment. But even if you do have items of value, you must decide whether you’re willing to put them at risk. For example, if you’re a recently established business, you might not be ready to use new company equipment to secure the loan. In that case, you might consider exploring unsecured loan options instead.

Either way, a personal guarantee is usually required with unsecured loans, which means you agree to pay back the loan using your personal assets if you’re unable to make payments.

Unsecured loans typically carry stricter requirements in connection with credit score and credit history. They also tend to have higher annual income thresholds because there’s no collateral backing the loan. If you’re a new business or lack an established business credit score, you might have better approval odds with a secured loan. That’s because you can offer a form of collateral to back the loan, helping make up for limited credit history or company income.

Accessing funds for your business can open up new opportunities to help you take your company to the next level. Business loans can also provide a much-needed lifeline to keep operations afloat or refinance existing debt. Whatever your reasons for considering different types of business financing, understanding the differences between secured and unsecured loans can help you make the right decision for your business.

If neither a secured nor an unsecured loan seems like the best option, there are alternatives—like business credit cards—that can help you lift your company to new heights. Compare business credit cards from Capital One to find a card that works for your company. Also, you can potentially get pre-approved today—without impacting your credit scores.