In a nutshell, an unsecured small business loan is a loan that requires no collateral but is rather based solely upon the creditworthiness of the small business borrower. A signature loan would be a good example of what has traditionally been considered an unsecured loan.
A particularly creditworthy small business owner (think 720+ personal credit score who has a strong relationship with their banker) might be able to qualify for an unsecured loan or line of credit from the bank. But the vast majority of banks prefer to secure loans with some sort of collateral like real estate, equipment, or other valuable business asset.
Banks (or other lenders) determine the loan-to-value ratio of your collateral based upon the nature of asset. In other words, your banker may allow you to borrow against 75 percent of the value of appraised real estate or 60 percent to 80 percent of the value of what they call ready-to-go inventory. Because lenders might consider their loan-to-value ratios differently, you’ll need to ask any potential lender how they intend to set that value.
Nevertheless, there are lenders who look at unsecured business loans a little differently than what’s implied by the traditional definition. Instead of collateralizing your loan or line of credit with specific collateral, they apply a general lien on business assets until the loan balance is paid in full. This streamlines the application process, allows borrowers without an impeccable personal credit score, and those borrowers who have a healthy business, but don’t have or don’t want to tie up business assets to get a small business loan, the ability to access financing.
A Different Type of Unsecured Business Loan
Unlike traditional lenders, there are online lenders who don’t require the same rigid credit standards associated with what the bank might need, so it’s possible an unsecured business loan or line of credit could be a good fit for your businesses, even if you have a less-than-perfect credit profile (provided you can demonstrate other healthy business fundamentals). These loans typically come with a higher interest rate than a similar collateralized loan, but offer some benefits you should consider:
- An unsecured online business loan typically takes less time to apply: Online lenders have almost become synonymous with quick approval times—sometimes just a few minutes. And, once approved you can have the funds available in your account as quickly as 24 to 48 hours. So if you’re looking for capital to take advantage of a business opportunity that requires you to act fast, it could be a good fit for your business.
- An unsecured loan is not dependent upon the value of the collateral: When applying for a traditional secured loan, the formula for determining the loan amount is calculated based upon a percentage of the specific asset being used as collateral. In some cases, you may even qualify for more money with an unsecured loan—because the lender is making loan decisions about you and your business based upon the health of your business, your cash flow, and your personal and business credit profile.
- An unsecured loan can help build your business credit: If your lender reports your payment history to the appropriate business credit bureaus—unlike using your personal credit cards or other financing that doesn’t report to the bureaus—your timely payments will help you build (or strengthen) your business credit profile. This is important enough that you should ask about it before you sign on the dotted line.
- An unsecured line of credit could also be an option: If you’d prefer a line of credit, some lenders also offer an unsecured line of credit that can used as needed, repaid, and used again. And, you only pay interest on the amount of credit you use—not any of the available line you don’t use.
An unsecured loan or line of credit isn’t the perfect option for every financing situation, but is a tool business owners can use to access capital, provided it’s a good fit for the loan purpose and the economics of the loan make sense. When looking into any business financing, when talking to a potential lender, make sure you completely understand the terms and the costs so you can make an informed decision.