What is an Unsecured Business Loan?
An unsecured business loan is a funding solution which requires no personal or business asset as collateral. However, these loans require the borrower to show the lender a good credit rating, with excellent financial history and cash flow forecast. The finance house takes more of the risk involved in granting the loan and therefore, demands a higher interest rate.
The lender is aware that the borrower might default and not be able to repay the loan and it is this risk which attracts the large repayment amortization than on a secured business loan.
The borrower must show through detailed cash flow analysis, that a regular monthly payment including interest is possible during the loan period. The loan period is usually shorter than a collateral based or secured loan; the amount of interest charged depends on the borrowing period.
Examples of Unsecured Loans
Although the interest rates are higher for an unsecured loan than a secured loan, they can still be lower than other funding solutions. For example, a revolving credit loan, such as a credit card, personal or student loan. These lines of credit are unsecured and involve a continual borrowing and payment plan, attracting a high rate of interest.
Unsecured Term Loans, by contrast to the revolving credit, mean that the borrower repays the loan in equal installments until the end of the loan term when the loan is fully paid off. This type of loan can be used by a business to consolidate debt repayment.
Alternative lenders for unsecured loans, such as merchant cash advance, and payday lenders charge the highest rates for their unsecured loans. These lending companies often make the borrower take bigger risks by agreeing to automatic withdrawal from a current account. The result is a never-ending cycle of borrowing and excessive repayment charges.
With a secured loan, repossession of collateral helps the lender recoup the losses if there is payment default.
However, with an unsecured business loan, unless there has been a personal guarantee made by a company director or owner, there is little to be done in the way of recoupment. Often the lender will resort to debt collection, and in dire circumstances, the borrower will be placed in a tenuous position and probably have to apply for bankruptcy.
1. Strenuous credit checks by the lender on the borrower’s financial status.
2. Companies with limited assets of one that does not wish to provide a form of collateral will be able to apply for an unsecured business loan.
3. In some situations, dependent on meeting the credit rating criteria, directors and company owners, will have to sign personal guarantees.
Pros and Cons of Unsecured Business Loans
- No risk to existing assets like a home, vehicles, other commercial property, or long-term assets
- Because the borrower doesn’t need to document their assets in an unsecured business loan, some parts of the loan underwriting process may be easier
- The interest rates will normally be higher than for secured loans
- For those without squeaky clean credit, unsecured business loans can have a particularly high debt load