Unsecured business loans are loans that do not require the borrower to provide a collateral or security, unlike secured business loans that require collateral. By not providing collateral, a business avoids the risk of losing its assets if it is unable to repay the loan. However, lenders make up for the high risk of the loan through high-interest rates. Besides, these loans require personal guarantees and filing liens.
Unsecured loans are an advantage to businesses that do not have assets to put as collateral. This article will give details related to unsecured business loans, risks and benefits that come with unsecured business loans.
Advantages of Unsecured Business Loans
- The business does not need to incur the risk of providing an asset as collateral, such as vehicles and other properties.
- The loan underwriting process of acquiring a loan is easier since the borrower does not need to document any collateral.
Disadvantages of Unsecured Loan
- The interest rates for unsecured loans are usually high.
- Businesses with poor credit scores may incur substantial debt loans due to high-interest rates.
How unsecured Business Loans Work?
Unsecured loans for small businesses work through the current cash flows of the business. A company agrees with a lender to get a fixed loan repayable within an agreed period. When the agreement is approved, the lender provides the business with funds. The firm acquires immediate ownership of any item it may buy with the funds. The firm then pays the lender in installments. For this kind of loan, the lender does not require any collateral.
The business does not risk its assets, while the lenders will charge high-interest rates to compensate for the high risk involved. It makes unsecured business loans more preferred for businesses looking to grow or those that are seasonal. Those who can qualify for unsecured business loans include; self-employed people and sole proprietors. However, the business must have been trading for between six to twelve months to be eligible for a credit.
Types of Unsecured Loans
Some of the unsecured loans include student loans, personal loans and credit card loans. All these can be categorized into several broad categories, which include revolving loans, term loan and debt consolidation loans.
1. Revolving Loan
A revolving loan is a type of credit where the borrower pays a commitment fee to the lender to borrow money and then he or she can use the money once it has been credited. Normally, the funds are used to meet the operating expenses. However, the amount varies with the current cash flow of the business. The agreement between the lender and the borrower determines the maximum amount of revolving credit. Apart from the commitment fee, the borrower also pays interest.
The lender looks at several factors to determine the creditworthiness of the borrower. Some f the factors include credit scores, current cash flow of the business. They do so by looking at the income statements and statements of cash flows. This type of credit is suitable for companies with substantial cash flow fluctuations. These loans have variable interest rates, which usually are high.
2. Term Loan
A term loan is a type of credit that usually has a specific repayment schedule with a fixed or floating interest rate. This type of loan is suitable for small businesses with proper financial statements. To cut on cost of the loan, a significant down payment is paid. A term loan can be short term, intermediate-term, or long term loan.
- A short term loan lasts for less than a year. Sometimes it can run up to 18 months. It is advanced to businesses that do not qualify for a line of credit.
- An intermediate loan usually lasts between one and three years. A business pays the loan in monthly installments from its cash flow.
- A long term loan usually lasts between three and twenty-five years. The loan requires collateral and often attracts monthly or quarterly installments from a business profits or cash flow.
Most of these loans are borrowed to finance real estate or the purchase of equipment. Small businesses use term loans to buy fixed assets such as equipment and furniture. Term loans usually have a fixed or variable interest rate. The maturity date and monthly or quarterly repayment schedule is agreed upon by the lender and the borrower.
3. Debt Consolidation
Debt consolidation involves getting a new loan to pay other liabilities and consumer debts. This means that several debts are combined into one to come up with better payoff terms. Debt consolidation can be used to deal with credit cards and student loans.
There are several ways to consolidate a loan into one. One of the methods is through consolidating credit cards into one credit card. This can be a better option, particularly of the credit card is charging low-interest rates. The other option is to make use of a credit card balance transfer feature to pay off the loan. Some lenders offer debt consolidation payment features. Creditors may provide this feature to enable a borrower to pay off the debt when the outstanding balance is huge. The debt consolidation can either be secured or unsecured.
Advantages of Debt Consolidation
Debt consolidation is helpful to people who:
- Have several debts
- Have outstanding debts are $10,000 or more
- Cannot negotiate lower interest rates for loans
- Having difficulties in repaying loans
- Receiving calls from debt collectors
Unsecured loans are better alternatives when an individual or a business that doesn’t want to risk its assets as collateral. Besides, they are better loans for business with significant cash flow fluctuations. They may be used to buy assets for startup businesses. However, loans usually attract high-interest rates, which could lead to huge debt accumulation.
Vincent is an experienced journalist from Kenya as well as a statistician. He has a degree in Applied Statistics with computing from the University of Eldoret.