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What is an unsecured business loan and how does it work?

Key takeaways

  • Unsecured business loans are types of business loans that do not require collateral

  • Lenders are more selective when it comes to offering some types of unsecured business loans and may require a personal guarantee or UCC lien

  • Unsecured business loans can come in the form of term loans, business lines of credit, invoice factoring, and merchant cash advances

If you run a business, there may come a time when you want to borrow money. Whether you’re trying to cover a cash shortfall or invest in growing the company, business loans can be a useful tool.

Many lenders will want you to offer business collateral when you apply, but that isn’t true of all business loans. If you don’t have collateral, some lenders offer unsecured small business loans, which can be used for various purposes, such as expanding operations, purchasing inventory or covering unexpected expenses. There are several different types, and there are pros and cons you’ll want to consider before applying for one.

What is an unsecured business loan?

An unsecured business loan is a type of business loan that doesn’t require any collateral. Collateral is an item of value that you use to secure a loan. If you can’t manage your unsecured loan and fail to make payments, the lender takes possession of the collateral to cover its losses, reducing its risk.

Because unsecured loans have no collateral, the lender takes on more risk when lending money to businesses. That’s why some types of unsecured business loans may have strict eligibility requirements.

How unsecured business loans work

Unsecured business loans work similarly to other types of loans. You submit an application, wait for the lender to decide, and if you’re approved, you get the cash and pay it back over time.

Since there isn’t any collateral involved, lenders are typically more selective about who they offer unsecured term loans to, especially if you want one with low interest rates. They also tend to ask the business owner to provide a personal guarantee. This is a promise to pay the loan back out of personal funds if the company defaults on the loan.

Other types of unsecured business loans have relaxed eligibility requirements and limited loan documentation and may be available to business owners with bad credit. This includes invoice factoring and merchant cash advances. But these types of bad credit loans come with a heavy cost, including high interest rates and fees.

Some lenders will also demand a Uniform Commercial Code (UCC) lien. A UCC lien is a claim against your company’s assets. If your company fails to pay the loan, the lender will come after these assets to recover its losses.

Types of unsecured business loans

There are many different types of unsecured business loans. Term loans and business lines of credit are often considered the best unsecured business loans for business owners with good-to-excellent credit. But there are also unsecured business loans for bad credit borrowers. This includes invoice factoring and merchant cash advances.

Term loans

With a term loan, you apply for a loan, specifying the amount you’d like to borrow and often specifying the reason for getting the loan. If the lender approves the application, it disburses the funds in a lump sum to your bank account. You then repay the loan in regular installments, typically over three to five years.

These are popular if you want to make a specific purchase and pay for it over the long term.

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Bankrate insight

SBA loans provide affordable financing to many types of small businesses. It’s even possible to get unsecured SBA business loans for up to $25,000, though not all lenders will offer this option.

Business lines of credit

A business line of credit allows your company to borrow money when you need extra cash. You only pay interest on the outstanding balance and can draw funds from the line of credit multiple times. It’s possible to get an unsecured business line of credit, but maximum loan amounts and interest rates may not be as favorable as secured business lines of credit.

These are popular for businesses that want to have the flexibility to cover unexpected expenses, though the cost of a line of credit can be higher than term loans.

Invoice factoring

Invoice factoring involves selling unpaid invoices to a lender at a discount. That lets you get paid for your invoices right away rather than waiting for your customers to pay you. For example, if you have an outstanding invoice for $5,000, a factoring company may buy it from you, giving you 85 percent of the amount ($4,250) and releasing the rest, minus fees, once the invoice is paid.

Factoring can be expensive, but many factoring companies won’t require a personal guarantee or collateral. That’s because you sell them your invoices and don’t actually borrow money from the lender.

Merchant cash advances

A merchant cash advance involves getting cash upfront based on your company’s typical sales numbers. You can then use the money to cover unexpected costs or buy inventory. This type of working capital loan is high risk and often used by business owners with bad credit.

You repay merchant cash advances automatically through a percentage of your future sales. These can be a good option to help cover seasonal and other short-term cash issues but can get quite expensive and make your cash flow issues even worse, putting you in a cycle of debt.

Where to get an unsecured business loan

You can find unsecured business loans from two general types of lenders, each with pros and cons.

  • Online lenders. These companies include fintech lenders like Bluevine. Alternative lenders tend to have quick online applications and funding timelines, making them good for businesses needing quick cash. But they often charge higher rates if your company has less-than-stellar credit.

  • Banks and credit unions. Like Bank of America, these are traditional brick-and-mortar lenders that may also have an online presence. They usually have slower processes and stricter lending requirements but may have business loans with more favorable interest rates and terms. They’re also good for companies that want a more face-to-face experience.

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Bankrate insight

Unsecured business loan interest rates vary widely, ranging from 7.00 percent to 99.00 percent. That said, businesses with good personal credit may secure lower rates falling between 8.00 percent and 10.00 percent.

Pros and cons of unsecured business loans

Pros

  • No collateral. The obvious advantage of these loans is that you don’t need any valuable assets that could get seized if you default on the loan.

  • Fast funding. Many lenders can fund unsecured business loans quickly, some within one to two business days.

  • Accessible. Some lenders work with bad credit applicants and offer products like lines of credit or merchant cash advances to a broad range of borrowers.

Cons

  • Slow application process. Small business loans from banks and credit unions may take longer to be processed and funded.

  • Personal guarantee. Depending on the lender, a personal guarantee is required to ensure the loan is repaid by the business owner if the business can’t repay the loan.

  • Stricter requirements. You’ll need better credit scores and finances to qualify for the best unsecured loans.

  • Higher cost. Unsecured business loan rates are typically higher than secured business loans since the lender takes on more risk. Loan fees can also be higher, driving up the cost of the loan.

Alternatives to unsecured business loans

If you don’t think an unsecured business loan is the best fit for your business, there are alternatives to explore.

  • Secured business loans: These loans require collateral such as real estate, vehicles or inventory. Lenders can seize these assets if the business defaults on the loan.

  • SBA loans: Loans through the SBA, which cater to diverse business needs, may require collateral, especially for larger amounts. However, some loans under $25,000 do not.

  • Secured lines of credit: These revolving credit lines are secured by collateral, offering flexible financing options. With lower risk to lenders, they provide easier qualification, even for businesses with poor credit, and interest is charged only on the amount used.

  • Invoice financing: Businesses can borrow against outstanding invoices to access immediate cash flow, with the invoices themselves serving as collateral. While this provides fast funding, it comes with associated fees and may not provide the full invoice value.

  • Business grants: Since these funds are non-repayable funds, they are awarded to small businesses without the collateral requirements. Offered through businesses, nonprofits, government agencies and other sources, business grants target diverse communities and business needs.

  • Crowdfunding: This option allows businesses to raise capital through public contributions, either as donations or in exchange for rewards or equity. However, it doesn’t guarantee the full amount of funding.

  • Peer-to-peer (P2P) lending: Using a specialized lending platform, businesses connect directly with investors who want to help them fund their endeavors. However, rates and fees can vary, but this option is most suitable for borrowers with less-than-perfect credit.

  • Business credit cards: Secured business credit cards require cash deposits, and the amount you deposit is usually your credit limit. Both secured and unsecured business credit cards can help you build business credit while avoiding interest charges. To do this, make sure you take advantage of the card’s grace period.

Bottom line

Unsecured business loans can be a great way for companies to borrow money. If your business doesn’t have great finances or has poor credit, a secured loan may be easier to qualify for and more affordable.

Before applying for an unsecured loan, make sure to shop around and compare multiple offers. If you put in the effort, you can find the best small business loan that will help your business achieve its goals.

Frequently asked questions

  • Getting an unsecured business loan can be easy since many lenders offer them. But they may have stricter requirements than loans with collateral, and you will likely have to provide a personal guarantee.

  • To qualify for an unsecured term loan or line of credit, your company will need to have solid revenue and good credit. You may also have to provide a personal guarantee. The eligibility requirements can be far more relaxed for other forms of unsecured business loans, like merchant cash advances or invoice factoring.

  • Some types of business loans, like merchant cash advances and invoice factoring, don’t require collateral and are available to business owners with bad credit. Equipment financing is another form of a business loan that doesn’t require collateral since the equipment you purchase acts as collateral. Some online lenders offer equipment financing to borrowers with bad credit.

  • Small business loans can be secured or unsecured. Loans that require a business owner to provide collateral are secured business loans. Using assets to secure the loan can help improve your chances of approval and even lead to business loans with lower interest rates. Unsecured business loans don’t require collateral. That puts more risk on the lender, leading to higher rates. And even though you don’t have to provide collateral, many lenders often require business owners to sign a personal guarantee, which puts your business and personal assets at risk if you fail to repay the loan.

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