Defining secured business loans
The main attribute of this type of loan is that it is secured with collateral. This means that assets are attached to the loan. Collateral is usually commercial or residential property but it can also be commercial machinery, equipment and vehicles. Lenders require collateral for secured business loans to reduce their risk in case the borrower can’t repay the loan.
No collateral is required with an unsecured business loan. However, the lender might require a personal guarantee. This is a personal agreement with the lender that you take responsibility or paying the loan. In effect, it puts all your personal assets on the line if loan payments can’t be made. Unlike a secured business loan, you are not using specific assets as collateral.
Suitability of secured business loans
These loans are better suited to certain businesses and circumstances, including businesses:
- Wanting to borrow substantial loan amounts
- That are established and have been in operation for several years
- Seeking a longer-term loan that can make payments over a longer period of time
- That have assets they can pledge as collateral.
Types of secured business loans
There is a range of secured small business loans to choose from.
Traditional term loans
These are the most popular type of secured loans and have a term of around three to five years. With this type of loan, you borrow a lump sum and make a regular payment to repay the principal and interest. The main benefit of traditional term loans is that they are predictable – you know when you will make payments and how much they will be. The main shortcomings with these bank loans are that there can be a lot of paperwork required and it can take up to two months to find out if you have been approved. Banks also have strict lending criteria so they reject around 75% of loan applications from SMEs, according to research conducted in 2017.
With a business overdraft, you borrow money by running a negative balance on your business transaction account. You get the overdraft up to a predetermined amount that you can draw from. You only pay interest on what you are using. In addition, you pay an establishment fee and a monthly accounting fee. The minimum amount of a business overdraft is usually $10,000 and they can go up to $250,000 and more.
This credit product is available in secured and unsecured versions. If the overdraft is secured, the interest rate will be lower and you can get a higher limit than with an unsecured business overdraft. This is common when comparing unsecured and secured business loans. Learn more about business overdrafts.
Business line of credit
With a business line of credit, you are given access to a predetermined amount of funds that you can use. There is no fixed payment schedule so you pay it back when you are able to do so. This makes it an effective option for managing cash flow.
Like a business overdraft, you only pay interest on the amount of money you have drawn from the line of credit. You will also pay an establishment fee and small (under $30) ongoing monthly line fee. You can get an unsecured business line of credit but this will be at a higher interest rate and you won’t be able to borrow as much. Find out more about business lines of credit.
Other types of secured business loans – self-securing business loans
Certain types of loans have collateral automatically connected to them, so are called ‘self-securing’ loans. These include:
- Equipment loans – the equipment serves as collateral until the loan is paid off. These secured business loans are short to medium term – three to five years. If the borrower defaults on the loan, the lender can take back the equipment and sell it to recoup the balance owed. Learn more about equipment finance.
- Invoice financing – invoice finance companies advance up to 85% of the value of outstanding invoices to the borrower. The business gets its money sooner and the finance company uses the invoices as collateral. In certain types of invoice finance, the lender ‘buys’ the invoices and collects outstanding money from the customers. Find out more about invoice finance.
- Inventory financing – these types of secured business loans are used to purchase inventory. Like equipment financing, the loan is secured by the inventory purchased. Get more information on inventory finance.
Making a decision about secured business finance
Whatever type of loan you choose, be sure that you understand the terms and conditions and that the loan is suitable for your financial situation.
If you decide that unsecured finance is a better option, you can find out more about unsecured business loans from Moula.