No Collateral, No Problem? The Pros and Cons of Unsecured Business Loans

04/11/2016 01:51 pm ET Updated Apr 12, 2017

For small-business owners, unsecured business loans can be a double-edged sword.

Sure, this type of loan does not require any collateral, meaning you won't have to risk your personal or business assets to secure the loan. But there's a downside: Unsecured business loans come with high costs and large payments. Borrowers should carefully weigh the negatives of unsecured business loans against the positives.

Here are the main pros and cons of getting a business loan without collateral and some tips on how to get funded.

The pros: Less risk, fast money

 
You won't lose assets in bankruptcy: Owning a small business can be risky; about half of all new businesses fail within their first five years, according to data from the Bureau of Labor Statistics.

The biggest advantage of unsecured business loans is that they don't require collateral, meaning you won't have to put your home or another type of asset on the line to qualify for financing. There's more risk when you have assets such as personal savings, business equipment, inventory or accounts receivable backing a business loan. If the loan is secured and your business doesn't make it, you'll likely lose those assets.

Faster access to cash: Because you don't need to supply collateral, lenders won't have to appraise the value of your assets. Funding will likely be much faster, requiring less paperwork and documentation.

In fact, online lenders offering unsecured business loans can get borrowers funded typically within just a few days to a few weeks at most, while secured Small Business Administration loans can take a few months or longer.

Bad credit isn't always an obstacle: Small-business owners with poor personal credit but strong business revenue may be able to get approved, although this will depend on each lender's requirements. If your business doesn't have strong revenue or is new, lenders may require a better personal credit score, as it shows you're a responsible borrower.

The cons: Higher rates, larger payments

 
Higher cost: Unsecured business loans are based on your credit score and the strength of your business, not on the value of the collateral. Because it would be harder for lenders to recoup their losses if you default on the loan, they'll likely charge you a higher annual percentage rate, the true annual cost of a loan, with all fees and interest included.

Unsecured business loans typically carry double-digit APRs and can go as high as 100%. The rate will depend on your annual revenue, credit score and business strength. In contrast, rates on SBA loans are between 5.75% and 8.25%, depending on the size of the loan.

Larger loan payments: Because unsecured business loans typically carry higher APRs and shorter repayment periods than secured loans, your payments will likely be higher.

For example, a $50,000 term loan repaid monthly over one year at 22% APR would carry a monthly payment of $4,632. The same loan repaid over three years would carry a monthly payment of just $1,858. (You'd also end up paying $11,314 more in interest on the three-year term loan, since it would take longer to repay.)

If you get a short-term loan, your small business would need to have enough cash flow each month to make the larger payment. Failure to repay the loan could damage your credit score, ruin your relationship with lenders and make it much harder to obtain financing in the future.

Smaller loan amounts: You're likely to obtain a higher loan amount with a secured business loan, since the amount is typically based on a percentage of your collateral's value. For example, online lenders offering unsecured business loans typically lend up to $100,000, but secured business loans can get you up to $500,000 or more, depending on the strength of your business, your credit score and the collateral.

This makes secured business loans a better option for purchasing real estate or equipment or for refinancing high-interest debt. Unsecured business loans typically are best for smaller, short-term business expenses, such as hiring employees or buying inventory.

Qualifying may still be difficult: While you won't need collateral, lenders still will want to see consistent cash flow to support the loan payments. Startups with a limited business history and weak annual revenue may have trouble getting unsecured business loans, especially if the owner has poor personal credit or a recent bankruptcy.

Tips for getting unsecured business loans

 
If you're still interested in getting a business loan with no collateral, here are a few steps to take.

Improve your credit score: Because lenders may focus more on your credit score if your business is new and lacks revenue, you can increase your chances of obtaining the loan if you improve your score. Check out some tips on how to raise your personal credit score fastBuilding good business credit can help you qualify for a secured business loan in the future.

Shop around:
Comparing lenders will help you get the best deal. Besides the costs of each loan, consider:
  • Prepayment fees.
  • Fixed or variable interest rates.
  • Ease and speed of the application and funding process.
  • Whether the lender reports your payment activity to business credit bureaus.

Craft a business plan: It doesn't hurt to develop a business plan that details exactly how you'll use the loan proceeds and shows your projected profits for the term of the loan. Lenders will appreciate that you've given a lot of thought to repaying the loan on time and in full.

Avoid costly providers: Think twice before considering merchant cash advances. This type of unsecured business loan comes with high approval rates and quick access to cash, but it's the most costly form of small-business financing, with APRs typically in the triple digits.

Steve Nicastro is a staff writer at NerdWallet, a personal finance website. Email: Steven.N@nerdwallet.com. Twitter: @StevenNicastro.

To get more information about funding options and compare them for your small business, visit NerdWallet's small-business loans tool page. For free, personalized answers to questions about financing your business, visit the Small Business section of NerdWallet's Ask an Advisor page.