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Getting a business loan can be an uphill climb for new small businesses. That climb is intensified when the business or its owners don’t have valuable collateral to secure the loan. Like any financing method, unsecured business loans have benefits and drawbacks. They make sense for some businesses in certain situations and not for others. With thorough research and thoughtful consideration, you’ll be able to determine whether an unsecured business loan is right for your company.
Often, lenders will require that a business put up collateral to back a loan. The collateral can belong to the business owner or to the business itself. Collateral is typically an item of great value, such as real estate or a vehicle. If the business defaults on its loan, the lender can take possession of the collateral and sell it to make up a portion of its loss. A loan that is backed by collateral is considered secured. A loan that is not backed by collateral is considered unsecured. Sometimes an unsecured loan is called a “signature loan,” as all the lender has to back the loan is your signature on the paperwork.
Since putting up collateral takes some of the risk out of the loan process for the lender, secured loans usually feature better interest rates and fewer fees than their unsecured counterparts. Unsecured small business loans are usually off-limits to businesses with low credit scores. However, if your business is in good financial standing, an unsecured business loan can be a good option.
Secured loans do add a significant risk for borrowers. If a business faces hard times and must default on its loan, it risks losing other valuable collateral essential for operations, which can make getting back on track even more difficult. If owners put up personal property as collateral, they risk financial demise by losing their business and potentially their home.
In addition to the risk factors mentioned above, there are a number of other potential advantages and detriments of obtaining an unsecured business loan.
Unsecured small business loans are not difficult to attain if you have good credit. If your credit is not great, it can be more of a challenge to find a lender willing to give you an unsecured loan. Since an unsecured loan is backed by just your good word, lenders want to see that you’re responsible with money and have a track record of managing debt responsibly. Without a strong credit rating, lenders don’t have proof that you will treat their investment sensibly.
Though it might surprise you, your assets are not completely off the hook with an unsecured loan. If a borrower defaults on an unsecured business loan, it’s true that the lender can’t repossess collateral to recover any losses. However, it can take the borrower to court or to collections. As a result, the borrower’s wages can be garnished, a lien put on their home or other property, or they can be ordered to repay the debt some other way. Defaulting on any loan is also very damaging to the borrower’s credit score, which will negatively affect their ability to access financing in the future.
Before pursuing any type of business loan, it’s wise to conduct some financial analysis within your business to determine how much money you need to borrow and what kind of a payment you can comfortably afford each month. Also, research the items (or services) you intend to purchase with the loan and decide on the exact figure you’re targeting. Lenders prefer a precise number to a ballpark range, so be as detailed as possible when estimating costs.
Contact the credit bureaus or sign up with a credit monitoring service to check your personal and business credit. Consider whether your score is good enough to land a decent rate on an unsecured loan. If not, take some time and dedicate it to paying down debt and improving your credit rating. Some credit monitoring services offer free education on how to better your score. Credit counselors are also great resources.
Next, research different lenders and the loan options they offer. Competing lenders might offer similar small business loans at different rates. Some lenders specialize in certain areas that could make them a better fit for your company. Online alternative lenders provide convenience. After submitting your application information, quotes come to you directly within a day. You can shop the options from the convenience of your home or office. Pick the lenders you’d most like to work with and the loan products that seem like the best match for your needs.
Start to gather the paperwork necessary for your loan application. Different lenders have different business loan requirements, but it’s worth noting that online lenders require much less! Lenders’ specific application processes will vary, but in most cases, you will need to fill out paperwork and submit a number of documents. After these are reviewed, you may receive some follow-up questions or requests for further documentation. It could take up to a month to receive an approval or denial from a traditional bank lender. Alternative online lenders move much faster and will let you know the status of your application within about 24 hours.
Once you’ve been approved for a loan, you will receive the funds almost immediately if you work with an alternative lender. It might take a week or so for the loan to fund with a traditional bank.
Documentation lenders will request include:
If you determine that an unsecured loan is not right for your business and you don’t have traditional collateral to back a loan, there are several other loan options to consider that use alternative backing methods.
Determining whether a secured or unsecured loan is right for your business can be challenging. Once you’ve assessed your current financial standing, your comfort level with risk, and where you hope to take the company, you’ll be equipped to determine the best financing choice for your small business.
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