The Top Pros and Cons of a Secured Business Loan
A secured business loan is a great way to fund new ventures, supplement your cash flow, and establish or re-build your business credit. Still, a secured business loan comes with risk; as you’ll required to submit a form of collateral to receive your financing.
In this blog post, we'll explain what a secured business loan is and how you can determine if its the right financing option for you.
What is a Secured Business Loan?
A secured small business loan is backed by an asset that you have, such as equipment, cars, or real estate.
If the loan defaults and you’re unable to repay it, the business lender has the right to seize that item as a payment. This gives them a form of security, so that if you can't make your monthly payments they can seize the collateral instead.
Since these business loans are less risky for the lender, the interest rate is usually lower and easier to obtain for the person that's borrowing money.
What are the Benefits of Secured Business Loans?
1. Lower Interest Rates
Secured business loans typically have low interest rates than other business financing products, such as:
Credit cards
Business lines of credit
This is because having secured collateral reduces the lender’s potential risk. Some rates are as low as prime plus one percent. If you'd like to avoid high interest payments, a secured loan could be a viable option for you.
2. Longer Repayment Terms
Secured loans can have longer repayment terms, sometimes if 10 to 30 years. Ultimately, your business loan lender will provide set terms based on your specific situation.
If you’re unable to repay a loan in a shorter term, pursuing a secured loan might be beneficial.
3. Easier to Obtain Financing if Experienced
If your business is established, it’s easier to obtain a secured loan because again, it’s less risky for the lender. In general, most banks and alternative lenders are less likely to work with startups because they haven’t been able to prove themselves yet.
4. Higher Dollar Amounts
Usually, secured financing comes in larger amounts because of the risk mitigation for the lender. Since they're a less risky financing option, they’re able to provide a larger loan amount.
If you’re in need a significant amount of money, you should start considering your collateral so that you can secure business financing. Although submitting collateral can be risky for business owners, it's also well-worth it if you need significant financing.
What are the Downsides of Secured Business Loans?
1. Requires Acceptable Securing Asset
If you don’t have an asset to use as collateral, you won’t be approved for a secured business loan. Luckily, some institutions will allow you to use your savings account as an asset, but usually a physical item is required. Therefore, if you don’t have significant inventory, equipment, or real estate, you probably won’t qualify for this loan option.
2. If You Default, You’ll Likely Lose the Asset
If you’re unable to repay the loan, you’re at risk of losing the assets that you submitted as collateral. This can be extremely detrimental to your business’s future, especially if these assets are pivotal to continuing your operations.
For example, if you own a landscaping company and submit all your tractors as collateral, it would be challenging to continue your business if this equipment is repossessed.
In addition, because you must submit the dollar amount that the required collateral is worth, the value could be higher than the value of the loan. Due to this, you could lose an asset that's worth more than a business loan, causing major financial strain.
3. Your Business Must Be Established
Although each online lender will have their own requirements, most companies will require that a loan recipient has been in business for two years under the same ownership to qualify for a secured loan.
In addition, there will also be sales and credit score requirements. Due to this, if your business is new or doesn’t have a strong credit history, procuring a secured loan will be difficult.
In Conclusion: Have a Business Plan Before You Apply for Additional Working Capital
If you’re an established small business owner that has a solid business plan and is looking to grow, a secured loan might be for you. It’s important to have a business plan in place so that you can responsibly repay your loan.
Consider all the facets mentioned in this post, and only take out as much money as you’ll need to accomplish your goals. Although there are benefits to taking out a secured loan from a lender, you may find that you can afford an unsecured loan. Not having to submit collateral can give you peace of mind, while still ensuring you have access to the financing you need.
Have you received this type of small business financing? Share your experience with us in the comment section below!
Editor’s Note: This post was updated for accuracy and comprehensiveness in May 2021.