The differences between Secured and Unsecured Loans
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Whatever your business, you're likely to need external finance sooner or later. Perhaps you want to invest in your business’s growth, or deal with unexpected costs. Perhaps you need to buy in stock, or simply need to keep afloat while you are waiting to be paid.
But getting the most appropriate kind of funding is important.
There are many types of business funding but if you are looking at a straightforward Term Loan – also known as Debt Finance – there are two types to consider: Secured and Unsecured Loans. With both you agree a loan deal with a provider, who will need to be paid back, with interest, over a set period with monthly repayments.
Both have their uses, their advantages and disadvantages, and it is important to get the most appropriate kind of loan for your particular needs.
Lenders make their decisions based on the risk that they might not get their money back.
The higher the risk, the higher rate you will pay, and if the risk is too high they won’t lend at all. With an Unsecured Loan, the lender will make a judgement on whether or not to lend based on the creditworthiness of the borrower and their business.
The risks to the lender that they will not be repaid are relatively high with this type of lending, so the interest charged will also be high, and the amount they will lend may be limited.
An Unsecured business loan works much like a personal loan. You make an application and, if accepted, a lump sum is paid into your business’s bank account. Interest is charged on the outstanding amount of the loan at a fixed or variable rate, and the lender may charge an arrangement fee which will be added to the repayments.
The loan is repaid in monthly or quarterly instalments over an agreed term, usually under 5 years.
The advantages of Unsecured Loans
- Unsecured business loans can be simple and fast to arrange.
- Lenders can check your online credit score and make a judgement accordingly.
- Some online lenders will actually make an instant decision, although the amounts offered in this way will tend to be small.
The disadvantages of Unsecured Loans
The main disadvantage of Unsecured Business Finance is the lack of security for the lender. To compensate for this greater risk they are usually more expensive than a Secured Loan.
The lending criteria are also stricter with Unsecured Loans than with Secured Loans. This means that there is a limit to what you can borrow.
In most cases, the lender will check your company’s underlying financial health a process known as underwriting, and request various types of documentary evidence from you.
Modern lenders can provide a fast service for unsecured lending, but you might expect to have to answer more questions, and possibly to provide more documents in support of your application. The lender will look at:
- Turnover, revenue and profitability
- Trading history
- Forecasts and business plans
- Your clients/customers
You may need to provide a personal guarantee to secure an unsecured loan. A personal guarantee means you as the business owner/ director will become personally liable to repay a loan if the business fails to pay. Companies with more than one director might need a personal guarantee from them all.
Secured Loans are often used to borrow large sums of money, often more than £250,000. They are ‘secured’ because to arrange them, the lender will require something as security in case you cannot pay the loan back. You give the lender a ‘charge’ over your security. This could your home or your business premises if you own them. They’ll have the legal authority to take the asset and sell it if you can’t make the agreed repayments.
Secured Loans are less risky for lenders, which is why they normally cost less in the long-run than Unsecured Loans - often known as a low cost secured business loan. But they mean more risk for you as a borrower because your loan provider can repossess your property if you do not keep up repayments.
The lender will look at the assets you want to use and make a valuation or inspection. They’ll also check to see if there are any charges already on it. If you want to use your premises as security, it will be worth more to the lender if you own it outright rather than have a large mortgage already on it. Of course, lenders favour ‘unencumbered’ assets.
Once the security has been valued and your loan amount and repayment structure agreed, you’ll give the lender a ‘charge’ over your security. This means they’ll have legal authority to take the asset if you can’t make the agreed repayments.
Remember, you can only borrow an amount less than the value of the security you provide. So you can get a £200,000 loan with security worth £100,000. Loans are usually 50–70% of overall asset value.
Assets used as security can include:
- Commercial property: offices, shops, warehouses and factories
- Commercial vehicles: trucks, vans, cars
- Heavy machinery: capstan lathes, CNC milling machines, printing presses
These are all 'hard assets’. In some cases, lenders will accept ‘soft assets’ such as your unsold stock or even your intellectual assets.
Advantages of a Secured Loan
- You can have longer to repay, and enjoy lower interest rates, meaning monthly repayments can be lower and easier to fit in with your cashflow.
- Secured Finance can cut the cost of borrowing, and can help you borrow larger sums of money than other types of lending
- Lenders may insist on Secured Loans for borrowers with an imperfect credit history, as they know the amount can be repaid.
Disadvantages of a Secured Loan
- If your business doesn’t generate enough cash to meet Secured Loan repayments and you fall behind with loan repayments, the lender can take your security.
- Requires valuations and legal costs, which you may have to pay for upfront.
- These due diligence processes mean it takes more time to get the funds.
Why you need Rangewell to arrange your business loans
There are many lenders, ranging from high street banks and the new generation of challenger banks to specialist, niche and P2P providers. The rates and terms they offer can vary substantially, and some like to specialise in certain business sectors, where they have more experience of the risks and opportunities involved.
Secured or unsecured, finding the right business finance lender is essential to minimise your costs. At Rangewell, we work with lenders across the entire UK market, and can search every lending product to help you find the most appropriate lender and the most competitive deal. Our team of experts can help you find the most appropriate kind of finance arrangement, the lenders who work in your sector, and the most competitive deals.
To find out more about working with Rangewell to find better answers to your borrowing needs, call us or apply today.