The Pros and Cons of No Collateral Business Loans
However, even if you don’t submit collateral, it doesn’t mean you can avoid recourse form your lender if you fail to pay off your loan. Many business funding lenders will require that you sign a personal guarantee. That means the lender can still come after your personal assets.
In addition, no collateral business loans are typically more expensive than collateralized loans.
All that’s not to say small business loans without collateral aren’t a viable option. It’s just important to recognize both the benefits and drawbacks. To that end, in this post, we’ll walk through the pros and cons of no collateral business loans.
First, though, let’s establish a common definition for collateral-free business loans.
What is a No Collateral Business Loan?
A no collateral business loan is a commercial loan that doesn’t require the borrower to submit an asset, such as inventory or property, to secure the loan.
You may also hear these types of loans referred to as unsecured business loans. To be clear, there’s no difference between an unsecured and a collateral-free loan. The word “unsecured” just refers to the fact that the loan is not secured by collateral.
The Pros of Collateral-free Business Loans
1. Less complicated application and approval process
When you’re approved for a secured business loan, your lender has to do additional paperwork to properly secure the loan. You may also need to have an appraisal done to establish a value for the collateral.
Of course, since collateral-free loans don’t involve collateral, you can skip the process of securing the loan altogether. The result is a faster, less complicated application and approval process.
2. Loan value doesn’t depend on your assets
To obtain a secured business loan, the value of your collateral must be equal to the value of your loan. So with secured business loans, the size of the loan you can get is limited by the value of your collateral.
Unsecured business loans don’t have this restriction, so you won’t be prevented from getting the loan amount you want because you don’t have enough assets.
3. Less risk to your assets
With a secured loan, the lender files a lien on your collateral. This lien gives the lender the legal right to take ownership of the assets if you don’t pay back your loan. With unsecured loans, there’s no lien, so your lender can’t seize your assets as easily.
However, as mentioned earlier, this doesn’t mean your lender has no recourse. It just means that the lender has to go through a more complicated, costly procedure to seize your assets.
The Cons of Collateral-free Business Loans
1. Higher interest rates
Securing a loan with collateral enables the lender to recoup their losses by selling your asset if you default. In effect, this gives the lender protection against the risk of lending to you. With less risk, lenders can afford to offer more favorable interest rates.
However, since collateral-free loans don’t offer this protection, lenders compensate by charging higher interest rates. Assuming all else is equal, an unsecured loan will always be more expensive than a secured loan.
2. Your lender can sue you
While there’s no collateral required to take out an unsecured loan, that doesn’t mean your lender can’t still come after your assets if you don’t pay. To do so, the lender would need to sue you in court to have a lien placed on your assets.
If you lose the case, you’d be obligated to pay your loan back, in addition to paying late fees. On top of that, you’d likely need to pay for court costs and attorney fees.
3. More difficult to qualify for
When an alternative lender evaluates a borrower for an unsecured loan, they’re relying heavily on that borrower’s creditworthiness. After all, they have no collateral to back the loan. So if the borrower defaults, they’ll need to go through a time-consuming legal process to recoup their losses.
Due to this increased reliance on creditworthiness, your credit score must be strong for you to qualify for an unsecured loan.
Conclusion: When Unsecured Loans Work Best
Many small business owners don’t have sufficient assets to serve as collateral. Others prefer to avoid the risk of losing their assets. For these borrowers, unsecured loans can be a great fit.
Plus, on smaller loan amounts for borrowers with good credit, unsecured loans offer relatively competitive interest rates. So while they’re not for everyone, collateral-free loans can be a great fit in the right scenario.
If you’re considering this type of business financing, just make sure you’re fully aware of the pros and cons listed above.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.