What is the Difference Between Secured and Unsecured Loans?

What is the Difference Between Secured and Unsecured Loans?

Published on 2021-09-29

Category: Small Business Owners, Business Loans

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For an entrepreneur, finances are always a key concern. That is why saving advice holds good, as it can carry you through the turbulent times of your entrepreneurial journey. But times come when the savings fall short of reaching the goal, and an immediate need for funds arises. Then, taking a business loan comes in handy.

Australians, as with people everywhere, take loans to fulfil fund requirements. There has been a noticeable spike in borrowings since July 2019 to the tune of $24 billion. So, this is the right time to seek a loan. But before you sign on the dotted line, let’s walk through the two basic types of loans - secured and unsecured.

Know the Difference- Secured Loans Vs Unsecured Loans

It is a secured business loan when you take a loan using something you own, like a property or an asset like a car. As the lender can take possession of your property or asset in case of default, his risk is covered. The pledging of the collateral enables him to offer you the loan at a lower interest rate as he can sell the security to cover the loan value amount in case of a default.

On the contrary, an unsecured business loan does not require the borrower to put any asset or security as collateral for the loan. This exposes the lender to a potential risk of losing money to loan default. As the risk is not hedged, the interest rate would generally be higher. Additionally, the lender will also emphasize several other factors like credit score, income flows etc.,of the business before approving a loan.

Some of the assets that can be used as security are:

  • Property: It could either be wholly owned or with equity in the partnership. The asset could be residential, rural, or commercial.
  • High net worth assets: Things that carry high value like jewellery.
  • Cash deposit: It includes deposits in the name of the borrower, like a term deposit.
  • Vehicles and equipment: It includes both used and new equipment, machinery or vehicles like a car, boat, or motorbike.

Here, we compare business loans for you to see:

Feature

Secured Loan

Unsecured Loan

Collateral

An asset is pledged

No asset is pledged

Interest Rates

Relatively lower

Relatively higher

Processing Time

Takes time as the collateral must be valued and documented

Shorter processing time as no collateral valuation is involved

Loan Amount

Depends on the value of the collateral

Depends on other factors like credit score, ability to repay etc.

Credit Score

Available even with a low credit score

Requires a fairly good credit score

Basis of Approval

Value of asset, income statements, and any other running loan

Borrower’s income and other existing loans.

Tenure

Long term

Short term

 

Secured and Unsecured Loans – Pros and Cons

Borrowing money involves risks both for the creditor as well as the borrower. Before deciding which type of loan works best for you, here is a brief on the pros and cons of each.

Advantages of Secured Business Loans:

  • Lower Interest Rate: The secured loans are accompanied by collateral. As such a loan poses less risk, the interest rates levied are usually less.
  • Large Loan Amount: While the risk is diminished, the collateral generally is a high-value asset. This allows for a larger loan amount disbursal.
  • Better Terms: The repayment tenure is longer for secured loans.

Disadvantages of Secured Business Loans:

  • Asset at Risk: If the borrower cannot repay whatever may be the circumstances, the creditors hold the right to take the asset in possession.
  • Credit Score Damage: An unfortunate default in repayment lowers the credit rating and affects future ability to borrow money.

Advantages of Unsecured Business Loans

  • No Asset Risk: The borrower does not stand any risk of losing the assets as they are not pledged for collateral.
  • Short Tenure: The loans are approved generally for the short term. This means a lesser cost of interest over time.
  • Multi-Use Loans: The loans can be used for any purpose as deemed necessary by the borrower.
  • Fast Processing and Quick Disbursal: The absence of collateral makes the processing easier and quicker. The loan amount is credited to the bank account within the short time of approval. You can avail of an unsecured loan even from an online lender.

Disadvantages of Unsecured Business Loans

  • Demanding Eligibility Criteria: In the absence of collateral, the eligibility criteria are stringent, like a good credit score.
  • Small Loan Amount: The amounts approved are small to ensure that the borrower can repay the loan.
  • High-Interest Rates: Interest rates for unsecured loans are generally higher.
  • Short Term: The loan must be repaid within the short term, for example,five years.

 

Unsecured loans- Who is it for?

It is well known that a secured loan can enable you to borrow more at lower interest rates. However, this exposes the asset to risk if you default on payment. On the contrary, the unsecured loan does not put the asset at risk. Loans like car loans are always secured, but unsecured loans can be the pathway to credit if you do not have an asset to pledge. Also, if you lack a substantial credit score or credit history, then an unsecured loan can help you build credit ratings. An unsecured loan allows you to borrow a specific amount as per the requirement or if you need funds in a hurry. Unsecured loans are a good option if your savings are not substantial and you do not want to put your asset on the block.

Unsecured Loan- Why go for it?

An unsecured loan can be used to cover any business expense, be it expansion or inventory building or any other. Though your lender might ask the purpose of seeking a loan, most lenders will just want to ensure the ability to repay.

Unsecured loans are the go-to solution for a small business owner who urgently requires funds on short notice. It offers some conveniences like:

  • Tenure: It ranges from 12 months to 5 years. You can select the period as per your capability to repay.
  • Collateral: It is available without placing any asset for security.
  • Less Documentation: Without collateral to validate, the loan requires minimal documentation for processing. Additionally, you can submit the documents online to financial institutions and get the loan approved quickly.
  • Flexible: The loan can be used to service varied business requirements.
  • Credit Ratings: As you repay the loan on time, the unsecured loan can help improve your credit history and score.
  • Fast Approval and Fast Disbursal: The loan is quickly approved as time is saved on evaluating the collateral. Therefore, the amount is also disbursed promptly to the borrower’s account.

Unsecured Loan- Are you Eligible?

An entrepreneur now has access to the best small business loans in Australia. Since you are applying for a loan, you need to check if you fulfil the eligibility requirements. Here is a checklist for you so that you can submit relevant documents:

  • Minimum six months in business with an active ABN.
  • Minimum turnover of $ 5000 per month
  • Good credit history

On meeting these requirements, your business with the loan application approval is ready for a leap.

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You are just one step away from securing the right loan to grow your business.

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