Basics of Unsecured Business Loans
With so many financing options available for small businesses, it can be challenging to identify the best financing choice for you. For business owners without any assets that could be used as collateral, it is exceedingly difficult - if not impossible - to receive traditional financing.
The good news is that there is a small business financing option available that does not require a specifically identified collateral to secure a loan. This financing option is known as an unsecured business loan.
In this article, we delve into how unsecured business loans work and what lenders look to in lieu of collateral to minimize credit risk.
How an Unsecured Business Loan Works
Small businesses typically seek an unsecured business loan when they cannot qualify for a traditional loan or are unable to negotiate better repayment terms with another lender.
An unsecured business loan does not require business or personal assets to be pledged as collateral. However, without any collateral to secure the loan, lenders face significantly more than do the borrowers. To minimize the credit risk, most lenders will not offer unsecured business loans for new business owners and will often charge higher interest rates than they would if the loan was backed by collateral. Unsecured loans also require higher credit scores than secured loans.
Types of Lenders that Offer Unsecured Loans
You can apply for an unsecured loan at many different financial institutions.
Banks: While many of the larger banks limit their unsecured personal loan options, a handful, such as the Bank of America, still offer them. Some local community banks may also offer unsecured loans. Additionally, most banks offer unsecured credit cards and you may also qualify for a customer relationship discount if you already have an account at a bank.
Credit unions: If you are already a member of a credit union, do ask about their unsecured loan options. Credit unions typically offer lower interest rates and more flexible repayment terms on their unsecured credit cards and unsecured personal loans. However, one potential downside is that the loan amounts may be smaller at these financial institutions.
Online lenders: There are many different online lenders to choose from. The advantage of working with online lenders is that they may offer higher loan amounts and same-day funding, and some may be willing to work with people who have lower credit scores. However, online lenders may charge higher interest rates than do other types of financial institutions.
Applying for an Unsecured Business Loan
Each lender will have specific requirements and restrictions when it comes to any of their unsecured loan programs. Lenders may ask you about the following information when you are applying for an unsecured business loan:
Credit – Lenders will pull your credit report to see how you have managed your past loan and credit payments. Naturally, lenders will want to see an established history of responsible credit use, low credit balances, and on-time payments. Make sure your personal credit score is at least 700 before applying for an unsecured business loan.
Income – Lenders will want to see that you have the means to repay the loan. They will want proof that your business is generating sufficient and stable income.
Debt-to-income (DTI) ratio - Lenders use this ratio to determine your ability to repay the loan. To calculate this ratio, divide your total monthly debt payments by your pre-tax income. The general rule of thumb for DTI is lower number is better.
Types of Unsecured Business Loans
Unsecured loans include:
Although these unsecured loans and lines of credit are only guaranteed by your promise to pay, the lender still technically has recourse in the event of nonpayment. The lender can hire a collection agency, take you to court to garnish your wages, and report your late payments to the credit bureaus. These actions will most likely cause your credit scores to drop, making it exponentially harder for you to apply for another loan in the future.
If you believe an unsecured loan is right for you, then start by researching loan terms among several banks, credit unions, and online lenders. Make sure to compare fees, interest rates, loan terms, loan amounts, and special features that lenders offer.
Once you have found a good fit, fill out the loan application, and wait for approval.
Accel Business Funding has provided invoice factoring, business loans, and business lines of credit and has funded many businesses for more than $380 million. When banks say NO, we say YES to funding in 24 hours!