Secured Vs Unsecured Loans
Don’t apply until you know the difference!
As a small business owner, it is important to know which type of loan to apply for at different stages of your business. It is therefore essential to know the difference between secured and unsecured loans.
Let’s be honest, applying for loans can be stressful!
Given the rise of fintech companies in India, you can now fill out an application online to borrow money for just about anything. First, however, you have to be sure of what kind of loan you want to get.
As a basic principle there are two types of loans to be aware of: secured and unsecured loans.
Secured loans are those loans which are protected by the asset being financed (primary security) or any other security offered for the credit facility (collateral secured). While property is the most common and preferred form of security, collateral can be held in various forms such as property, cars, stocks, bonds, mutual funds and other assets that have an associated value. The bank will hold an interest in the security, and in the event that you are unable to pay back the loan, the lender will be able to act on their rights against your collateral in order to recover their costs. This means you could lose your collateral.
Why would a small business owner want to get a secured loan? There are lots of reasons!
1. You don’t need a perfect credit rating: If your credit rating is less than perfect, you may face a few challenges while trying to get a loan. However, since a secured loan is backed by an asset or collateral, a lender may be ready to lend to a borrower they perceive as riskier.
2. Interest rates are relatively lower: Interest rates for secured loans often are lower. The security interest they have taken in the borrower’s collateral gives the lender an additional layer of monetary protection in the event of a loan default.
3. Longer repayment period: Lenders may be willing to provide longer term loans if there is collateral provided. This gives the borrower enough time to pay off the debt.
Unsecured loans are those which are given to you without any assets attached to it (no collateral). If you are not able to pay back the loan amount, the lender doesn’t have the right to take any of your personal assets as an alternative form of recovering his loss. Therefore, unsecured loans are often priced at a higher interest rate as the lender is taking a bigger risk while lending to you without any leverage.
Despite having a high interest rate, there are several advantages of applying for unsecured loans:
1. No risk to your personal assets: Applying for an unsecured loan means you do not have to offer any of your personal assets as collateral. You know that whatever happens in business, your family, home and personal properties won’t be at any risk.
2. Less stringent pre-requisite: Unsecured loans are generally short duration and for smaller amounts. Therefore most lenders have a short list of prerequisites, which if complied with, they review before giving the loan compared to that of a secured loan.
3. Fast application and approval: With the rise of fintech companies, the speed and efficiency of being approved for a loan has become much faster.
Deciding the correct type of loan for your business begins at choosing the right lender and agreeing upon a fixed rate of interest, which you can repay comfortably. This is a very important step in the process, as it will help to ensure that you do not place too much pressure on your business and its cash flow. It also helps to avoid any potential repayment issues, which ultimately could impact your credit and long-term ability to get debt.
A small business owner can decide which type of loan is a better fit given the nature of their business, quality of their credit history, duration of the loan and personal preference for providing security. All of these considerations are factors in identifying the right option for you. However, in financing a growing business, it is not uncommon to use a combination of secured and unsecured loans.