Having to provide collateral can be a deal breaker for most small business owners. Even if you don’t submit collateral, it doesn’t mean you can avoid recourse from your lender if you do not pay off your loan. Many business funding lenders require that you sign a personal guarantee which means the lender can come after your assets.
No collateral business loans tend to be more expensive than collateralized loans. It is important to recognize the pros and cons of a no collateral business loan. In this article, we will go over the pros and cons so you can decide if it is right for you.
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 to secure the loan.
You might also hear those types of loans referred to as unsecured business loans. There’s not a difference between an unsecured and a collateral-free loan. The term unsecured just means it is not secured by collateral.
The Pros of Collateral-free Business Loans
- Less complicated application process: your lender has to do paperwork to secure the loan properly. You might also need to have an appraisal done to establish the value for the collateral. 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.
- Loan value doesn’t depend on your assets: 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.
- 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.
The Cons of Collateral-free Business Loans
- High interest rates: securing a loan with collateral enables the lender to recoup the loss by selling your asset if you default. However, since collateral-free loans don’t offer this protection, lenders compensate by charging higher interest rates. An unsecured loan will be more expensive than a secured loan.
- You can be sued: your lender can sue you to have a lien placed on your assets. If you lose the case, you are obligated to pay back your loan in addition to the late fees. In addition to that, you will have to pay for court costs and attorney fees.
- Hard to qualify for: when an alternative lender evaluates a borrower for an unsecured loan, they are relying on the creditworthiness on that borrower. So, if the borrower defaults, they’ll need to go through a time-consuming legal process to recoup their losses.
The Bottom Line
Many small business owners don’t have enough assets to serve as a collateral. others prefer to avoid the risk of losing their assets. For these borrowers, unsecured loans can be a great fit. Collateral free loans might not be for everyone but can be a great fit if it is the right scenario. If you are considering this type of financing, make sure to review the pros and cons.