The main advantage of unsecured business loans is that collateral is not required to get this form of financing. In contrast, SBA and conventional business loans almost always require collateral to provide a second source of loan repayment if the borrower can’t make the loan payments.
The main downside to unsecured business loans is that they almost always have higher interest rates compared to SBA and conventional business loans.
There is a big downside to unsecured loans. Because lenders are forced to take on more risk with unsecured loans, they will almost always charge you higher rates and higher monthly payments compared to a loan secured by collateral.
Because an unsecured loan is not secured by collateral, lenders giving out these loans focus heavily on the business owner’s personal credit history.
There is a high correlation between the personal creditworthiness of a business owner and their business’s likelihood of paying back an unsecured loan. As a result, when lenders evaluate a loan application, they look for red flags in a potential borrower’s credit history.
Items such as previous bankruptcy filings, liens, judgments or failure to pay student loans or child support will probably result in the loan application being denied. A history of late payments for staple expenses such as a mortgage, car payments or credit card bills will cause them to conclude that the risk of default is high.
The following is an example of one lender’s criteria for granting an unsecured loan:
- FICO score of 720 or better
- No bankruptcies or foreclosures
- No late payments for 2 years
- 8 – 10 year minimum credit history
- 3 – 4 term loans (car loans and mortgages)
- 3 – 4 credit cards with 10K + limits ideal
- 20% or less usage of credit card limits
Corporate entity with an Employer ID number
- No income verification is required
In most cases, verification of income is required in order to get an unsecured business loan.
In the above example, income verification was not required. However, this is usually not the case. This is especially true if you are trying to borrow a lot of money. Lenders will often request up to three years of personal and business tax returns to verify your income if you are seeking an unsecured loan for $25,000 or more. When the stakes are high, lenders want to verify that you have the financial resources to pay back the loan if your business venture fails or goes poorly.
A FICO score of 700 or above greatly increases your odds of getting an unsecured business loan.
While your personal credit score might not make or break your chances of getting an unsecured business loan, it will definitely impact your borrowing cost. In general, if your FICO score is less than 700, your cost for borrowing money will significantly go up.
Currently, many banks are reluctant to give out short-term, unsecured loans.
Before 2008, banks were handing out huge numbers of unsecured loans. At that time, if you had a decent credit score, you were granted a loan or an unsecured line of credit. Unfortunately, many of these loans went into default when the economy went into a recession in 2008 and 2009. Because of these huge losses, many banks are now unwilling to give an unsecured business loan.
In the current lending environment, it is mostly non-bank lenders that are giving out unsecured business loans.
It is recommended that you compare the interest rates and terms from at least three lenders before making a final decision.
Beware of very high interest rates for certain types of unsecured loans.
Payday loans and credit card cash advances are examples of unsecured loans that have very high fees and interest rates. With payday loans for example, the average loan time is two weeks, and the interest charged is the equivalent of 400% annual interest rate (APR) or more. The current national average APR for credit card cash advances is currently around 24%.
An SBA or conventional business loan will always give you better rates and terms compared to unsecured loans.
Because collateralized loans have less risk, lenders are willing to provide better interest rates. As a result, if you have business or personal assets that could be used as collateral, you might want to seriously consider using them to lower the rate on your loan.
In most cases, the best source of debt financing is an SBA loan.
SBA loans usually have the best rates and terms because they are guaranteed by the Small Business Association. One of the leading providers of SBA loans is Newtek, the “Small Business Authority.” In most cases, Newtek can pre-qualify a business for an SBA loan for as much as five million or as little as fifty thousand dollars in as little as 48 hours.