If you are an SME in the UK, access to finance may be at the forefront of your business plans.
Stimulate your cash flow, and it could help you unlock the door to growth and investment. Whatever you are considering a business loan for, it’s important to understand the difference between secured and unsecured loans so that you can make the right borrowing decision.
This article gives you a concise breakdown of either loan type, followed by some considerations for businesses in the UK.
Secured loans
A secured loan is backed by an asset. This asset is known as collateral and provides security to the lender.
The business asset used for a secure loan could be a property, vehicle, or piece of equipment. As part of the agreement, the lender has a claim on this collateral, and this means that secured loans are usually; a) easier to obtain and b) can offer more favourable terms.
Collateral
Collateral reduces the lender’s exposure to risk. For instance, a construction firm might use its vehicles or building equipment as collateral when applying for a loan.
If repayments can’t be met, the lender has the legal right to take possession of the asset to recover the debt.
Lender risk
From the lender’s perspective, the presence of collateral significantly lowers the risk involved. Under the terms of a secure loan, lenders are more likely to approve higher borrowing amounts, even if the borrower’s trading history is relatively short.
Interest rates
Because the lender’s risk is lower, interest rates on secured loans are typically more competitive than those on unsecured loans.
Borrowing amounts
Secured loans generally allow for larger borrowing limits. When valuable collateral such as equipment or property is involved, lenders feel more comfortable extending to a higher sum. This can smooth the path to investment in real estate or technology needed by a business.
Examples
Common types of secured business finance include; commercial mortgages, for purchasing or refinancing business premises; vehicle finance; equipment finance; or property-backed loans.
Unsecured loans
In contrast to secured loans, unsecured loans are not tied to any specific asset.
Lenders will base approval on factors such as the creditworthiness and financial performance of a borrower, as well as their trading history.
Unsecured loans can be quicker to arrange, because no collateral is needed. This gives SMEs quick access to funds.
Collateral
Unsecured loans require no collateral. Your business will not need to put forward any assets or property. For this reason, unsecured loans can be more attractive to newer businesses without many assets.
Lender risk
With unsecured loans, there is no asset for a lender to claim if payments stop. This means lender risk is higher. The flip side is that to compensate, lenders may charge a higher interest rate, and will require strong evidence of a company’s financial health.
Interest rates
Interest rates for unsecured loans will typically be higher than for secured products.
Despite the extra cost, the advantage for SMEs is the speed and simplicity that can be ideal for short-term funding needs or capitalising on business opportunities.
Borrowing amounts
Unsecured borrowing typically means smaller loan amounts. This reflects the greater risk.
Smaller loan amounts make unsecured loans suitable for bridging cash flow gaps or working capital, rather than funding for major investments.
Examples
Common types of unsecured loans include; overdrafts, unsecured business loans, business credit cards, and professional practice loans (tailored financing options for professionals like doctors, dentists, and solicitors).
Key considerations for UK businesses
Let’s wrap up with some important aspects to bear in mind for businesses in the UK:
Credit score
This may be a big factor in your eligibility for a loan. Both business and personal credit scores could be taken into account. A strong credit record can help secure more favourable terms, especially for unsecured loans.
Risk
Every loan carries a level of risk. Secured loans mean you could lose the asset you’ve pledged if you default. Unsecured loans won’t put specific assets in jeopardy, but missing payments can harm your credit profile and ability to borrow in the future.
Purpose
Finally, consider the purpose of the loan. For funding long-term investments (think equipment or new premises), a secured loan can be more suitable. If your need is short-term or project-based (such as smoothing cash flow or covering expenses), an unsecured loan may offer a better solution.
