Secured vs. Unsecured Loan: 5 Main Differences
When rapid access to financing is imperative to smooth out cash flows or cover unforeseen business expenses, business borrowers have several different options at their disposal. Prospective borrowers have the option of choosing between an unsecured loan or a secured small business loan. Despite both being feasible options, there are some differences that borrowers should be aware of before applying for a loan.
What Is The Difference Between Secured and Unsecured Loans?
The obvious difference between secured and unsecured loan options is that an unsecured loan does not require collateral. By contrast, secured loans require collateral to act as security in case a borrower defaults on repayment.
Beyond collateral requirements, there is a big difference in the interest rates between secured and unsecured loans. With unsecured loans, lending is based on the borrower’s creditworthiness. Hence, loans are riskier for the lender, resulting in higher interest rates. Secured loans are less risky as the lender can repossess the collateral held as security for the loan and resell it.
With an asset at risk of repossession in case the borrower fails to meet the terms of the loan, there is generally a lower risk of default with secured loans. Unsecured loans do not pose any risk to a borrower’s assets, but instead their creditworthiness. Consequently, unsecured loans may carry a higher risk of default which further contributes to higher interest rates.
Unsecured loans, also referred to as signature loans, have fewer documentation requirements. Accordingly, the main qualifications are proof of creditworthiness, steady income, and a strong repayment history. Borrower will likely also receive funds much faster. Secured loans require more documentation which consequently results in a longer loan processing time.
The asset used as collateral in a secured loan needs to be insured to maintain its value throughout the loan payment term. Conversely, this is not something that a borrower of an unsecured loan needs to concern themselves with.
A Few Final Thoughts
The differences between secured and unsecured loan options do present prospective borrowers with some questions. While unsecured loans pose no risk to the borrower’s assets, their higher risk of default consequently results in high interest. By comparison, secured loans have lower interest and a lower risk of default, but pose a risk of loss to the borrower’s property. Although there are benefits and drawbacks to each, many borrowers prefer unsecured loans as they pose less risk to property, require less documentation and paperwork demands, and importantly, have faster processing times.