What is the difference between a secured and unsecured working capital loan?

When it comes to exploring various financing options, whether you are selling products, services or delicious beers from a famous microbreweryOne of the most important distinctions that your business must make is between a secured and unsecured working capital loan. Below, we highlight the basics of each so you can move forward with a smart and strategic decision.

Guaranteed working capital loans

Essentially, a secured working capital loan is backed (or “secured”) by collateral in the event of default. There are different types of guarantees, including real estate, equipment, vehicles, and in some cases personal property as well. Each lender has their own approach, definitions and criteria.

The biggest advantage of a secured working capital loan is that they are usually available at lower rates than an unsecured working capital loan (which we’ll explore shortly). Additionally, most conventional lenders and virtually all banks will only offer secured loans. There is no unsecured option available, and an application that does not have enough guarantees listed will be rejected.

However, there are significant risks associated with secured working capital loans that you may find problematic or unacceptable. The first is that you risk losing a valuable asset if you default. Second, lenders are known to undervalue collateral because it is in their best interests to do so. Third, an asset listed as collateral cannot be sold during the life of the loan unless it is replaced by another asset, which is a time consuming process and usually involves additional administrative costs. In addition, there is no guarantee that a lender will agree to accept a replacement property, or that it will give it the same value (i.e. that it will be able to give it a lower value, thus requiring the addition of new assets to the list of guarantees).

Unsecured working capital loans

As the term suggests, an unsecured working capital loan is not backed by collateral to secure repayment obligations. Of course, this does not mean that the refund is optional, or that you can arbitrarily change the terms and conditions. It just means that you don’t have to pledge any assets (business and / or personal) in order for your loan application to be assessed and possibly approved.

Obviously, the most compelling advantage of an unsecured working capital loan is that it is not necessary to pledge any assets as collateral. There is also no risk of the assets being undervalued, and the approval process is usually faster (some banks can take weeks to value the assets pledged as collateral).

The downside of an unsecured loan is that the rates are generally higher compared to a secured option. However, this downside is somewhat mitigated by the fact that some lenders who offer this type of business financing will allow you to prepay your loan if you wish, without incurring additional fees or interest.

What is right for you?

Of course, it is beyond the scope of this article to advise you definitively on the best option for your business: a secured working capital loan or an unsecured working capital loan. However, it’s safe to say that the smartest and safest thing you can do is do your due diligence, ask as many questions as you need and get all the facts you need before you take a decision – not after. This way, you will ensure that your choice of business financing is rewarding rather than regrettable.

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