Unsecured business loans work in a similar way to personal loans. A lump sum is advanced to the business and repaid in monthly or quarterly installments over a pre-agreed time period. Interest is charged on the outstanding amount of the loan at a fixed or variable rate as per the loan agreement. Sometimes the lender will also charge a fee to arrange the loan which will be incorporated into the repayments.
As opposed to a secured loan, where some asset of the business or business owner (e.g. property) is offered as security against the loan, with a secured loan the lender has very little recourse in the event that the business is unable to make payments. Because of this lack of security the lender will often charge a higher rate of interest on unsecured loans than on secured loans.
For the same reason the application process and lending criteria are also often stricter with unsecured loans than with secured loans. The lender needs to be assured that the risk involved in loaning the money is appropriate to the reward.
Pros and cons of unsecured loans
The chief advantage of taking out an unsecured loan is that you don’t need to put any of the business’s, or your own, assets at risk. In the event that the business is unable to make repayments on the loan the lender has no claim on any of the business’s property.
The disadvantage of unsecured loans is that they will nearly always be more expensive than a secured loan. The increased cost of borrowing will have a negative impact on the profitability of the business and could exacerbate any underlying financial difficulties.