If you seek to use business assets as the basis of a loan, then a secured business loan may be just what you need.
With this type of business loan, if you cannot repay the money to the lender, they will use the sale of assets provided as security to cover their costs.
The amount you can borrow depends on the value of the assets provided as security within the loan, ranging from machinery to vehicles, property, land and more.
In this article, we’ll explore secured business loans, what type of collateral may be appropriate, and the likely charges for this type of finance.
What is a Secured Business Loan?
A secured business loan is a type of financing where the borrower puts up collateral, such as property or equipment, to secure the loan.
If the borrower defaults on the loan, the lender can seize the collateral to recoup their losses. Secured business loans typically offer lower interest rates and longer repayment terms than unsecured business loans but also have a higher risk of losing the collateral if the loan is not repaid.
Example of a Secured Business Loan
A small business owner is seeking £50,000 in financing to purchase new equipment for their company. They have a good credit score and own a commercial property that they are willing to use as collateral for the loan.
The owner applies for a secured business loan from a lender who offers them a loan at an interest rate of 5% per annum, with a repayment period of 5 years. The monthly repayment amount comes out to be £947.37. The owner signs the loan agreement and provides the commercial property as collateral.
In this scenario, the secured business loan provides the owner with the funding they need to purchase the new equipment, and the use of collateral helps to secure a lower interest rate and favourable loan terms.
Pros and Cons of Secured Business Loans
- Lower interest rates: Secured loans typically offer lower interest rates than unsecured loans, as the lender takes on less risk.
- Longer repayment terms: Secured loans may offer longer repayment terms, giving the borrower more time to repay the loan.
- Access to larger loan amounts: Lenders may be willing to offer larger loan amounts for secured loans, as the collateral provides added security.
- Improved loan terms: With a secured loan, the borrower may negotiate better terms, such as lower interest rates or longer repayment periods.
- Risk of losing collateral: If the borrower defaults on the loan, the lender can seize the collateral, potentially causing significant financial loss to the borrower.
- Longer approval process: Secured loans may have a longer approval process, as the lender will need to assess the value of the collateral before approving the loan.
- Higher eligibility requirements: Secured loans may have higher eligibility requirements, such as a minimum credit score or a certain amount of collateral.
- Reduced flexibility: The borrower may be required to use specific collateral, limiting their ability to use it for other purposes.
How Do Secured Business Loans Work?
The loan application process for a secured business loan is fairly standard. Prospective borrowers make an application, offering their basic requirements:
- Loan Amount
- Duration of Loan
- Details of any Security Offered
Lenders will then assess the level of risk, checking credit scores, the asset’s value, and the borrower’s reliability. If their requirements are met, they will make an offer.
Criteria & Eligibility
Eligibility criteria for secured business loans typically include:
- Collateral – Aside from turnover and credit, asset value remains the biggest factor in your likelihood of getting the green light on a secured loan. If the business is too new or small to have its own, directors may be asked to put personal assets on the line by signing a personal guarantee document.
- Turnover – Of course, all lenders have their own specifics, but the preliminary criteria all providers will need is a healthy level of monthly turnover. Lenders positively want to lend you money since that’s how they run their own business, but they need a certain amount of confidence you’ll be able to pay it back, which starts with turnover.
- Credit Score – The business credit score check is standard practice in the lending industry since it provides immediate data on the potential customer’s financial reliability. It’s important to realise lenders will investigate the business’s and the individual’s credit ratings as part of their analysis.
- Years in business: Most lenders require that the business has been operating for a minimum of 2 years.
What Can Be Used as ‘Collateral’ ?
Lenders will always prepare hard assets (cash, building and land etc.) over soft (intellectual property) because they represent greater security in most cases.
Types of Collateral You Can Use:
- Commercial machinery or equipment
Securing a Business Loan with a Personal Guarantee
Where the business has no collateral of its own to offer, it is still possible to gain business finance via the use of a personal guarantee.
These documents allow a company member (often a director) to offer a personal asset (often a house) as a loan guarantee. While these can be a useful means of securing finance, they are also risky to put one’s name to since, should the business become insolvent, it can place your family’s house on the line.
We also recommend using personal guarantee insurance should your secured loan necessitate a personal guarantee.
How to Apply for A Secured Loan
The application process for a secured business loan typically involves the following steps:
- Preparation: Gather necessary documents, including financial statements, tax returns, and a business plan, to support the loan application.
- Research: Compare different lenders and loan options to find the best fit for the business.
- Application: Submit the loan application and required documentation to the lender.
- Assessment: The lender will assess the loan application and determine the loan amount and terms that can be offered.
- Collateral evaluation: The lender will evaluate the collateral offered to ensure it sufficiently covers the loan amount.
- Approval/Denial: If the loan is approved, the borrower will sign a loan agreement and provide the collateral. If the loan is denied, the borrower may need to reapply with a different lender or revise the loan application.
- Funding: Once the loan agreement is signed and the collateral has been provided, the loan will be funded.
Are Secured Business Loans Regulated in the UK?
Where the loans are for limited companies, they are regulated by the FCA.
Individuals and sole traders can borrow from unregulated lenders, however.
Secured Business Loans that may be Eligible for the Enterprise Financial Guarantee (EFG)
The government set up the Enterprise Financial Guarantee to make it easier for smaller businesses to take advantage of secured loans.
With EFG loans, the lender still uses a commercial lending facility, but the government stands in as security, offering to cover 75%of the losses the lender might suffer in case of default.
There are fairly strict criteria for acceptance which include:
- Appropriate business niche
- Viability of business plan
- Turnover below £41m
- Seeking finance of between £1,000 and £1.2 million
As of June 2018, more than 30,000 EFG loans have funded over 3.2bn for British businesses.
Choosing the Right Secured Business Loans
When choosing the right secured business loan, consider the following factors:
- Loan amount: Determine the funding needed and compare loan options to find the best fit.
- Interest rate: Compare the interest rates offered by different lenders to find the most favourable terms.
- Repayment terms: Consider the repayment terms, including the length of the loan, the monthly payment amount and the due date.
- Collateral requirements: Understand the collateral requirements and ensure the business has sufficient collateral to cover the loan amount.
- Eligibility criteria: Check the eligibility criteria and ensure the business meets the requirements.
- The reputation of the lender: Research the lender’s reputation, including customer reviews, to ensure the lender is reputable and trustworthy.
- Fees and charges: Consider any fees and charges associated with the loan, such as origination fees or prepayment penalties.
Secured Loan FAQs
What types of collateral can be used for a secured business loan?
Common types of collateral used for a secured business loan include property, equipment, inventory, accounts receivable, and savings accounts.
What are the eligibility criteria for a secured business loan?
Eligibility criteria for a secured business loan may include a minimum credit score, years in business, revenue and cash flow, and sufficient collateral. Requirements vary among lenders.
What happens if I default on a secured business loan?
If the borrower defaults on a secured business loan, the lender can seize the collateral to recover the loan amount. This can result in significant financial loss for the borrower.
Can a secured business loan be refinanced?
Yes, a secured business loan can be refinanced. This involves obtaining a new loan to repay the original loan and can be used to obtain better loan terms or lower interest rates.