For those new to business loans, it’s worth exploring some of the basic terminology you will encounter around loan security.
We’ll explain the key differences between secured and unsecured business loans and the implications this will have on you.
What is a Secured Loan?
Any financial provider lending money will assess risk before signing on the dotted line. The principal way in which they mitigate risk for themselves is via gaining ‘security’ which means the rights to some kind of asset in the event of loan forfeiture.
In the typical example of this, a borrower will offer their property as security, meaning the lender gains the reassurance that there is a verifiable asset of a certain value should the loan repayments not be made.
For the lender, this means that the contract you sign will include clauses around security, and the details of the assets listed as collateral.
What is an Unsecured Loan?
Sometimes people either don’t wish to, or don’t have the assets, to obtain a secured loan. In this case, there is the option to apply for an unsecured loan which can give access to finance without the need for security.
Unsurprisingly, unsecured loans are typically for smaller amounts than secured ones, and may carry higher interest rates.
They also require a stronger credit score than secured ones, since the lenders will need to feel confident of your track record and ability to repay under the agreed terms.
Advantages of Secured Loans
- Available for much larger amounts than unsecured finance
- Available for those with imperfect credit scores
- Available for longer terms than loans without security
Disadvantages of Secured Loans
- The loan security can be sold by the borrower should you become insolvent or become unable to pay
- My required a personal guarantee where corporate assets are insufficient
Advantages of Unsecured Loans
- More widely available than unsecured.
- Appropriate for startups and businesses without fixed assets
- Can be available with an initial payment holiday of up to 3 months
- Longer loans (ie. 3-5 year) come with a better interest rate, meaning shorterm term loans will be more expensive
Disadvantages of Unsecured Loans
- They can be expensive
- They require a high credit score if you are going to get the best interest rates
Personal Guarantee Clauses
If you are a business seeking a loan but lack the corporate security, lenders will offer the opportunity to secure finance via a personal guarantee clause. In essence, this means you can secure your business loan by using your personal asset – often a family home – as security.
While the personal guarantee clause has become a standard part of corporate finance, it should be used with caution. Many borrowers, full of excitement during the early stages of a new venture, will sign the guarantee without fully acknowledging the implications. If a business becomes insolvent, you could lose your family home so, with this in mind, we always encourage the use of personal guarantee insurance as a protective strategy.
Personal guarantee insurance means a large percentage of the loan will be insured should your company default. The ongoing costs can be paid as business expense.
Can You Get a Business Loan without a Personal Guarantee?
One of the questions we are commonly asked is whether it’s possible to arrange business finance without a personal guarantee.
The short answer is yes, in some cases. With the expansion of the alternative lending market, a range of specialist lenders do undertake loans without insisting on PG clauses.