How to Get a Business Loan Without Collateral
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Not having collateral to pledge for a loan won’t necessarily stop a business from securing funding. However, in order to qualify for a loan without collateral, a business owner will have to do some research to learn about the different options that exist.
Whether considering a line of credit or term loan, rates may be higher without collateral since the bank will be taking a larger risk in the event that the borrower defaults on the loan. Lenders who offer loans without collateral will place a higher premium on creditworthiness than on collateral.
When it comes down to it, it really all depends on the loan someone is trying to acquire, explained Amanda Arnold, vice president of marketing and business development with the Credit Union of Georgia.
So let’s dive in and find out how to get a business loan without collateral.
Do small business loans require collateral?
Some small business loans require collateral, while others do not. Secured loans refer to loans that are backed by collateral, while unsecured business loans are loans that do not rely on collateral to secure the loan.
Collateral is an asset that a borrower uses to secure a loan. Collateral provides security for the lender because in the event of loan default, the lender can seize the asset to make up for their losses. The best case scenario for lenders is for the business succeed, not to claim collaterally.
A borrower is more likely to secure a loan with more favorable terms when collateral is used. Some examples of collateral include buildings, inventory, vehicles, accounts receivable and inventory.
Without a way to recoup on costs–particularly if the loan is for a large amount–lending becomes risky and can be problematic for a bank if their funds are tied up in the accounts of its clients.
For a small business owner that wants to grow their business–but might not have enough collateral for the loan or simply doesn’t want to pledge collateral–they can still secure financing through an unsecured loan.
Unsecured loans are offered mainly through alternative lenders, although some commercial banks have unsecured options in addition to secured loan options.
Types of collateral you can use for small business loan
A few examples of acceptable collateral include real estate and other property (i.e. vehicles, boats, airplanes), business savings accounts receivable and inventory. Let’s break things down into bite-size information.
Real property: Real property can be real estate, such as a home. Property is a good form of collateral for banks because the value of property remains even with the progression of time. The concern with real property is that if you use a home as collateral, the implications could be dire if you default. Real property can also include equipment, vehicles, boats, planes and motorcycles.
Business savings account: Using your business savings as collateral works to the advantage of a lender because if a borrower defaults on a loan, the account can immediately be liquidated. This type of loan is high-risk because a business could lose its savings. Putting up a cash-secured loan (also called a savings-secured loan) as collateral will net a lower interest rate for the loan.
Invoices: If you’re still waiting for invoices to be repaid and it’s affecting cash flow, another option is to offer these invoices as a form of collateral. In exchange for outstanding invoices, the business owner will get a quick infusion of cash that will be repaid, minus the factoring fee.
Blanket liens: Blanket liens give lenders access to all business assets in the event of default. The action protects lenders, but can be difficult for borrowers due to the possibility of losing ownership of the assets. Lenders can file a UCC lien, which gives them priority in seizing assets if the borrower defaults.
Securing additional financing will also be more difficult if you have a blanket lien, unless a new lender will be willing to take a second, or third-lien position to the first lender.
Inventory: Despite the fact that inventory may depreciate, it can also function as collateral. If a business needs inventory, the inventory itself can act as collateral. To account for depreciation, a lender might work with a third-party to determine the value of the goods. Inventory isn’t the most secure type of collateral because they could lose money if the business doesn’t sell the inventory or the lender is unable to sell the inventory.
How to get an unsecured business loan
Alternative lenders will most likely be the best source for securing unsecured loans, although some commercial banks may have unsecured options. The Credit Union of Georgia, for example, offers two types of unsecured loans: Signature Loans and credit cards.
The application requirements will be similar to the application requirements for secured loans. Here are some things to consider before getting started:
- Research all options- Read reviews online and get advice from those in your inner circle who have experience with unsecured business loans. There are countless comparison websites for banks and online lenders. Compare loan terms, interest rates and whether they are fixed or variable-rate loans. You can never know too much when it comes to securing money for your business.
- Review (and improve) your credit- Get a copy of your credit score from major agencies such as Dun & Bradstreet, TransUnion, Experian or Equifax. Credit can be improved by paying off the balance on a credit card and also by making sure that you have positive credit history included on the report. If you have a positive payment history with a supplier that isn’t reflected on your credit report, contact them about reporting this information, which can help to improve your credit score.
- Look at cash flow and forecasts- Figure out what your cash flow currently looks like and determine future projections. Review your cash flow to make sure that you can afford to take on debt, particularly debt that will cost more than a secured loan. A good rule of thumb is to keep your debt-to-assets ratio within a reasonable amount, which can vary by industry. A debt ratio less than 100% is indicative of a company that has more assets than debt, while a debt ratio above 100% is indicative of a company that’s functioning with more debt than assets.
- Develop business plan- The business plan should show your growth strategy, identify strengths and weaknesses, and supply current and future revenues. The business plan can provide a better picture of your risk level and your ability to repay a loan. A non-bank lender may not ask for a business plan, but it’s not a bad idea to have one ready.
Collateral-free business loans: Pros and cons
|Less stringent application process than traditional lenders.||Higher interest rates and smaller loan amounts.|
|Quick approval with some online approvals within 24 hours.||You might be required to pledge a personal guaranty, which will be a personal asset. If a borrower defaults, the borrower will lose their pledged asset.|
|Assets are safe because nothing was used to secure the loan, such as equipment.||Payment terms might be more frequent, with daily or weekly payment periods.|
Business funding that don’t require collateral
Many avenues exist for unsecured lending. Approval will depend on things like your revenue, credit score and number of years in business, among others. Below is a list of business funding types that don’t require collateral:
- Term loans: Unsecured term loans are available through online lenders such as Kabbage, but will carry a higher annual percentage rate (APR). Depending on the lender, your credit doesn’t have to be immaculate.
- Line of credit: A line of credit from an unsecured lender works the same way as a line of credit that’s secured with collateral. It offers flexibility to a business by allowing them to access funds when needed. Similar to term loans, factors that may be considered are your credit score, revenue and time in business.
- Business credit cards: Most credit cards are unsecured unless you specifically apply for a secured credit card. Be sure to use credit cards responsibly, especially after the introductory interest rate has expired.
- Merchant cash advance: A merchant cash advance company will advance cash to a business in exchange for future credit card sales, which is repaid periodically until the debt is repaid in full. MCAs are often the most expensive funding option for fast cash.
- Invoices: Some alternative lenders provide advances in exchange for invoices. The invoices serve as collateral, so you don’t have to provide anything up-front to secure the loan other than your invoices.
Businesses can find unsecured lending or secured lending for their business loan. Unsecured loans may be more expensive and have shorter loan terms, so it’s important to carefully weigh your options before signing on the dotted line.