Secured vs unsecured business loans: what’s the difference?

One of the first choices you face when borrowing for a business is whether the loan will be secured or unsecured. The difference is about what the lender can fall back on if the loan isn’t repaid. That single distinction affects how much you can borrow, how long you can borrow for, how the cost compares and what is at risk if things go wrong. Neither is better in every case. The right choice depends on what you are borrowing for and what your business and its directors are comfortable putting at stake.

What is a secured business loan?

A secured business loan is backed by an asset. If the business can’t repay, the lender has the right to take and sell that asset to recover what it is owed. The security is usually recorded formally, for example as a legal charge over property or a debenture over company assets.

Common forms of security include:

• Commercial property owned by the business.
• Residential property owned by a director, including buy-to-let property.
• Equipment, machinery and vehicles.
• Unpaid invoices or stock, as in invoice finance and asset-based lending.
• A debenture, which gives the lender a charge over the company’s assets more generally.

Asset finance and commercial mortgages are types of secured lending where the item being bought acts as the main security. With other secured loans, the asset offered as security doesn’t need to be connected to what the money is spent on. A director might, for example, offer a buy-to-let property as security for a loan to fund an expansion.

What is an unsecured business loan?

An unsecured business loan isn’t backed by a specific asset. The lender relies mainly on the strength of the business: its trading history, cash flow, accounts and credit record. Because there is nothing specific to recover if the loan goes unpaid, the lender takes on more risk.

“Unsecured” doesn’t always mean nothing is at stake. Most unsecured business loans to limited companies and LLPs require a personal guarantee from one or more directors. If the business can’t repay, the lender can then pursue the guarantors personally for the amount owed under the guarantee.

How they compare

The trade-offs are broadly predictable, although each lender sets its own terms:

• Amount: secured loans can often be larger, because they are limited by the value of the security as well as affordability. Unsecured amounts are usually smaller and tied more closely to turnover and cash flow.
• Term: secured loans can run for longer, sometimes many years for property. Unsecured loans tend to be shorter.
• Cost: because the lender’s risk is lower, secured lending is often priced more keenly than unsecured lending for a similar business, though fees for valuations and legal work can add to the cost.
• Speed: unsecured loans can often be arranged more quickly, because there is no property to value or charge to register.
• Risk to you: with secured lending, the specific asset is at risk. With unsecured lending, a personal guarantee may put the director’s own finances at risk.

When a secured loan may suit

Secured lending often makes sense for larger amounts, longer-term investment and purchases where the asset itself provides the security. Buying premises, refinancing existing property debt, buying expensive machinery or raising a substantial sum for expansion are typical examples. It can also help a business with a limited trading history or a weaker credit record, because the security gives the lender extra comfort. Bear in mind that arranging security takes time. Property usually needs a valuation and legal work, and the lender will want to register its charge before releasing the money, so plan ahead if your timing is tight.

When an unsecured loan may suit

Unsecured lending tends to suit smaller amounts, shorter terms and situations where speed matters, such as taking on a new contract, buying stock, covering a cash flow gap or investing in marketing or staff. It is also an option for businesses that don’t own significant assets, or whose directors would rather not put property on the line. Lenders will look closely at bank statements and recent trading, so steady income and a clean account matter more here than with secured lending. Expect the amount on offer to reflect what your cash flow can comfortably support.

Questions to ask before you choose

• What exactly is being used as security, and what happens to it if repayments are missed?
• Is a personal guarantee required, and is it limited to a set amount or unlimited?
• What is the total cost, including arrangement, valuation, legal and early repayment fees?
• Does the term match the life of what you are paying for?
• Could a different product, such as asset finance or invoice finance, do the job better?

Both secured lending and personal guarantees are serious commitments. Read the agreement carefully, make sure you understand what you could lose and take independent legal advice before signing a charge or a guarantee.