Introduction
Getting a business off the ground and scaling it up requires a significant amount of hard work and good business sense. However, intent and capability are not enough for an entrepreneur to succeed. One of the key factors that decide the viability of a business is the availability of adequate capital. Whether it’s for expansion, day-to-day operations, purchasing equipment, or addressing unforeseen expenses, businesses often require external funding. Small businesses, in particular, operate on limited resources and liquidity, making access to timely and reliable financing even more critical.
One of the most crucial decisions a small business owner faces when seeking a business loan is choosing between a secured or an unsecured loan. This decision can significantly impact the business’s financial flexibility, risk exposure, and growth trajectory. Secured loans require collateral, such as property, equipment, or inventory, which acts as a security for the lender, often leading to lower interest rates and higher loan amounts. In contrast, unsecured loans do not require collateral, making them more accessible to businesses that may not have valuable assets to pledge, though they often come with higher interest rates and stricter eligibility criteria.
Understanding the differences between a secured loan and unsecured loan, their respective benefits and drawbacks, and how they align with your business’s financial health and goals is essential to making an informed borrowing decision. The right choice can provide the necessary capital while maintaining financial stability and ensuring sustainable growth.
What is a Secured Loan?
A secured loan is a loan backed by collateral—an asset such as real estate, inventory, or equipment. Lenders use this collateral as security, reducing their risk in case of default. This is the preferred option for most traditional lenders since it reduces the risk of lending and provides them with a tangible asset to recover funds if the borrower is unable to repay.
One of the key features of secured loans is that they typically come with lower interest rates and higher loan amounts compared to unsecured loans. Because the lender has collateral as security, they are more willing to offer favorable terms, including longer repayment periods and flexible conditions. However, the risk for the borrower lies in the potential loss of the asset if they fail to meet repayment obligations.
When considering a secured loan, it’s essential to understand the different secured loan features that can impact borrowing decisions. These include the type of collateral required, the loan-to-value (LTV) ratio, interest rates, repayment tenure, and eligibility criteria. The loan amount is often determined based on the value of the collateral, and some lenders may have specific requirements regarding the type of asset that can be pledged.
There are many examples of secured loan types, including loans against property (LAP), and business loans backed by equipment or inventory. Each of these loans serves a specific purpose and requires an asset to be pledged as security.
Likewise, there are different examples of collateral for a secured loan, such as residential or commercial property, machinery, raw materials or even accounts receivable in some cases. The type of collateral accepted depends on the lender’s policies and the nature of the loan.
Grow your MSME with collateral-free business loans
Features of a Secured Loan
- Requires Collateral as Security: Borrowers are required to pledge an asset such as property, inventory, or equipment, which acts as security for the loan.
- Generally Offers Lower Interest Rates: Since lenders have collateral to mitigate their risk, they can offer more competitive interest rates compared to unsecured loans.
- Higher Loan Amounts Available: The loan amount is often determined by the value of the pledged asset, allowing borrowers to access larger sums of capital.
- Longer Repayment Terms: Secured loans typically come with extended repayment periods, making it easier for borrowers to manage cash flow and repayments.
- Lower Risk for Lenders: With collateral in place, lenders have a safety net in case of default, reducing their overall financial risk.
Examples of Secured Loans
Examples of secured loans include:
- Loan Against Property (LAP): Using commercial or residential property as collateral
- Equipment Financing: Loans secured by machinery or equipment
- Inventory Financing: Loans backed by business inventory
What is an Unsecured Loan?
An unsecured loan is a type of financing that does not require the borrower to pledge any collateral. Instead of relying on assets as security, lenders assess the borrower’s creditworthiness, business financials, and repayment capacity to determine loan approval. Since there is no collateral involved, lenders take on more risk, which often results in higher interest rates compared to secured loans.
Unsecured business loans are particularly beneficial for small businesses that may not have significant assets to pledge. These loans provide quick access to funds for working capital business loans, expansion, or other business needs without the risk of losing valuable assets. However, due to the higher risk for lenders, the approval process may involve stricter eligibility criteria, including a strong credit score, steady revenue, and a proven track record of financial stability.
Features of an Unsecured Loan
- No Collateral Required: Businesses can access funding without pledging assets, making unsecured loans a great option for MSMEs looking for flexible financing.
- Quick Access to Funds: With AI-powered underwriting and automated approvals, unsecured business loans are processed faster, ensuring that businesses receive funds when they need them most.
- Flexible Repayment Terms: Digital lending models allow for structured repayment plans suited to a business’s cash flow, reducing the burden of short repayment periods.
- Inclusive Financing for a Wider Range of Businesses: AI-driven credit evaluation helps assess a borrower’s financial strength beyond traditional metrics, enabling more MSMEs to qualify for funding despite limited credit history.
Examples of Unsecured Loans
Examples of unsecured loans include:
Business Loans from NBFCs:
- MSME Loans provided by NBFCs like Kinara Capital are collateral-free.
- NBFCs also provide unsecured Working capital Business loans
- HerVikas programme from Kinara Capital provides collateral-free business loans for women-owned businesses.
Difference Between Secured and Unsecured Loans
| Aspect | Secured Loan | Unsecured Loan |
| Requires Collateral | Yes | No |
| Loan Amounts | Larger Loan Amounts | Smaller Loan Amounts |
| Repayment Periods | Longer Repayment Periods | Shorter Repayment Periods |
| Paperwork | Lot of Paperwork | Very Minimal |
| Approval Process | Slower Approval Process | Faster Approval Process |
| Suitable for | Large Scale Businesses | MSMEs/Small Businesses |
Which Loan is Better for You? Secured or Unsecured Loan?
The right loan option for your business largely depends on your specific financial needs and situation. If you require a large loan amount with lower interest rates and have valuable assets to pledge, a secured business loan is likely the best choice for you. This option can offer higher loan amounts and more favorable repayment terms, making it ideal for businesses looking to secure substantial funding for expansion or capital needs. On the other hand, if you prefer quick funding without the risk of losing assets and need access to capital without pledging collateral, unsecured loans might be a better fit. While these loans generally come with higher interest rates and smaller amounts, they offer the flexibility of a faster approval process and less documentation.
Conclusion
Both secured and unsecured business loans have unique benefits, and the best choice depends on your business’s requirements. Best secured loans provide larger sums with lower interest rates, but they require collateral and a more thorough approval process. Unsecured loans, while faster to obtain and requiring no collateral, come with higher costs and more limited funding. By carefully evaluating your financial situation, risk tolerance, and funding needs, you can make an informed decision that supports the growth and success of your business.
Kinara Capital is a non-banking financial company (NBFC) that offers collateral-free or unsecured loans to MSMEs for a variety of business purposes. The company provides loans to cover day-to-day business needs, purchase equipment and machinery, and fund long-term growth plans. Kinara also provides loans against property to help MSME customers who need higher amounts of financing .The company provides loans through an end-to-end digital process on the myKinara App, which means MSMEs can access their business loans in just 24-hours.
FAQ
Can I convert an unsecured loan into a secured loan?
In some cases, lenders may allow converting an unsecured loan into a secured loan if the borrower provides collateral later.
When does it make sense to take a secured loan?
A secured loan is suitable when you need a large loan amount at lower interest rates and have assets to pledge.
Which loan type is easier to get approved for?
Unsecured loans have a simpler approval process but require strong creditworthiness. Secured loans may take longer but offer better terms.
What are the interest rate differences between secured and unsecured loans?
Secured loans typically have lower interest rates, while unsecured loans have higher rates due to increased lender risk.
Which loan type is better for small businesses? Secured or Unsecured Loan?
It depends on the business’s financial health and requirements. Small businesses with assets may benefit from secured loans, while those needing quick access to funds might prefer unsecured loans.
