This article is for educational purposes and does not constitute legal or tax advice. For specific advice applicable to your business, please contact a professional.

What’s the Difference Between a Secured vs. Unsecured Loan?

The key difference between a secured and an unsecured loan is collateral. Secured loans require collateral (like property or inventory) to back the loan, while unsecured loans don’t require collateral but rely on creditworthiness. 

As a business owner, you may need to apply for financial assistance to meet operating expenses, expand your business, pursue new opportunities, acquire business assets, or refinance debt. If you’re considering a business loan, it may come in a secured or unsecured form. But what are the main advantages of a secured vs. unsecured loan?

Differences between secured vs. unsecured loans loans

There are several key differences between secured and unsecured loans. While collateral is the main differentiating factor, there are disadvantages as well as advantages to secured vs. an unsecured loan. Here are some of the key features, both pros and cons, of secured vs. unsecured loans:

Pros of secured loans:

• Higher borrowing limits
• Lower interest rates
• Easier to qualify for with a lower credit score

Cons of secured loans:

• Require collateral (like property or inventory) to back the loan in order to reduce the lender’s risk
• Lengthier loan approval process
• Risk of collateral seizure in the event of a loan default

Pros of unsecured loans: 

• No collateral requirements
• Faster loan funding
• No asset seizure upon default

Cons of unsecured loans: 

• Typically require higher credit scores
• Stricter approval criteria
• Higher interest rates
• Lower borrowing limits, rarely in excess of $100,000
• Negative impacts on credit score in the event of default

While you are likely familiar with many types of secured loans, including mortgages and home equity loans, where your home serves as collateral, or automobile loans, where your vehicle provides the collateral, there are also secured business loans. Secured business loans will typically be backed by company assets, such as equipment or inventory.

Personal loans are typically unsecured vs. secured. Thus, they are not backed by any collateral. Other types of personal loans include credit cards, student loans, and medical loans. Unsecured business loans are fairly common, especially for established small businesses or those with strong credit. Since they don’t require collateral, they’re popular for quick funding, but approval depends heavily on company revenue, credit score, and time in business. Consequently, startups or risky ventures may struggle to qualify for unsecured business loans. An unsecured business loan not backed by collateral may require a personal guarantee. 

Common examples of unsecured business loans include: 

• Term loans, which are lump sums repaid over time, perhaps to fund inventory purchase or business expansion
• Business lines of credit, which feature a reusable line of credit up to a limit, such as a business credit card
• Merchant cash advances, which is upfront cash repaid via future sales
• Invoice financing, where your business borrows against unpaid invoices

How does a secured loan work?

Secured loans are ideal for businesses needing large sums, lower interest rates, or that have weaker credit but valuable assets. While a secured loan is backed by collateral, thus inherently reducing the lender’s risk, qualifying for a secured vs. an unsecured loan will involve meeting the following requirements:

• Collateral that matches or exceeds the loan’s value
• A solid credit score of 600 or higher
• A low income to debt ratio that proves repayment ability
• Business history: Some lenders require at least a year in operation

Terms for secured loans vs. unsecured loans tend to be more favorable overall, often featuring loan amounts of 50 to 100% of the collateral’s value as well as lower interest rates (4-15%) given the reduced risk to the lender. Repayment terms are also generally longer, sometimes up to 30 years. Secured loans generally come with more fees than unsecured loans, however, including origination fees, appraisals (if property is involved), and potential early repayment penalties.

How does an unsecured loan work?

When considering the differences between a secured and an unsecured loan, businesses in need of fast, flexible funding without collateral may be best suited to an unsecured loan. Unsecured loans are ideal for short-term needs or for businesses with strong credit. In order to qualify for an unsecured loan, a business will need to meet the following requirements:

• A higher credit score, typically 680+ for competitive interest rates
• Solid revenue and reliable cash flow to ensure repayment ability
• At least one to two years in operation 
• A debt-to-income ratio lower than 40%

Terms for an unsecured vs. a secured loan tend to be less favorable since lenders don’t have collateral to protect risk. That means smaller loan amounts, typically ranging from $1,000 to  

$100,000, as well as higher interest rates, up to 30%, because of lender risk. Repayment terms are also shorter, ranging from three months to 10 years with fixed monthly payments. Unsecured loans may come with origination fees, too, and, like any loan, will have late payment penalties.

Should you get a secured or unsecured loan?

So what are the main advantages of a secured vs. an unsecured loan? A secured loan isn’t necessarily better than an unsecured loan. The right loan depends on your business needs, risk tolerance, and financial health. You’ll likely want to opt for a secured loan if you need a larger amount of funding, desire lower interest rates, or have weaker credit but own valuable business assets to pledge as collateral. An unsecured loan will be a better option if you prefer no collateral (or have none), maintain a strong credit score (680+), and need faster, simpler funding. In exchange, however, an unsecured loan typically comes with higher rates, smaller loan amounts, and stricter approval processes.
Choosing a secured vs. an unsecured loan is really about weighing the trade-offs: Secured loans offer cost savings, while unsecured loans provide flexibility and speed.

Best practices before taking out a secured or unsecured loan

Lenders will take many factors into account when considering  your application for a business loan, regardless of whether it’s secured or unsecured. Thus, it’s important to make sure your business is in as strong a financial situation as possible before applying for a loan:

• Maintain your credit: According to a recent Federal Reserve Bank Small Business Credit Survey, nearly 50% of small businesses reported being in fair or poor financial condition Your small business credit score matters for loan qualification, not to mention interest rates, especially if you haven’t been in business long or don’t have valuable business assets.
• Consider your business history: Businesses with a very short history could pose greater risk to a lender as there isn’t much history to gauge whether or not you can repay the loan.
• Keep track of business documents: Lenders may request documents to help prove the financial health and viability of your business. These documents vary but could include a business plan and loan proposal, financial statements, and loan application history.
• Know your debt-to-income ratio: Lenders will likely evaluate your business’s  debt-to-income ratio in the loan application process to assess if your business debt and equity could pose a financial risk.

If you’re a Square user, Square Loans¹ automatically extends an offer through the Loans tab of your Dashboard. Payment frequency, business health, and customer mix are among the factors that are used to determine eligibility. Once approved, your Square Loan will be repaid automatically with a percentage of your daily sales, with no hidden fees. Plus, you can get your loan funds deposited instantly into your Square Checking² account, or get your money as soon as the next business day to keep things moving.