When your business needs capital to grow, a secured loan can be one of the most effective ways to get it. By using your company’s existing assets as a guarantee, you reduce the lender’s risk, making them more willing to offer the funds you need at favorable terms.
The Secured Business Loan Process
Getting a secured loan involves more than a simple application. Because an asset is involved, the process includes a few extra steps to protect both you and the lender.
- Pledging Collateral: The first step is identifying which asset you will pledge. The lender needs to agree that the asset is valuable and stable enough to serve as collateral.
- Asset Appraisal: The lender will order a professional appraisal to determine the fair market value of your collateral. This value is crucial, as it determines the maximum loan amount, often expressed as a Loan-to-Value (LTV) ratio. For example, with an 80% LTV on a $100,000 property, you could borrow up to $80,000.
- Approval & Lien: Once the loan is approved, the lender places a legal claim, known as a lien, on your collateral. The lien is a public record that prevents you from selling the asset until the loan is fully paid.
- Funding & Repayment: With the lien in place, the funds are disbursed to your business. You then make regular payments as outlined in your loan agreement. After your final payment, the lender releases the lien, and you own the asset free and clear.
What Can You Use as Collateral?
Many business assets can be used to secure a loan. Lenders are often flexible, but the most common types of collateral include:
- Real Estate: Commercial properties owned by the business.
- Equipment: Heavy machinery, company vehicles, or specialized computer systems.
- Inventory: The products and materials your business holds for sale.
- Accounts Receivable: The money owed to your business from customer invoices.
- Blanket Lien: A lien that covers all of your business assets, rather than a single piece of property.
Benefits and Risks of Secured Loans
Benefits:
- Lower Interest Rates: Lenders take on less risk, so they can offer more competitive rates.
- Higher Loan Amounts: You can typically borrow more money with a secured loan than an unsecured one.
- Easier Qualification: Businesses with limited credit history or lower credit scores may find it easier to qualify.
Risks:
- Potential Loss of Asset: If you default on the loan, the lender has the legal right to seize and sell your collateral.
- Longer Application Process: Appraisals and legal filings for liens can extend the time it takes to get funded.
- Restrictions on Assets: A lien prevents you from selling or transferring the asset without the lender’s approval.
Secured vs. Unsecured Business Loans
The primary difference lies in the collateral requirement. An unsecured business loan does not require you to pledge any assets. Instead, lenders base their decision on your company’s revenue, cash flow, and credit history.
| Feature | Secured Business Loan | Unsecured Business Loan |
|---|---|---|
| Requirement | Backed by collateral (e.g., property, equipment) | No collateral required |
| Interest Rate | Generally lower | Generally higher |
| Loan Amount | Typically larger amounts available | Often smaller loan limits |
| Risk to Borrower | High (risk of losing the asset) | Lower (no specific asset at risk) |
| Approval Time | Slower due to appraisals | Faster, with streamlined underwriting |
According to the U.S. Small Business Administration (SBA), many of its popular loan programs, like the 7(a) loan, may require collateral, especially for larger amounts.
Frequently Asked Questions (FAQs)
1. What happens if I miss one loan payment?
Defaulting is a process, not a single event. Lenders usually prefer to work with borrowers to find a solution, as seizing collateral is a costly last resort for them. If you foresee trouble making a payment, communicate with your lender immediately.
2. Is a secured loan always the better choice?
Not necessarily. If your business has strong credit and consistent revenue, you may qualify for an unsecured loan. While the interest rate might be higher, an unsecured loan is often faster and doesn’t put your assets at risk. The best choice depends on your financial situation and tolerance for risk.
3. Will I lose my collateral if my business fails for other reasons?
If your business declares bankruptcy, a secured loan gives the lender priority over other creditors regarding the pledged asset. The court will oversee the process, but the lender has a strong legal claim to the collateral to recoup their investment.