Unsecured vs. Secured Debt: The Basic Breakdown

E.J. Simonsen
Published On: Nov 2, 2021 9:30:00 AM
Updated On: Nov 16, 2021 9:34 AM

 

 

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When your business needs to borrow money, you have two basic types of debt options  — unsecured and secured. While this might seem like a simple distinction, the choice your business makes can have a significant impact both on the amount of funding you receive, as well as what you put at risk.  If you're new to the business debt process or have questions about business debt, here's what you need to know about unsecured vs. secured debt:

Unsecured vs. Secured Debt: The Basic Breakdown

Looking for the simple answer?

At its most basic, the difference between unsecured and secured debt is collateral:

  • Secured debt is backed by collateral that the lender can seize if the borrower stops making payment. 
  • Unsecured debt is not backed — or secured — by collateral, and if a borrower stops making payments, the lender's only real option is to sue the borrower for that unpaid balance. 

While this description helps you understand the very basic differences between secured and unsecured debts, the distinction can become a bit more complex when we're talking about business debt in particular. 

If you're looking to learn more about both unsecured and secured business debt, this article will walk you through the definitions, advantages, and disadvantages of both options, so you can make the best decision for your business. 

Part 1: What is Unsecured Debt?

As mentioned above, unsecured debt is any debt that has no collateral backing it. With unsecured debt or an unsecured loan, when a business defaults on those payments, the lender has no property and no assets to seize to recoup their losses. 

Examples of Unsecured Debt

Common examples of unsecured debt are credit card debt, student loans, and personal loans When it comes to business debt, the types are similar: business credit cards, certain business loan, and lines of credit. Though there are some differences, in all of these types of debt, the borrower receives money or a line of credit without having to put up collateral. 

Advantages of Unsecured Loans for Businesses

If your business can get the money it needs without putting anything up for collateral, you're off to the races, right? Herein lies the key benefit of unsecured loans: 

    • Less debt and fewer stipulations. An advantage of unsecured debt, whether a loan, advance, or funding is that they are often intended to be short-term funding solutions. Thus, the amount is usually lower than a secured debt, which helps keep the business’s overall debt load lower, and unsecured debt lenders rarely require stipulations such as minimum cash reserves, on-hand inventory, or debt-to-income ratios. 
    • No risk to key business assets. With an unsecured loan, your business doesn't have to worry about risking a particular asset in the event of a missed payment. That said, it's important to remember that should a business default on an unsecured debt, the lender might pursue personal guarantees or sue you or the business in an attempt to seize assets.
    • Faster and easier. Since there are no assets for the lender to evaluate, no liens or security instruments to draft, and no collateral to encumber, unsecured debt is often dispersed, or advanced, faster than secured loans or debt.

Disadvantages of Unsecured Debt for Businesses 

While unsecured loans can make it easy for your business to get access to the money you need to get operations going, they do come with a few catches. 

    • Challenging terms. When compared to secured debt, the terms associated with an unsecured loan, advance, or debt is oftenmuch more challenging. For example, you may have to make payments more frequently than every month, you may have a shorter grace period before a default, and you may have to provide proof of a high credit score, or personal assets before the lender will feel comfortable signing off on the unsecured loan or advance. 
    • Higher rates and fees. Because lenders are taking a greater risk when it comes to unsecured debt, the rates and fees are usually much higher. This means your business will likely end up paying much more than if the debt was secured.
    • Personal and business assets are often at risk. Unsecured debt lenders almost always require the business owner to personally guarantee the debt, loan, or advance. If your business is unable to make payments on an unsecured debt, the lender will most likely sue the business and its owner. While the lender does not have a guaranteed right to seize a particular item or collateral, they can still pursue individuals and other business assets. 

If you're having trouble with a lender trying to collect on an unsecured debt, it's best to get support from business debt relief attorneys as soon as possible. It's important to get ahead of those lenders before they freeze personal and business bank accounts, and make daily operations even more difficult. 

There's a lot to say about unsecured loans, so while we're going to move onto secured debt next, don't hesitate to contact the attorneys at The Lane Law Firm for answers to any additional questions you might have about unsecured debt. 

Part 2: What is Secured Debt?

Secured debt is any debt that is backed by an asset, like property, equipment, inventory, or even accounts receivable business bank accounts. In the event that a business defaults on secured debt, the lender is able to seize that specific asset as collateral. 

Examples of Secured Debt

Common business secured loans include equipment loans, factoring agreements, vehicles loans, and property mortgages. Outside of the business world, auto loans, home loans, and equity loans are all considered secured debt as well. 

Advantages of Secured Debt for Businesses

Secured loans are a much smaller risk for lenders. Because they have an asset to use as collateral, they can be more lenient on interest rates and terms. Some of the advantages of secured debt include: 

    • Favorable terms. Secured debt has much more favorable terms than unsecured debt. You will likely only need to make monthly payments, and your lender may even offer refinancing options as you continue to make those repayments. Your business also won't have to provide as extensive financial or credit score records. Because your business is offering the lender a valued asset as collateral, your reputation as a borrower isn't as important. 
    • Lower interest rates. Since a secured loan is backed by a specific asset, lenders often charge lower interest rates, because they can reasonably expect that even if a business defaults on a loan, they will still have an asset to sell to recoup that lost revenue. 
    • Clear consequences of default. Should your business default on a secured loan, your business knows exactly what's at risk. While unsecured loans do not require collateral, in the event that a business defaults, the lender can sue the business, which can potentially freeze all assets. For a secured loan, losing the asset that is collateral is the greatest risk. The lender cannot seize any assets not defined as collateral.  

Disadvantages of Secured Debt for Businesses

While secured debt provides protections for both borrower and lender, there are some disadvantages for businesses hoping to secure the funding they need to get a new product or initiative off the ground. 

    • Sufficient collateral is required. To take out a secured loan, a business has to have sufficient assets to leverage against the amount the business is asking for. This can be tough for newer businesses that may not have started production yet, or that may not have purchased equipment. With fewer assets, it can be difficult to get a secured loan for the amount you need. 
    • Business assets are at risk, should the business fail to make payments. The clearest disadvantage of secured debt is that your business' assets are at risk in the event of a missed payment. If the assets your business has used as collateral are integral to the company's daily operations, a lender's seizure of that property could render the business inoperable. 
    • Accounts receivable loans or factoring agreements may not work out. These types of secured debt can be risky for lenders and businesses alike. If the business’s customer fails to pay, the expected collateral never materializes and the loan or advance may be considered in default or the terms may change. In these situations, the lender may have a claim or be able to lien additional assets or even entire bank accounts.

Unsecured vs. Secured Debts: Which is Better For My Business?

Both unsecured and secured debts or loans provide different benefits for different businesses. There is no right answer to the question, "which is better?". The more important question is, "which is better for your business?"

In general, secured debts are a safe, low-cost option for the business that has accrued assets it can comfortably leverage, or that is worried about a poor borrowing history. Unsecured debts are a better choice for businesses that have a great credit history, that are looking for smaller loans, or that don't yet have enough assets to leverage for the loan it needs. 

No matter what, if your business has secured or unsecured debt that's starting to pile up, it's always best to talk to a professional sooner, rather than later. Regardless of what type of debt your business is in, a qualified business debt attorney can help you avoid asset seizure or litigation. To get help with your business debt relief, get in touch with the experienced Lane Law team today!