When you’re applying for a small business loan, your lender might require some collateral for it. If you’ve applied for a home mortgage or an auto loan, then you’re familiar with secured debt.
In short, secured debt is debt that uses collateral to provide additional security for the lender in case you default on your loan.
Read on to learn all about secured debt and what it means for your small business loan.
What you need to know about secured debt
Lenders offer secured debt for two reasons. For one, it gives you an incentive to pay back your loan according to your agreement. If you stop making your payments and go into default, your lender has coverage for their losses through your collateral. Having that coverage reduces the lender’s risk overall.
Another advantage for you as the borrower? Secured debt often has better loan terms like lower owner-equity requirements, longer repayment periods, more flexible approval criteria, and lower interest rates.
Most of the time, your business assets (like your equipment) will be enough to secure the loan. However, depending on the size of your loan or the loan program, your lender could ask for personal collateral to secure it.
There are two types of secured debt for small business loans:
- Blanket lien: This is the most common type of secured debt and it covers all assets. A blanket lien is documented through a UCC-1 filing. If you default on your loan, the UCC-1 filing sets an order in which the collateral can be claimed by lenders.
- Liens on specific assets: If your loan is financing an equipment purchase or real estate, the loan might be secured by a lien on that specific asset. In these cases, the asset that’s purchased (or refinanced) through the loan is typically enough to meet the collateral requirements for your debt.
In either case, the lender that made the UCC filing on your asset has priority access to that collateral. If you need more funding or want to refinance an existing loan, the UCC filing will play a role in your ability to secure additional financing.
If you’re applying for an SBA loan, you should be ready to offer collateral before you apply. For the SBA 504 loan program, the commercial property or equipment you’re purchasing will typically serve as the collateral for the loan.
However, SBA 7(a) loans may have additional collateral requirements in order to secure the loan. It depends on the loan amount and how you plan to use the funds.
For example, if your SBA 7(a) loan is less than $25,000, then no collateral is usually required. The same goes for SBA Community Advantage loans. If you’re going to use an SBA 7(a) loan to fund a project for your business, make sure to talk through the details with your lender.
As with any business debt, you’ll need to let your lender know if you have any significant changes to your business. This includes when you’re planning to move locations, making a business pivot, or if you’re selling your business.
What is unsecured debt?
While most small business loans will be secured by a business asset, there are some funding options that don’t require collateral. These loans are known as unsecured debt. If you have a credit card, then you already have experience with unsecured debt.
Unsecured debt is riskier for lenders since there’s no pledged collateral they can claim if the loan isn’t paid back. For that reason, unsecured debt will have a higher interest rate and stricter approval requirements. Compare your credit card’s interest rate to the interest rate of your mortgage or auto loan. Because the loans are secured by your car and your home, the interest rates are likely much lower.
Which type of debt is right for your small business financing needs?
The best way to determine if you’re ready for any kind of debt is to meet with reputable lenders, discuss your needs, and decide which loan option is the best fit for your business’s needs. Be sure you fully understand the terms of your loan, including if any additional collateral is needed.
Pursuit can help you find the funding option that best fits your needs
If you have questions about which loan option is best for your small business, including whether to take on secured debt, Pursuit can help. With over 15 different loan options, we can help you successfully navigate the loan process, including SBA options, to secure the funds you need. Contact Pursuit today.