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The Pros and Cons of Unsecured Business Loans

When you are a small merchant, an unsecured business loan can seem like a blessing and a curse. It is not rare to seek an unsecured business loan when your new business is still having growing pains or you are still building or recovering your credit. It gives you the small burst of cash you need quickly to get whatever hurdle your faces. However, before you jump in and apply for a loan, weigh the pros and cons.

The Pros

Pro: No Collateral

Unlike secured loans, this type of loan doesn’t require collateral to qualify for financing. Therefore, if you fail to repay the loan or go bankrupt, the lender can’t seize your home or other personal or business assets. This is pretty important since about half of small business fail within its first five years in business, according to the U.S. Department of Labor’s Bureau of Statistics.

Pro: Get Money Sooner

Since the process for obtaining an unsecured business loan is much simpler and requires less paperwork and documentation, you get cash quicker. Collateral isn’t a part of the equation here so time is not spent appraising the value of your properties and assets. Oftentimes, a borrower can get money in just a few days. Keep in mind that some lenders, however, will require you sign a personal guarantee. A guarantee is a legal promise to repay the loan. If you sign a personal guarantee and don’t repay the money, the borrower is personally responsible.

Pro: Credit score is less of a factor

If you have strong business revenue potential but poor personal credit, there is still a good chance you will get approved for an unsecured business loan. Of course, this depends on the specific lender. If your revenue is weak or your business has been operational long enough to give a good picture, a lender may require a personal credit score check.

The Cons

Con: Higher Costs

Since a borrower is qualified for an unsecured business loan based on his/hers’ business revenue strength and their credit scores, not the assessed value of their assets, lenders charge higher rates. Many times, lenders charge a higher annual percentage rate (APR) with all fees and interest because it will much more difficult for them to recoup anything from you if you default on the loan. It is important to remember that an APR often starts in the double digits and can climb from there based on your annual revenue, business strength, and credit score.

Con: Bigger monthly payments

First, most unsecured business loans come with shorter terms, which mean the funds have to be paid sooner. Couple that with higher APRs and you are looking at a much higher payment than if you were going with a traditional small business loan. Also, interest rates also are much higher on unsecured loans. For example, if you took out a one-year loan for $15,000 with an interest rate of .08% and an APR of 20%, you can expect to pay $1,391 per month.

Con: Smaller loan amounts

Since an unsecured loan is not based on the value of your collateral, loan amounts you can receive are lower. Most unsecured business loans cap out at $100,000. With this in mind, unsecured loans are much better for smaller, short-term operational expenses, such as hiring a new employee or expanding your inventory.

Con: No Tax Exemption

Unlike secured loans, the interest on this type of loan is not tax deductible.

In Conclusion

Even though unsecured business loans are ideal for smaller or new businesses with less-than-perfect credit scores, qualifying for loans is not easy. Be prepared to prove to lenders that you have a reliable, consistent cash flow to cover loan payments. New businesses with little business history or weak revenue streams will have the most difficult times. With that being said, if you can need money quickly for smaller projects that don’t require you jumping too many hurdles, then an unsecured business loan may be the option for you. Though payments and rates may be higher, if you think this cash will take your business to the next level, it may be the best option for you.

If you have an idea in mind, look at all of your options, your current cash flow, and your revenues before you apply for any type of financing or loan. When you think you are ready to move ahead with an unsecured business loan, turn to First American Merchant (FAM). Its application process is simple and easy, and it is known for offering solutions that help businesses grow and thrive.