If you have managed to keep your small business afloat through the first year—or even the first two years, congratulate yourself for having accomplished what roughly 40% of business owners cannot. By now, it is time to initiate your plans for growth, and you may need lines of credit for that. But, which is going to be better for you and your business—secured or unsecured lines of credit?
Each has benefits and drawbacks, and suits some situations better than others.
Unsecured lines of credit allow business owners to retain control of their assets. On the other hand, secured lines of credit put business—and usually, personal—assets on the line. Those assets can be real estate owned by the company or the individual(s) named as the borrowers. It take a strong stomach to agree to hand over the home you share with your family if the business falls on hard times, and is often the single condition that makes business owners choose unsecured lines of credit.
Other assets used as collateral for secured loans can include business equipment, inventory or accounts receivable.
Banks are in the business of making money by lending money. Consequently, when the lions share of the risk is borne by the borrower—as is the case with secured loans—banks typically charge lower interest rates; when borrowers choose unsecured lines of credit, they may face higher interest rates. How high is determined by personal and business credit histories and the degree of promise shown in their business plans and indicated by past performance.
Besides secured or unsecured lines of credit, there is another option: credit cards. Many business owners finance their businesses with personal or business credit cards; however, this option should be considered as a last resort because credit card rates are higher than that of secured or unsecured lines of credit, and the interest can break a business.
Another drawback to financing with credit cards is that, unlike more traditional secured or unsecured lines of credit, they have a variable interest rate that can be suddenly adjusted upward (but rarely downward), and their limits can be suddenly reduced.
Business owners and consumers are wise to obtain an unsecured line of credit before they need one. An unsecured line of credit benefits the borrower in myriad ways, but represents a level of risk for lenders that requires them to set a higher standard for lending than for most other loan products.
Anytime a lender approves an unsecured loan of any kind that isn’t tied to some kind of collateral, the lender takes a greater risk than with a home or business loan secured with real estate or other assets that a lender can seize should the borrower become unable to repay the loan.
However, an unsecured line of credit is typically used for expenditures related to intangibles or goods that rapidly lose value, placing the lender at a different level of risk. For this reason, it is imperative that a business owner or consumer acquire an unsecured line of credit before it is needed to resolve current financial issues that might disqualify them for a loan.
The ebb and flow of business expenses dictate that almost any business needs an unsecured line of credit to meet occasional expenses. Sometimes accounts payable exceed accounts receivable. Sometimes a necessary seasonal inventory increase will not realize a return for several months. For these and many other purposes, an unsecured line of credit can make the difference between a business’ failing, surviving or thriving.
The same applies to personal finance and the benefits of an unsecured line of credit. A tax bill is due in November, but a year-end bonus does not come until December. Proud parents have resources enough to give their children excellent educations, but withdrawing investments prematurely carries a penalty.
An unsecured line of credit is also an invaluable tool that enables the borrower to take advantage of time-limited opportunities. If, for instance, a business owner is awarded a sizeable government contract that would finance significant growth for the company, but fulfilling the contract will require personnel and equipment investments, an unsecured line of credit will make it possible.
A homebuyer who has a chance to buy a dream house at a great price would have to pass on the opportunity if he has to pay two mortgages until his current residence sells. Again, an unsecured line of credit can bridge the gap.
Whether its used to meet emergency expenses, cover temporary cash flow shortfalls or fulfill dreams, an unsecured line of credit is the loan product that can do it all for the borrower with good credit and fortitude.