Secured small business loans can help you unlock your business’ full potential. Learn about how they work and if you should consider getting one.
If you own a small business, you might be struggling in an insanely competitive market. You need to go above and beyond to stand out and establish your position.
In many cases, small businesses can’t do this on their own. Due to limited resources, they may not be able to support business growth – at least not to the level they want – without external funding.
According to the New Zealand Banking Association, only 30% of small businesses are debt-free. The other 70% have received over a million business loans combined.
Most small business owners first turn to secured loans before they explore other options. Secured loans are a common form of business lending, and are often chosen as an initial business lending option for small businesses seeking funding. In this article, we’ll talk about the reasons why that might be a good idea.
But first, let’s answer one of the most common questions that borrowers have.
How Are Business Loans Secured?
Secured small business loans require collateral in the form of business assets. This is because lending to start-ups and small businesses is often very risky. As they usually don’t have a distinguished financial track record, the lender has to assume a higher risk. There’s the chance that they won’t be able to repay the loan. That’s why lenders ask for security.
With unsecured loans, the lender takes on more risk, which can result in higher interest rates or stricter loan terms.
So how are business loans secured, exactly?
You’ll have to put up an asset such as a business vehicle, machinery, or commercial real estate as collateral. The bank or lender will then determine how much you can borrow based on the asset’s value.
For this purpose, they’ll use the loan-to-value (LTV) ratio. For instance, if a lender uses an LTV of 80% and assigns a value of $100,000 to your collateral asset, you’ll be able to borrow up to $80,000.
Of course, as long as you meet your loan terms and repayments, nothing will happen to your asset. In the event of any defaults on the loan, the lender has the right to take your asset and sell it to recoup the money. If the sale of your asset doesn’t meet the outstanding amount of the loan for whatever reason, you’ll still owe the difference.
Similarly, if your asset loses too much value over the term of the loan, the lender might ask you to pledge more assets to keep the loan.
Secured loans may suit businesses that have valuable assets to offer as collateral and are seeking larger loan amounts or better terms.
With all that, is it worth taking on this risk?
Benefits of Secured Small Business Loans
There are a few upsides to taking out a secured loan. The first is the ability to take out larger loan amounts compared to an unsecured loan. As you’re putting up security for the loan, the lender will be more open to giving you a higher amount.
Secured loans can be used to fund long term investments such as property, machinery, or business expansion, making them ideal for significant, lasting business loans needs.
You can use that cash injection to finance any aspect of your business. It’s important to consider all costs associated with the loan, including fees and repayment obligations, to ensure it aligns with your financial planning. A great example is a company that had to restock its inventory:
After being in business for a while, a small retail business knows that its peak season is December and January. One year, sales were so good that the business sold out its entire inventory.
To ensure uninterrupted growth, they chose to take out a $30,000 loan to restock their inventory. This would allow them to continue to make money, perhaps with even better results in the year ahead.
True to form, the business used the loan to buy the necessary stock and sold it at a higher profit margin, partly to pay for the cost of the loan. They were able to repay the loan and boost their cash flow at the same time.
In this example, the secured loan provided the necessary fund for business growth while allowing the owners to retain control without involving external investors. Unlike equity financing, secured loans do not require giving up ownership or bringing in new investors.
Aside from the higher loan amounts, you might also be able to negotiate a lower interest rate with a secured loan. This relates back to the lower risk that the lender is assuming because of the collateral, often resulting in more favorable borrowing conditions and cost savings over the loan’s duration.
Still, you must keep in mind that the interest rates will also depend on your credit history and financial standing. You need to pay attention to everything that determines whether you’re a reliable borrower. However, assuming all else is equal, a secured business loan should be cheaper than an unsecured one.
Lastly, you can expect the repayment terms to be rather long. In many cases, you may be able to stretch out the repayment period for as long as 30 years. This can allow you to repay the loan more comfortably without affecting your cash flow. However, missed payments can result in penalties or even loss of the collateral asset. Understanding the fee structure and payment schedule is crucial to avoid unexpected expenses and ensure timely payments.
Secured loans suit businesses with valuable assets and a need for larger, longer-term funding. Lenders may also consider how much of your own money you are investing in the business when assessing your loan application.
Drawbacks of Secured Loans
Just because secured business loans come with convenient benefits, doesn’t mean that they’re always a good idea. In fact, you should only consider borrowing through a secured loan if you’re 100% sure you can meet your payment obligations, as failing to do so involves significant risk, including the potential loss of your collateral.
The main reason is pretty obvious. If you default for any reason, you risk losing your security asset. If you put up the building as collateral, you’d have to move your business location. You’d also lose all the equity you had built up in that asset.
Furthermore, a default will do severe damage to your credit score. This will make it harder to take out a loan in the future. Missed payments can also increase the overall costs of the loan due to penalties and fees. While secured loans are generally easier to obtain for people with bad credit, the cost of the loan will go up.
Some lenders might be willing to work something out if you run into problems paying off the loan. They may offer to restructure the loan to help you avoid defaulting. Still, you should carefully weigh the risk and reward before taking out a secured business loan.
Eligibility Criteria for Secured Business Loans
When considering a secured business loan, it’s important to understand the eligibility criteria that lenders use to assess your application. Lenders will closely examine your business’s credit history and overall financial position to determine your ability to repay the loan. A strong credit record and a healthy cash flow can significantly improve your chances of approval and help you secure more favorable interest rates.
To qualify for a secured business loan, your business must be able to provide assets as security. These assets can include property, equipment, vehicles, or other valuable physical assets owned by the business. The lender will evaluate the value of these assets to decide how much you can borrow and what interest rate you’ll be offered. The more valuable and liquid your assets, the better your loan terms are likely to be.
In addition to assets, lenders will want to see a solid business plan that outlines your goals, strategies, and how you intend to use the funds. Demonstrating a stable cash flow and a clear plan for growth or investment reassures lenders that you can comfortably repay the loan. Other factors, such as your industry, business experience, and the strength of your management team, may also play a role in the lender’s decision.
By preparing strong financial records, providing valuable assets, and presenting a compelling business plan, you can increase your chances of qualifying for a secured business loan with competitive interest rates and flexible loan terms.
The Application Process for Secured Loans
Applying for secured loans involves several key steps designed to help lenders assess your business’s financial health and ability to repay the loan. To start, you’ll need to gather your financial statements, such as balance sheets and profit and loss statements, to give lenders a clear picture of your cash flow and financial position. These documents are essential for demonstrating your business’s stability and profitability.
Next, prepare a detailed business plan that outlines your objectives, strategies, and projected revenue. This plan should show how you intend to use the loan funds and how you’ll generate enough income to repay the loan. A well-prepared business plan can make a strong impression on lenders and improve your chances of receiving a favorable loan offer.
Once your documents are ready, you can submit your application to your chosen lender. The application will typically ask for information about the loan amount you’re seeking, your preferred interest rate, and your desired repayment terms. The lender will then review your application, assess your creditworthiness, and evaluate the assets you’re offering as security.
If your application is approved, the lender will present you with a loan offer detailing the interest rate, repayment schedule, fees, and any other terms and conditions. It’s a good idea to compare offers from different lenders and review their lending products to ensure you’re getting the best interest rate and loan terms for your business needs. Many lenders allow you to apply online, making the process more convenient and efficient.
By carefully preparing your financial statements, business plan, and supporting documents, and by comparing offers from various lenders, you can navigate the application process for secured loans with confidence and secure the funding your business needs to grow.
Are Secured Loans for You?
As you can see, applying for a secured business loan can be an excellent way of funding the growth of your business. You can get the desired amount at terms and conditions you’re comfortable with.
But this also comes with the associated risks, up to the loss of your collateral asset.
If you’re not willing to take on the risk, unsecured business loans or unsecured loans might be a better option. An unsecured business loan is a type of unsecured financing that doesn’t require your business assets as security, and the application is usually much easier and quicker. With unsecured financing, you can borrow money without providing collateral, but this may result in higher interest rates due to increased lender risk. Other lenders may offer different terms or incentives, such as rewarding early repayment, compared to traditional banks. When applying for any business loan, you may need to provide financial documents such as a balance sheet and a cash flow forecast to demonstrate your business’s financial health.
Should you find this option more appealing, Unsecured Finance New Zealand can offer you the funds.
