What are the different types of business loan?

Business loans are some of the most versatile financial products available to any business, with variations to suit all types of businesses, from start-ups to enterprises.

With such a wide variety of tailored products it can be difficult to understand the key differences between each.

In this guide we’ll focus on the most common types of loans: secured loans; unsecured loans; term debt; and revolving debt, explaining what they are, and why you might consider using them.

As with all financial decisions, it’s a good idea to seek independent specialist advice that takes into account the specific circumstances of your business before applying for any financial product.

What is a secured loan?

A secured loan, often provided by financial institutions such as banks, is a type of credit that is backed by property or assets that you own, like your house.

Secured business loans serve as a versatile financial tool that can be used to support various business needs.

These can range from the acquisition of new machinery and tools to covering payroll expenses.

Furthermore, these loans could also fund the expansion of your business premises, facilitating growth and allowing for an increase in capacity or services.

This type of loan uses your property as collateral, providing the lender with an assurance that they can recover their funds in case of non-repayment.

Hence, it's also referred to as asset-backed lending.

Under this arrangement, you borrow a predetermined amount and are required to make regular repayments.

Failing to meet these repayment obligations could result in the loss of your asset.

Secured loans come in various forms.

For instance, a company director may leverage their personal home to generate funds for their business, a process akin to remortgaging.

Alternatively, they might use the loan to acquire machinery or even another business, with the loan secured against the company's assets like business premises.

Secured business loans are generally thought of as a lower-risk form of lending for financial institutions.

This often results in the availability of larger loan amounts and more favourable interest rates for borrowers, making them an attractive financing option for businesses looking to expand or invest in their operations.

What are the advantages of a secured loan?

There are a variety of benefits to taking out a secured loan including:

Larger drawdowns

Secured loans offer substantial borrowing capacity, with larger loans on offer as a result of a reduction in risk to the lender by the presence of an asset as security.

This is contingent upon the equity present in the asset used as loan collateral.

Longer payment terms

Secured loans offer extended repayment terms that can surpass the typical 3-5 years associated with unsecured loans, providing you with a more extended period to repay the debt.

Lower payments

Coupled with lower interest rates, this extended repayment duration of a secured loan often translates into lower monthly repayments.

This predictable and manageable repayment structure is particularly beneficial for new businesses grappling with cash flow uncertainties.

Poor credit history

Secured loans are also an attractive option for borrowers with less than stellar credit histories.

Lenders are more inclined towards secured loans in such cases, as the collateral provides an assurance of repayment even in the event of a loan default.

What are the disadvantages of a secured loan?

As with all financial products, there are downsides to using a secured loan, depending on your business’s financial circumstances:

Risk of loss+

In order to obtain a secured business loan you have to pledge a business asset as collateral.

If you don’t possess such an asset, or if you are reluctant to risk it as security (perhaps due to the fear of losing it in case you fail to make timely repayments), you will not qualify for a secured business loan.

It's crucial to note that in the event of a default on your loan, the lender has the right to take possession of the asset and turn it into cash (a process called liquidation) to recover their money.

Arrangement costs

When procuring a secured loan, it's probable that initial costs will be incurred.

For example, if a property is being used as collateral, expenses such as valuation fees and legal fees may apply, particularly if the lender imposes a legal charge on the property.

Importantly, these valuation costs must still be covered, even in cases where your loan application is rejected, or the approved loan amount is less than what you initially applied for.

Time to arrange

Securing a business loan often involves an extensive process due to the lender's need to conduct thorough due diligence.

This ensures the lender's risk is minimised.

Therefore, the approval time for such loans might be longer than expected.

To expedite the process and prevent any unwarranted hold-ups, it's advisable to gather all the required business documents before starting your application.

This proactive approach can help streamline the process significantly.

What are examples of secured loans?

• Invoice financing
• Bridging loans
• VAT loans
• Asset refinancing

What is an unsecured loan?

Unsecured loans, which are offered by a variety of lenders, stand out by not requiring any asset to be put up by the borrower as collateral for the loan amount.

As a result, unsecured loans present a viable financial solution for businesses that are either light on assets or experiencing rapid growth and need immediate access to funds.

It's important to note, however, that lenders typically require a personal guarantee as a form of assurance for loan repayment.

Providing your credit history is strong, securing an unsecured loan tends to be quite simple.

However, it's worth noting that these loans usually have higher interest rates compared to secured loans.

It's advisable to review the APR (Annual Percentage Rate), which incorporates any fees charged by the lender for the loan service.

For small businesses, unsecured loans often come in the form of cash flow loans and working capital loans.

These types of loans could be particularly useful for managing slower, off-peak trading periods.

They operate on the premise of borrowing against future peak revenues, which will be used to repay the loan.

What are the advantages of a unsecured loan?

Unsecured loans can be an ideal choice for several reasons:

Security

If you require a relatively small sum, say £10,000, opting for an unsecured loan could be beneficial.

This is especially true if you own property that you'd rather not risk losing through repossession.

Flexible payment terms

Unsecured loans offer flexible repayment terms that can extend up to approximately five years.

A longer loan period often translates into lower interest rates on the loan amount.

No need to provide collateral

Since unsecured loans do not require collateral, lenders evaluate them based on your business's trading position.

They may also conduct background checks on aspects like credit history, cash flow situation, balance sheet, and cash reserves.

Moreover, they might request a personal guarantee against the loan.

What are the disadvantages of a unsecured loan?

As with all financial products, there are downsides to using an unsecured loan, depending on your business’s financial circumstances:

Higher risk for lenders

When no assets are provided as collateral, lending institutions bear a higher risk compared to a secured loan.

Consequently, they tend to provide loans of smaller sums, shorter repayment durations, and at elevated interest rates.

However, this is not always the case.

Businesses that can demonstrate a strong trading track record and maintain a commendable credit score may potentially receive more advantageous loan terms, mitigating some of these drawbacks.

What are examples of unsecured products?

Examples of unsecured loans include:

• Start Up Loan
• Mezzanine finance
• Business overdraft
• Merchant Cash Advance
• Asset finance

What is the difference between secured and unsecured loans?

Secured business loans are different from unsecured loans by requiring collateral to back them up.

This form of loan is generally considered less risky for lenders, as borrowers secure the loan with their business assets.

When you approach a lender about obtaining a secured loan, the lender may already know what type of assets will be suitable, such as equipment or property.

The additional security for the lender of the asset often leads to advantageous terms for borrowers, such as the ability to borrow larger sums and enjoy lower interest rates.

On the other hand, unsecured business loans can be an excellent alternative for young businesses that haven't yet accumulated any assets.

These loans typically expedite the application process, as there's no need for lenders to spend time assessing collateral or assets, making them a convenient and speedy option for new enterprises.

What is term debt?

Term debt refers to a type of loan (either secured or unsecured) that has a predetermined repayment schedule, typically spread over several months or years.

For instance, if you borrow £50,000 and agree to repay it in monthly instalments over a five-year period, that represents a term debt.

Such loans usually come with a fixed interest rate and set payments, contributing to their predictability and ease of budgeting.

Term loans serve as a conventional financing choice for both established enterprises and start-ups.

Term loans can be employed for various purposes, including the purchasing of new equipment or business expansion.

A wide range of institutions, including most banks and online lenders, offer business term loans.

The maximum amount you can borrow is determined by several factors, such as your industry, the intended use of the loan, and your business's financial condition.

Given their prevalence as a loan option, it is highly probable that you'll find a term loan with rates and terms that align with your business requirements.

However, one should note that the qualification process for term debt can be time-consuming.

This is primarily because each loan necessitates a fresh application, thereby extending the approval timeline.

What are examples of term debt?

Examples of term debt products include:

• Start Up Loan
• VAT Loan
• Bridging loan
• Asset finance

What is revolving debt?

Revolving debt, also known as a line of credit, is a type of credit that doesn't require fixed monthly payments.

Instead, the charges are determined by the current outstanding balance of the loan.

Similarly, the interest rate on revolving debt is calculated based on the total outstanding balance.

This means that both the repayment amount and the interest rate can fluctuate over the life of the loan, depending on how much of the available credit you use.

Credit cards are the most prevalent type of revolving debt.

They fit into this category because they only require the cardholder to make a minimum payment each month, rather than a fixed payment.

Another distinctive feature of revolving debt is the absence of a set owed amount.

Instead, there is usually a credit limit that caps the total debt.

This structure differentiates revolving debt from other forms of loans and debts, which typically have a fixed principal amount.

With revolving debt, the outstanding balance for a specific month determines the amount due.

Furthermore, revolving debt tends to carry higher interest rates compared to term debt.

Additionally, the interest rate on revolving debt is typically variable, meaning it can change over time, as opposed to a fixed rate that remains constant throughout the loan term.

Revolving credit serves as a beneficial financial tool for both individuals and businesses requiring swift and flexible access to funds.

For those experiencing significant variations in cash flow, a revolving line of credit could provide a handy solution to manage daily costs or unexpected expenditures.

This form of credit also offers the convenience of making purchases in the present and deferring payment until a later date.

Therefore, it offers a level of financial flexibility that adapts to the user's specific needs and timing.

What are examples of revolving debt products?

There are a number of financial products that can be described as revolving debt, including:

• Working capital revolvers
• Business credit cards