Business and consumer loans will typically fall into one of two categories: secured or unsecured debt.
The main difference between these two areas of finance concerns collateral, which protects the lender in the event that the debtor defaults on repayments.
In this post, we look at secured vs. unsecured debt, what they both offer and the advantages and disadvantages of each so you can make the most informed decision on which option is best for your situation.
Unsecured Debt vs. Secured Debt
Secured debt
A secured debt means the borrower will take out a loan, securing this with collateral or an asset against the loan.
This means that if the borrower defaults on the repayments, the lender can use its rights to seize the asset to collect the outstanding funds.
For example, secure debts can include mortgages and motor finance, where the borrower’s home or car is also put up as collateral. If the borrower misses payments or stops paying, the lender can seize control of the vehicle, for example, and sell it to offset the remaining outstanding amount.
Businesses also have the option of a secured loan using property, capital, equipment, stock, invoices, or cash as collateral.
Advantages of secured loans:
- There is less risk to the lender, so you may receive more favourable terms and more lenient credit requirements.
- The better your credit rating, the lower the interest rate you can receive, which means your monthly payments will also be slightly lower.
- Provides a sense of security to the lender.
- Easy application form and process.
- Tend to offer longer payment terms, so spread the cost.
Unsecured debt
Unsecured debt has no collateral backing, so the lender receives little security. This means that if the borrower defaults, the lender will have to find alternative means to collect what is owed.
Often, this is where small business debt collection comes in, and working with professional collection teams like Direct Route can help. Working to establish robust credit control processes and procedures and implementing debt collection services can mean successfully collecting any outstanding invoices and avoiding further defaults.
Unsecured debts are issued depending on a borrower’s creditworthiness and promise to repay.
Due to the higher level of risk, these types of loans have higher interest rates. There are also stricter requirements and terms, which often include late payment fees and additional interest charges.
Types of unsecured loans can include a business line of credit that allows you to purchase goods so you can carry on with your everyday business/projects.
Advantages of unsecured debt:
- You don’t risk losing your collateral.
- Quicker approvals compared to secured loans.
- You can use the loan as you want/need.
Debt Collection Services
Whether you opt for a secured or unsecured loan will depend on considerations such as:
What do you require the loan amount for? For example, an unsecured loan will be your best choice for quick purchases or emergency cash flow. However, if you’re looking to purchase larger items such as machinery or property, a secured loan will be the best option.
You will also need to take into account your credit score and credit history, as depending on this information will also depend on your loan options.
You must always make your repayments, and if you have a number of loans, you can take one of two approaches to repaying these:
Snowball method – continue to make the minimum payments on all of your loans, and with money left over, make additional payments on your smallest debts first, building up to paying off the larger ones.
Avalanche method – again, continue to make the minimum payments on all of your loans; however, with money left over, order your debts by the highest interest rate to the lowest and look to make additional payments on those with the highest to pay these off first.
If feasible, debts can be consolidated into one manageable monthly payment. Often, a secured loan is used to pay off high-interest unsecured debt, allowing you to achieve more favourable terms and repayment options.
Check out our latest post on the difference between revolving and non-revolving credit.
Note: If you have a poor credit history, a secured loan is the better option and can help improve your credit rating.
Alternatively, an unsecured loan may work better for you if you have an excellent credit score and don’t want to put up any collateral.
Small Business Debt Recovery
Each type of debt we’ve discussed above has its own pros and cons, and you need to consider your financial needs when making the best choice for you.
It is also always worth remembering that debt recovery services are available to help when customers default on repayments.
At Direct Route, our team specialises in collecting outstanding invoices and chasing overdue payments.
Helping to keep your cash flow flowing and maintain good working relationships with your customers, contact us today.