If you’re working on expanding your business, chances are that you’ll consider small business loans or financing of some kind. One of the first things you’ll learn when researching this topic is that there are two basic types of small business loans: secured and unsecured loans, otherwise known as loans with and without collateral.
What’s Collateral?
Collateral refers to anything you pledge as security when taking out a loan, that you agree to forfeit in the event that you can’t pay back the amount you borrowed. An example of collateral might be a physical property that you own. You agree to hand over this property in the event that you default on a loan.
A “secured loan” refers to any loan that requires collateral. A home mortgage is a very common example of this type of loan, where the house serves as collateral to secure the loan. An “unsecured loan” is the opposite, a loan without collateral required.
3 Tips For Getting Unsecured Financing
1. Check your credit
The majority of lenders will check your credit score before deciding to approve you for any business loan. Since an unsecured loan is potentially riskier for the lender (since there is nothing for them to repossess in the event of default), they are generally more likely to approve loans for applicants with very high credit scores.
Since applying and getting rejected for any loan can negatively affect your credit score, you’ll want to check it yourself before deciding to apply.
There are multiple ways to check your credit for free. It used to be that you could request a free copy of your credit report from each of the three major reporting agencies (Equifax, Experian, and TransUnion) once per year. Today, the FICO Score Open Access program from the Fair Isaac Corporation (also known as FICO, the makers of the credit score) has made free credit scores much easier to get. You can still request your free credit report from one of the agencies, but you may also be able to find your personal credit score just by logging in to your bank account online.
Keeping track of your credit score and using it to determine the best time to apply for the unsecured loan of your choice will help you increase your chance of being approved.
2. Raise your credit score.
FICO uses five separate factors to calculate your score: your history of paying back loans on time (generally contributing about 35% of the score), the amounts you currently owe (30%), the length of your credit history (15%), how frequently you apply for new credit (10%), and the types of credit you are using (10%). FICO may weight these factors slightly differently depending on the circumstances, but this gives you a general idea of how important they are, most of the time.
The good news about this is that some of these numbers are within your control. There are many things you can do to raise your credit score over a period of months.
For example, if you know you want to apply for unsecured business financing in the near future, you can hold off on applying for new credit, and be diligent about making any payments you owe on time.
You can also hold off on canceling any of your oldest accounts, like that credit card you’ve had since you were 20 that you don’t use much anymore. Hanging on to those old accounts helps increase your average age of credit, which will help raise your credit score.
Credit Utilization Ratio
Finally, you can try to keep your credit utilization ratio at or below 30%. That means using only 30% or less of the total amount of revolving credit you have across your accounts. According to Experian, one of the three major credit reporting bureaus, this is a key factor in your credit score.
Here’s a simple equation for this:
Credit Utilization Ratio = (Your total debt) / (Your total available credit)
After a few months of focus, by making any debt payments on time and working to fix common credit score mistakes, you may be able to gain a few valuable points. If you can, that will put you in a better position to get approved for financing.
3. Apply with a co-signer
Another way to improve your chances of being approved for an unsecured loan is to apply with a co-signer who also has a good credit score.
Do you have a business partner with a high credit score? Does your business partner have a long credit history and a spotless track record of paying off their debts on time? Together, you could make a stronger case for being approved.
Of course, the opposite is also true, too: if you apply for financing with a co-signer, and they turn out to have something problematic in their credit report, that can negatively affect your loan application. If you do get approved for financing with a co-signer, you’ll both be responsible for paying back the loan. If one of you misses a payment, you’ll both be held responsible. For these and other reasons, you should only consider co-signing a loan with someone you know and trust.
Not all types of financing will allow you to apply with a co-signer, but some do. Most major banks and credit unions, as well as many online fintech lenders, have options for applying for financing with a co-signer. If you’re concerned about your own credit history, and you have a possible co-signer in mind, this could be an option worth researching before you apply.
About Fundbox
Irene Malatesta is a senior content strategist and editor at Fundbox. As a writer, marketer, and strategist, she focuses on connecting business owners with the tools and education they need to grow and thrive.