There was a time when starting a business looked daunting for an individual, and not many people had the courage to take that unknown bet. But now times have changed and more people are venturing into entrepreneurship. This has led to the growth of micro, small and medium enterprises (MSME) which cushions the economic growth as well. The MSME sector provides the banks with a lending opportunity of $70 billion, according to a recent Assocham and Ashvin Parekh Advisory services. The sector is still underserved with only 40-70 per cent of financial requirements being met by banks.
Unlike before business owners have multiple options such as NBFCs, banks, online lenders and other institutions to access finance. However, as a business owner you should understand the importance of a secured and unsecured loan. The two types of loans have a different bearing on the way you run a business. Let’s understand the implications of a secured and unsecured loan for business owners.
How secured and unsecured loan differ?
Loans are usually taken to start a new business, maintain or expand existing business. Unsecured business loans are typically those which don’t require any collateral. Collateral is an asset that a lender accepts as security for a loan. In case of an unsecured business loan, you don’t have to provide any asset against your loan and such loans get approved on the basis of your credit score and income levels. But unsecured business loans are considered too risky for lenders, and therefore the rate of interest is higher as compared to secured business loans.
Such loans are required to tap new business opportunities that help the owners to implement ideas and ensure business growth. Banks and institutions have their own criteria for extending unsecured business loans. Hence, make sure you understand the provisions for taking such a loan. Remember, your creditworthiness and repayment history will come to the picture at the time of loan approval. Some institutions sanction loan only if your business is operational for a minimum of 6 Months. You can apply for an unsecured loan from Rs 50000 depending on the size of your business and requirement. The tenure of the unsecured business loan is flexible and can range between one-five years, or more. You can avail an unsecured business loan with an overdraft facility as well. Private companies, public companies, and partnership firms can apply for an unsecured business loan.
Most SMEs in India do not have much collateral to offer, and hence find it difficult to access business loans from the formal banking sector.
However, the government has made it easier for businesses to access loans through collateral free loans. One can easily avail collateral free loans under Credit Guarantee Fund Trust Scheme for Micro & Small Enterprises. The government-backed collateral-free loans under this scheme can be availed from banks and online lenders such as Lendingkart at a reasonable interest rate.
Things to consider
Interest: Unsecured business loans always attract higher interest rates as there is no collateral whereas secured loans may require collateral – a movable or an immovable asset. In case of a failure to service the loan, the mortgaged asset will be taken by the bank. Since there is no collateral in unsecured business loan you need not worry about the assets in case of a failure of repayment. As a business owner carefully consider the rate of interest and how the rate of interests will impact EMIs. Secured loans are usually taken for the purpose of buying a home or car. However, there is no specific reason to take unsecured loans.
Tenure: Mostly unsecured loans have a limited duration whereas, in case of secured business loans, the maximum tenure can go up to 30 years.
Credit score: Today credit score and credit report are one of the key documents required to get a collateral-free loans loan. Keep in mind that applicants with a poor credit history may fail to access unsecured business loan in the absence of any collateral. An individual’s credit score ranges between 300 and 900. If you have a credit score of 750 points or above you are considered loan worthy. A good score also helps you negotiate interest rate and other charges with your lenders. You can improve your credit behaviour by making timely repayments. Keep a tab on your credit report and credit score to avoid any kind of loan rejection owing to a low score.
Offer document: The offer document clearly mentions the nitty-gritties of a loan. Go through the documents before making up your mind for unsecured business loan. If you are not clear about any particular condition, then talk to a financial advisor from the bank or seek help from online lending platforms.
Prepayment fee: There is a fee attached to the prepayment of a loan. Some banks charge a prepayment fee, while others may waive it off depending on the relationship between the lender and the borrower.
Type of interest: If you have applied for any loan then you would be aware of the two types of interest rates i.e. fixed and floating. The EMI remains the same for a fixed rate of interest, while it keeps fluctuating if the loan has been granted on floating rate. The floating rate of interest usually changes as the rate is guided by market forces and RBI guidelines.
Income: In unsecured loans, income is of paramount significance as the amount of loan to be sanctioned depends a lot on the borrower’s income and his ability to repay. Moreover, a bank prefers to lend to companies which have accounts with them. Such businesses can find it easier to avail a loan if the borrower is an existing customer of the bank.
What should you choose?
Like any other loan, the applicant needs to submit an application along with documents. There is minimum documentation for unsecured business loan in the absence of any collateral as compared to a secured loan but may take longer processing time. The foremost requirement for a business owner is that the venture has to be based in India. Also, it might be easier to access unsecured business loan if you are employed. A good track record of credit history can make the process smooth as the lender can rely on your repayment capacity. Similarly, a stable business owner can easily access an unsecured loan than a first-time business owner.
Ideally, applicants who have an established business and a strong credit score can easily access unsecured business loan, but it can be a little risky for banks to offer such loan in the absence of any track record.
Although collateral-free loans are beneficial for well-established businesses to fund their working capital, start-ups need to have a clear idea about paying back the loan within that time. You may still look out for an unsecured business loan to fulfil your business requirement, but make sure you repay instalments on time. With the changing outlook and easier access to finance, it’s the best time to fund your business aspirations.