Most businesses in India raise working capital either through secured or unsecured business loans. However, unsecured loans attract a higher rate of interest. This is because, while the lender, a Bank or Non-banking Financial Company (NBFC), keeps some form of collateral in secured business loans, no collateral is required for unsecured loans. This means a higher risk for the lender, hence a higher rate of interest.
This may be a dampener for businesses, especially Small & Medium-sized Enterprises (SMEs) due to the higher interest rate but it makes a lot of sense for a short-term requirement. Most businesses may not have an asset which they can keep as collateral. Further, any secured loan will take longer for disbursement owing to a long list of formalities required, including valuation of the asset being posted as collateral.
What is a Collateral?
A collateral is any kind of asset owned by a business. It may be a house, a plot of land, gold, machinery etc. These assets are used as a 'security' while borrowing 'secured' business loans either from a Bank or an NBFC.
Let’s understand why unsecured business loans can be a better choice when compared to secured business loans, even at higher interest rates, especially if you are looking to fulfill your working capital requirements.
1. Quicker Loan Approvals
Approvals on unsecured business loans are quicker in comparison to secured business loans as there is a lot of paperwork involved in the latter. Since the turnaround time is shorter in unsecured business loans, it enables businesses to run their daily operations smoothly. Moreover, businesses having limited collateral can gain quick access to working capital.
2. Lower Interest Payout
Despite charging a higher interest rate, unsecured loans help businesses by granting flexibility of interest payout. Businesses can restrict their payout to only the amount they have used in a unsecured business loan. This option is not available in a secured loan where the interest is to be served on the entire loan amount sanctioned. Another advantage of unsecured business loans is that they do not levy any foreclosure/penalty charges on the borrower/business. Hence businesses can pay back a partial or the entire amount whenever they have ready cash.
The very reason for a higher rate of interest for unsecured business loans is that it is collateral-free. Emerging businesses can hence greatly benefit as they are in general deficient in collateral.
4. Purchase Financing Power
Unsecured business loans help businesses negotiate with their suppliers as they have ready access to working capital. With a strong working capital position, these businesses are in a position to pay their supplier on a shorter payment cycle and also procure raw materials at a lower rate (facilitated by advance payment).
Working capital is key for any business to grow. It often poses a challenge for businesses which lack collateral. Unsecured business loans is the best available option for them.
In the last couple of years, a lot of NBFCs have been set up providing unsecured credit lines up to INR2cr, including companies like OfBusiness, Indifi and Capital Float.
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