What are the categories of Business Loan?
Business loan offered by the scheduled banks and NBFCs to self-employed professionals and self-employed non-professionals has two broad categories in form of secured business loan and unsecured business loan. So, understanding the difference between secured business loan and unsecured business loan is an important step towards achieving financial literacy, which in turn can have a long-term effect on the financial position of the borrower.
Secured Business Loans:
Secured business loans are a type of loan that requires collateral as security. Collateral can be any movable or immovable fixed asset owned by the borrower, such as residential or commercial or industrial property, equipment, or inventory.
The secured business loan is provided by the lender bank only by mortgaging the collateral security so that the borrower provides the lender with an assurance that the loan will be repaid.
Unsecured Business Loans:
Unsecured business loans do not require any such collateral as security. These loans are granted based on the creditworthiness, business vintage and history, financial stability and prospect of the borrower.
Since there is no collateral involved, unsecured loans pose a higher risk to the lender, resulting in higher interest rates, lower borrowing limits with less tenure compare to that of the secured business loans.
The application process for unsecured loans is faster and involves less paperwork compared to secured business loans.
What are the benefits of secured business loan and unsecured business loan?
Benefits of Secured Business Loan:
- Lower and competitive rate of interest:
The rate of interest for secured business loan and unsecured business loan are different. A secured business loan rate of interest is always maintained at a reasonable level because the risk factor of the lender bank or NBFC is always lower.
The lender bank or NBFC always offer a secured business loan at a lower interest rate than unsecured business loans. A business loan with a high-interest rate can be a barrier to expansion because the loan EMIs are likely to be high.
2. Higher Loan Amount and longer tenure:
The amount of loan offered for secured business loan and unsecured business loan are not same. In case of secured business loan, the loan amounts are more approved as because of longer tenure and attached collateral as security ultimately reduces the risks significantly.
The lender will approve loan amounts that are as close to the value of the collateral as possible, leaving no room for potential loss.
Even if the vintage of the company is low or has inadequate net worth, the borrower can still have a chance to avail an adequate amount of business loan due to longer loan tenure based on the valuation of the collateral. Loan collateral enhances the creditworthiness.
3.Flexibility in repayment option:
A secured business and unsecured business loan which are provided as term loans have a long repayment period ranging from 36 months to 180 months depending upon the product compared to that of the secured business loan and unsecured business loan provided as working capital loans.
Because of the longer repayment period ensures a low Equated Monthly Instalment (EMI). Paying large amounts in EMI may appear stressful when your business is in its early stages. Smaller EMIs allow the business entity to continue operating with less risk.
4.Loan Approval:
The loan approval process for both secured business loan and unsecured business loan are done based on creditworthiness and financial eligibility parameters. But when a collateral security is provided by the borrower for the business loan, the chances of getting the approval for the loan increase up to a large extent.
Most secured business loans have better chances of getting approved when compared to unsecured business loans due to low risk.
Benefits of Unsecured Business Loan:
1.No requirement of collateral as security:
The borrowers do not have to provide any collateral as security to acquire an unsecured business loan. A guarantor may not be necessary as well if it matches with the policies of the lender bank or NBFC. There is no risk of property seizure because no collateral is mortgaged or lien with the loan to the lender bank or NBFC.
2. Quick approval and disbursement of the loan:
The loan sanction and disbursement process of unsecured business loans require less time compare to that of the secured business loan because of lesser requirement of documentation and shorter process of verification as it does not require much time-consuming paperwork. All the required documentation can be submitted online and thus the applicant can get instant loan approval.
3. Amount of loan not constrained by the value of an asset:
The requirement of secured business loan and unsecured business loan provided by the banks and NBFCs to the borrower mostly depend upon the loan amount required for the end use.
There are instances where it has been found that a borrower with sound profile and satisfactory credit track record has been provided with larger loan amount without any collateral as security compare to that of a secured business loan.
So, it can be said that loan amount is not constrained by the value of asset so provided as collateral security the property or asset given as collateral by the borrower. Such restrictions do not apply to unsecured loans, and the amount approved is based on your credit score, your company’s cash flow, or any other lending parameters fixed by the lender.
What are the disadvantages of secured Business Loan and Unsecured Business Loan?
Disadvantages of Secured Business Loan:
- Detailed documentation and heavy paper work:
In case of both secured business loan and unsecured business loan the required documentation for processing is necessary. But the significant amount of documentation is more in secured business loan since the borrower will have to submit the standard documents i.e., proof of identification, age, and residence, as well as documents pertaining to the ownership of the property to be mortgaged as collateral security.
The applicant also has to attach a massive amount of specimen signatures to a series of documents, and if even one of them does not match the others, then it has to be repeated and thus the entire process becomes very tedious.
2. Living in debt for long time:
The tenure for secured business loan and unsecured business loan are long and short respectively. So in case of secured business loan if the borrower fails to return the secured business loan in a timely manner, then the collateral will be taken over by the lender bank or NBFC.
Even after that, if the whole debt isn’t paid off, then the borrower may be forced into a life in which all your earnings go to the bank. Most of the time, the borrower will be paying interest and penalty costs, with the principal amount remaining relatively unchanged.
3. Value of loan amount to the value of asset:
The whole process of calculation of final loan amount that to be disbursed for secured business loan and unsecured business loan gets different at one point. The loan amount that is provided to the borrower in secured business loan is determined based on the value of the collateral so mortgaged and it does not exceed 60% of the valuation of the same.
4. Credit score and credit track record disruption:
The credit score and credit track records get disrupted due to continuous failure in payment of EMIs for both secured business loan and unsecured business loan. But in case of secured business loan if the loan repayment is not done as per the norms of the lender bank or NBFC, then the credit bureau score will drop significantly and the credit track record will also get disrupted thus restrict the borrower to get further loans or credit facilities.
If the lender bank or NBFC has to seize the home and other assets by applying Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, then the credit score and rating may suffer irreversible damage.
Disadvantages of Unsecured Business Loan:
1.Requirement of high creditworthiness:
The credit score and credit track record for secured business loan and unsecured business loan are mandatory. The requirement of very high and impressive credit worthiness is necessary for unsecured business loan compare to that of secured business loan.
Since there is no collateral security is required in form of security, it becomes quite risky for the lender bank or NBFC to provide loans unless and until the credit score and credit track records matches the required parameter.
To avoid a heavy amount of loss, lenders keep the eligibility criteria strict, where it is necessary for the borrower to have a good credit history.
2. Higher Interest Rate:
The rate of interest rate of secured business loan and unsecured business loan are fixed by the lender bank or NBFC as per the profile of the borrower which mainly depends upon the credit track record, credit score, profile and prospect of the business ventures sustainability and vintage of the business, income stability and growth.
For lenders, collateral-free business loans are always risky and for that reason the risk so involved always attracts higher rate of interest compare to that of secured business loan.
3. Smaller Loan Amounts:
The loan amount for the secured business loan and unsecured business loan are calculated on the financial eligibility and purpose of the loan based on the rate of interest and tenure for which the loan is provided.
In case of unsecured business loan, the rate of interest is charged high due to excess risk involvement and the tenure so given is less thus resulting to smaller loan amount.
What are the differences between Secured Business Loan and Unsecured Business Loan?
The basic differences between secured business loan and unsecured business loan are mainly based on the below mentioned points:
- Borrowing limit: The borrowing limit of secured business loan and unsecured business loan varies due to some important factors like rate of interest and tenure of the loan. If an applicant requires a higher loan amount, then one should opt for a secured business loan. But if the borrower is having sound profile of business and exceptional credentials with good CIBIL score and financial history, then one can get a decent amount through unsecured loans too. .
- Repayment tenure: The repayment tenure for both secured business loan and unsecured business loan are fixed as per the policies of the lender company. A secured loan usually offers a longer repayment term as compared to the unsecured finance option. But it is up to borrower if he or she wants a loan with a longer tenure or not.
- Interest rates: The rate of interest for secured business loan and unsecured business loan are fixed subject to the risk involved. Business loan interest rates for a secured loan are generally lower because the lender already has security in place and can recover the loss in case of a default. Hence, we can say that the higher the risk, the higher the interest rate.
- Disbursal: The disbursement process of the loan amount for both secured business loan and unsecured business loan are done by the lender bank or NBFC on priority basis. But If borrowers are looking for a loan urgently, then one must know that secured loans usually take longer to process as there are more formalities involved. However, an unsecured loan requires minimal documentation and typically takes quicker to process.
