Understanding Small Business Loans in India: Secured vs Unsecured Working Capital Loan Options

Introduction

The availability of timely and adequate financing is crucial for small businesses to meet their working capital needs and sustain daily operations. Small business owners can choose between secured funding options like loans against property or unsecured business loans that do not require collateral security. Understanding the differences between these business loan options can help entrepreneurs make informed financing decisions.

What Is a Secured Loan?

 Secured business loans are a common way for small companies to get funding. With these loans, an asset is used as collateral to secure the loan. This means that if the business cannot repay the loan as promised, the lender can take the collateral asset.

There are two main types of secured small business loans:

1. Loans Secured by Collateral: For this type, the business pledges a physical asset as collateral for the loan. Common examples include property like land or buildings, vehicles, equipment, or even things like gold and jewellery. If the loan is not repaid, these physical items can be seized by the lender.
2. Loans Secured by Personal Guarantee: Instead of putting up physical property as collateral, the small business owner uses personal assets as the guarantee. So if the business defaults on the loan, their personal bank account, home, or other assets may be used to cover the unpaid amount. This still poses a risk to the owner's personal finances and property.

In essence, secured small business loans use valuable property as collateral from either the company itself or its owners. This gives the lending institution a way to get their money back if the borrower cannot make the required loan payments on time.

What Is a Unsecured Loan?

An unsecured loan does not require the borrower to put up any collateral. With these loans, the lender does not take claim to a borrower's property or assets if the loan is not paid back. Instead, unsecured loans are approved based on the borrower's creditworthiness alone.

There are two main types of unsecured loans:

1. Revolving Loans: These loans have a credit limit that can be spent, repaid, and spent again. Examples are credit cards and personal lines of credit.
2. Term Loans: With term loans, the borrower takes a loan for a fixed amount and repays it in equal instalments over a set period until the loan is fully paid off. Common examples include personal loans, student loans, and signature loans from banks.

In recent years, online and app-based lenders have gained popularity for providing unsecured loans. They use fintech to approve these loans quickly based on analysis of the borrower's financial background. So, unsecured business loans are becoming more accessible to small company owners through such lenders.

Secured vs Unsecured Working Loans

Here is a simple comparison of secured vs unsecured working loans:

Secured Loans

• Require collateral (assets like property) to secure the loan
• Lower interest rates as risk is lower for lender
• Larger loan amounts allowed
• If unpaid, the lender can seize collateral

Unsecured Loans

• No collateral or assets are required
• Interest rates might be high since it's a higher risk for the lender
• Smaller loan amounts granted
• No assets at risk if unpaid

In summary, secured working loans allow borrowers to get lower rates and bigger loans because they are backed by collateral. But the borrower's assets are at risk if the loan goes unpaid.

Unsecured working loans are easier to qualify for and don't put assets in jeopardy. But they come with higher rates and smaller loan amounts since no collateral is tied to the loan.

So, small businesses need to weigh their specific needs and risks when choosing between secured and unsecured working capital loans. Those with assets to spare can benefit from fast loans, while others may prefer unsecured.

Key Considerations for Small Business When Choosing a Business Loan

The business loan type small enterprises choose would depend upon:

1. Purpose – Secured funding for significant expansion needs and unsecured for short-term needs.
2. Eligibility – Startups favour unsecured loans offered without collateral.
3. Interest Rate Sensitivity – Secured loans mean lower interest costs on large principal amounts.
4. Risk Appetite – Potential of losing pledged assets in case of secured loan default.
5. Collateral Requirements – Evaluate the collateral requirements that are asked by the financial institutions. Choosing a right NBFCs helps the businesses to avoid huge collateral requirements.

Conclusion

Both secured and unsecured loans have specific benefits for small companies seeking working capital finance. By evaluating factors like requirement amount, cost, eligibility and risk tolerance, small business owners can decide on the ideal loan option for funding their diverse needs. The availability of customised products makes it possible to choose loans aligned to a company's unique financial situation. Unsecured loans are more accessible to fulfil the emergency requirements of entrepreneurs since these are collateral-free loans. The collateral-free feature of the unsecured loan ensures the loan process is effortless and easily accessible. Beyond that, unsecured loans generally provide borrowers with the flexibility to use the funds as needed.