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A business loan is a sort of debt that is taken by a person or a company. The lender, which is usually a corporation, a financial institution, or the government, gives the borrower a lump sum of money. In exchange, the borrower agrees to a set of terms, which may include finance charges, interest, a repayment schedule, and other conditions. Loans and other financing options for consumers are divided into two categories: secured loans and unsecured loans.
What is a Secured Loan?
A secured loan is one that is given out by a financial institution and uses an asset as collateral or security. You can, for example, utilize your home, gold, or other valuable assets to secure a loan amount corresponding to the asset’s value. The bank or financial organization that is providing the loan will keep the asset’s ownership deed until the debt is paid off in the case of a secured loan.
Benefits of Secured Business Loan
1. Lower Interest Rate:
A secured business loan’s interest rate is always maintained at a reasonable level. Because the lender’s ‘risk factor’ is always lower, lenders offer secured business loans 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’s EMIs are likely to be high.
2. Higher Capital Amount:
Larger loan amounts are approved as the bank’s liability decreases, and risks are significantly reduced. The lender will approve loan amounts that are as close to the value of your collateral as possible, leaving no room for potential loss.
Even if your company is new or has a low net worth, you can still acquire a large business loan provided your loan collateral is valuable. Loan collateral enhances your creditworthiness.
3. Flexible Repayment Option:
A secured business loan has a long repayment period. The longer repayment period ensures a low EMI. Paying large amounts in EMI may appear stressful when your business is in its early stages. Smaller EMIs allow your firm to continue operating with less risk.
4.Better Chances of Loan Approval:
When you add security to your loan, your chances of getting approved for the loan increase. Most Secured loans have better chances of getting approved when compared to Unsecured loans.
Disadvantages of Secured Business Loan
1. Heavy Paperwork:
Secured loans require a significant amount of documentation since you will have to submit the standard documents (i.e., proof of identification, age, and residence), as well as documents pertaining to the ownership of your asset. You’ll also have to attach a massive amount of specimen signatures to a series of documents, and if even one of them doesn’t match the others, you’ll have to repeat the entire tedious process.
2. Living in debt:
If you fail to return the loan in a timely manner, your collateral will be taken. Even after that, if your debt isn’t paid off, you’ll be forced into a life in which all your earnings go to the bank. Most of the time, you’ll be paying interest and penalty costs, with the principal amount remaining relatively unchanged.
3. Value of Asset must Match or Exceed Loan Amount:
The loan you’re looking for must be refundable through the sale of the asset you’re putting in. If the bank is unable to collect its losses through the sale of the collateral, it will approach you with a deficiency judgment, which will bind you to pay your debt.
4. Credit Bureau Score:
If you skip on secured loan repayment, your Credit Bureau score will drop significantly. If the bank has to seize your home and other assets, your credit score and rating may suffer irreversible damage.
What is Unsecured Business Loan?
Unsecured loans are a type of financing where the borrower is not required to submit any collateral to the bank or NBFC. These unsecured business loans are based on an applicant’s financial records, credit score, income, etc. Without submitting any collateral or security to the bank, an unsecured business loan for a startup can be used to establish a new firm or to expand or manage the business flow. Because no collateral is required, the risk component for the bank or NBFC remains high.
Benefits of Unsecured Business Loan
1. No Collateral Required:
You don’t have to put up any collateral to acquire an unsecured business loan. A guarantor is also unnecessary. There is no risk of property seizure because no collateral is hypothecated to a lender.
2. Quick Loan Approval:
Unsecured loans require very little documentation and do not require time-consuming paperwork. All the required documentation can be submitted online and get instant loan approval.
3. Amount of loan not constrained by the value of an asset:
The secured loan amount is usually determined by 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.
Disadvantages of Unsecured Business Loan
1. Requires High Creditworthiness:
As there is no collateral as a form of security, it becomes quite risky. 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:
For lenders, collateral-free business loans can be risky. And therefore, they may have a higher rate of interest. NBFCs, on the other hand, can provide you with a business loan at a nominal interest rate.
Before applying for a business loan, calculate the EMI using a business loan EMI calculator.
3. Smaller Loan Amounts:
Because no collateral is required to approve the loan, lenders, and banks make sure that the loan is repayable. That is why small loan amounts are offered.
In a Nutshell
Finally, to summarize, if you need money right away and don’t want to put up any collateral, an unsecured loan is the best option. However, if you have a low credit score and require a large sum of money over a longer period, a secured business loan may be a better fit for your company.
Furthermore, if you’re looking to reduce your debts, it could be a good idea to pay them off first before applying for a business loan. Consider your company’s requirements before making a decision!
