Business Loans are specifically designed for businesses to obtain funding to finance their operations, expand their business, purchase equipment, or acquire inventory. These Loans, usually offered by Non-Banking Financial Companies (NBFCs) and financial institutions, can be secured or unsecured.
However, before you can take a secure loan, you should know how much collateral the lender requires and the type of collateral they accept.
What Is Collateral?
A collateral is an asset with a financial value offered to a lender as security against a loan. If the borrower cannot repay the loan, the lender holds the right to use the collateral and recoup their losses. Collateral can be anything from personal or business assets such as real estate, equipment, vehicles, inventory, or accounts receivable. However, property is the most common form of collateral for a loan for business.
Do All Business Loans Require A Collateral?
No, you can get large and small Business Loans with or without collateral. While NBFCs provide collateral-free Business Loans to well-established businesses, startups or small businesses with a low turnover can take a Business Loan against collateral security.
What Are Business Loans Without Collateral?
The creditworthiness of the small business owner determines the approval of unsecured Business Loans. The lenders give these loans after scrutinising personal and business credit scores, as well as the business’s financial health, time in operation and regular cash reserves. NBFCs can offer an unsecured Business Loan of up to Rs 40 lakhs for a tenure of up to 60 months.
How Much Collateral Do You Need For A Business Loan?
As stated, if you opt for an unsecured loan, you do not require any collateral. When opting for a secured loan, the amount of collateral you need to provide will majorly depend on factors like:
- The loan amount you wish to borrow
- The lender’s policies and eligibilities set for borrowers
Generally, the higher the collateral value, the better your chances of being approved for the loan and receiving favourable terms.
One of the most common ways lenders use to determine how much collateral they require is by utilising a loan-to-value (LTV) ratio. The LTV ratio is the percentage of the loan amount the lender is willing to lend based on the value of the collateral. For example, if you offer a property of Rs 1 lakh as collateral for a Rs 70,000 loan and the lender considers an LTV ratio of 50 percent, you will get Rs 50,000 (50 percent of Rs 1 lakh).
Lenders typically have different LTV ratios depending on the collateral type. For example, a lender may have a higher LTV ratio for real estate than inventory or accounts receivable. This is because real estate is considered a more stable and long-term asset, whereas inventory and accounts receivable are subject to fluctuations in the market.
In addition to the LTV ratio, lenders consider various other factors when determining how much collateral you need to provide for a Business Loan. Some of these factors include:
- Your credit score: A good credit score can increase your chances of being approved for a loan and may lower the amount of collateral required.
- Your business’s financial history: Lenders will review your business’s financial statements, including income and cash flow, to determine your ability to repay the loan.
- Your industry: Some industries are considered riskier than others, and lenders may require higher-value collateral to offset that risk.
- The loan amount: Generally, the larger the loan, the more collateral the lender will require.
What Types Of Collateral Are Accepted By Lenders For Secured Loans?
Lenders accept a variety of collateral for Business Loans, depending on the type of loan, whether big or small business loan and the lender’s policies. Here are some of the common types of collateral that the lenders accept:
- Real estate: Commercial and residential property, including vacant land, built-up properties, and apartments. These are often the most valuable and stable assets used as collateral. Real estate is a popular choice for collateral among NBFCs, who provide large loan amounts for a longer tenure to business owners without end-use restrictions.
- Equipment: Machinery, vehicles, and other tangible assets used in a business operation are used to get secured loans. The value will depend on the asset’s age, condition, and market value.
- Inventory: Products or materials a business has can be a form of collateral. Lenders may or may not accept inventory as collateral: they will typically assign a lower loan-to-value (LTV) ratio due to its potential volatility in the market.
- Accounts receivable: The money owed to your business by customers who have not yet paid their invoices can be used as collateral. Again, the lenders may or may not accept accounts receivable as collateral but will typically assign a lower LTV ratio because of the risk of non-payment.
- Personal assets: Personal property such as a home or car the business owner owns can be used as collateral. However, you must confirm with the lender if they accept them as collateral.
Keep An Eye Out for Liens
A lien in a Business Loan is a legal claim a lender places on a business’s assets, such as property or equipment, as collateral for the loan. When a lender places a lien on a business’s assets, it means that the lender has the right to take possession of those assets and sell them to recover the amount owed on the loan. This helps to protect the lender’s interests if the borrower fails to repay the loan.
Liens can be either voluntary or involuntary. Voluntary liens are those created by agreement between the lender and borrower, while involuntary liens are created by law or court order. In the case of a Business Loan, a voluntary lien is typically created through a security agreement that outlines the terms of the collateral.
Conclusion
A large or small Business Loan can help a business operate smoothly or expand. But the business owner needs to ensure they have gained clarity on the terms and conditions of the loan, its collateral, and other aspects when opting for one.
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