Unsecured loans are a type of loan that are given without the applicant having to provide any collateral to the bank. These loans are given on the basis of an applicant’s credit score and income. Since there is no collateral, the risk factor is high for the bank. Therefore, the banks charge a higher rate of interest on these loans as compared to secured loans.
Types of Unsecured Loans
The common types of unsecured loans are:
- Personal Loans
- Business Loans
- Education Loans
- Credit Cards
- Payday Loans
Business Loans
These are loans taken with the intent of starting a new business, maintaining or expanding an existing business, or for any other business need. These loans inject fresh capital into the business and help the entrepreneurs or management to realise the organisation’s true potential.
Features of Unsecured Business Loan
Different banks have varied criteria and features for their unsecured business loan products. Here are some common features of these loans:
- These loans are given without any collateral.
- An unsecured business loan usually has a high rate of interest as the risk taken by the lending bank is high.
- These loans are given on the basis of the creditworthiness and repayment history of the business applicant. Other criteria may also be considered.
- In most cases, banks require that the said business be in operation for at least 2 years.
- The loan amounts can vary from Rs. 1-2 lakh and go up to Rs. 45-50 lakh, depending on the business size and need.
- The tenure of the loan is usually flexible and can range from 1-5 years, or more.
- Most banks also offer an unsecured business loan with an overdraft facility.
- These loans are beneficial for well established businesses.
- Private companies, public companies and partnership firms can apply for an unsecured business loan.
Benefits of Unsecured Business Loan
Here are some common features of an unsecured business loan:
- Easily Accessible: All that an applicant needs to do is fill out the application and submit the necessary documents. The loan process can also be done online.
- Loan Based on Income: Banks give loans based on the applicant business’ income. Higher the applicant’s income, the higher will be the loan amount. This is because banks assume that high income businesses will have the capacity to repay bigger loan amounts.
- Minimum Documentation: There is minimum documentation so the loan process is hassle free.
- No Collateral: There is no collateral required for this loan. Therefore, the applicant does not have to worry on the bank taking over their business assets.
- Established Business: An unsecured business loan works for established businesspersons with strong credit scores.
Points to Note for Unsecured Business Loans
Just like other loans, an unsecured business loan also has some points that applicants need to note:
- Interest: The rate of interest on unsecured loans is high. There is no collateral and so the banks consider it to be a risky investment. Therefore, a higher rate of interest is charged from the business for the unsecured business loan.
- Short Tenure: An unsecured business loan can be availed for a limited tenure. The maximum tenure that banks allow is 5 years, in most cases.
- First Time Loan Applicants: This loan is not ideal for start-ups and entrepreneurs. The banks check the credit worthiness and repayment history of the applicant. In this scenario, first time applicants seem like risky investments.
- Bad Credit Score: Applicants with a bad credit score will find it very difficult to avail this loan as there is no collateral that can work against the higher risk banks will have to take.
Difference between Secured Loans and Unsecured Loans
- Tenure: Secured loans have a much higher tenure than unsecured loans. In secured loans, the maximum tenure can go up to 30 years. In unsecured loans, the maximum tenure is usually of 5 years or less.
- Rate of Interest: Since the risk factor in unsecured loans is high, the rate of interest will also be high. In secured loans, since collateral is already given, the rate of interest is low.
- Collateral: In secured loans, an applicant has to provide a type of collateral – a movable or an immovable asset. Failure to repay the loan will lead to loss of the hypothecated / mortgaged asset. This is not the case in unsecured loans. There is no collateral and so the applicant’s assets are safer.
- Requirement: Secured loans are taken based on specific requirements. For example, car loans are taken for cars, home loans for purchase of a home or renovation. Unsecured loans may be taken for unspecified purposes and can be used in accordance with the applicant’s wishes, as long as they are not prohibited.
Eligibility for Unsecured Business Loan
- The business should be based in India.
- The applicant should be in a stable job. In case of self-employed individuals, their business should be in operation for at least 3 years.
- The loan applicant should have a basic minimum salary. The higher your income, the bigger the loan amount you can avail.
- The applicant must have a strong credit score. The credit score represents the repayment capacity of the individual.
Factors Affecting Unsecured Business Loan Eligibility
- Age: Youngsters are considered to be risky investments as they do not have a history of strong business management or leadership. This is because they are just starting out and are considered unproven candidates by the bank.
- Job Stability: It is important that their business be operational for at least 3 years. Stable businesses are considered more loan-worthy as compared to newer organisations.
- Credit Score: The credit score is a measuring stick on which the creditworthiness of an individual is judged. The score is based on loan and credit card payments made by the applicant. It is measured on a scale of 900 points. Individuals with a credit score of 750 points or above are considered loan worthy.
- Income: Some banks require that the applicants have a minimum salary bracket. In unsecured loans, income is of vital importance as the amount of loan that can be borrowed heavily depends on the applicant’s salary.
- Businesses with Accounts in Bank: A bank prefers to give loans to companies that have accounts with the bank. These businesses can easily avail a loan as the bank has prior experience of working with them.
What is a Credit Score
Credit tells us about an applicant’s financial behaviour. The credit score is calculated on the basis of an individual’s loan and credit card payments. This tells us whether the applicant is trustworthy when it comes to repayment of loans. This tool is used by banks to ascertain the creditworthiness of an applicant.
Factors that affect Credit Score
- Timely Payments: In order to maintain a good credit score, timely payments are a must. Avoid defaulting on your EMI amounts and plan your expenditures accordingly.
- Prepayments: These are payments made with the intent of early foreclosure of a loan. Making prepayments goes to one’s benefit as it shows that the applicant is serious about repaying their loan.
- Expenditure: Careful expenditure of loan amount gives the impression that the applicant is careful about his spending. Individuals who end up spending the entire loan amount in one go may be considered to be reckless spenders. Thus, their rating goes down.
- Multiple Loans: Applicants with multiple loans seem desperate for finance and point to bad financial management capabilities. This impacts their credit score in a negative way.
- Guarantor: If you act as a guarantor for an individual who is a loan defaulter, then this will have a negative effect on your credit score.
- Loan Amount: Seeking big loan amounts that you may not be able to repay makes the applicant look bad. Therefore, it is important to go for an amount that you / your business will be able to pay back.
Things to Note When Taking an Unsecured Business Loan
- Offer Document: This document explains in detail the nitty-gritty of the loan. It is advised that the applicants go through it once before committing to anything. It would also be helpful if they seek the help of a finance expert in order to understand the loan particulars.
- Prepayment Fee: Prepayments are payments made with the intent of foreclosing a loan before its due date. Banks may charge a prepayment fee or waive it off, based on the relationship the unsecured business loan borrower has with the bank.
- Rate of Interest: There are two types of interests: fixed and floating. In a fixed rate of interest, the EMI amount remains the same. On a floating rate basis, the EMI amount keeps fluctuating as the rate of interest keeps changing. This is because on a floating rate basis, the interest rate is dictated by market forces and RBI guidelines.
Frequently Asked Questions
Here are a few FAQs that people may have about an unsecured business loan:
1. What is the difference between a secured loan and an unsecured loan?
Ans. Secured loans are loans where collateral has to be given in order to avail a loan. The lender is in a comfortable position because an asset has been kept as collateral. So, an applicant can get a loan at low interest rate with a comfortable tenure. In unsecured loans, there is no collateral so the risk on investment is high. This leads to high interest rates and shorter tenures.
2. Why should I go for an unsecured business loan?
Ans.This loan is easily accessible and does not require any form of collateral. This loan is given on the basis of the applicant’s credit score and income. This loan is ideal for applicants who have an established business and a strong credit score.
3. I wish to start a new business. Should I get an unsecured business loan?
Ans. Unsecured business loans are not ideal for young entrepreneurs and start-ups. This is because these loans are given on the basis of the credit history and repayment capacity of the applicant. Young entrepreneurs are just starting out so they do not have any financial track record of business growth or stability. This makes it difficult for them to avail a loan.
4. What are the factors that affect the loan eligibility for unsecured business loans?
Ans. Following are the factors that affect the loan eligibility for unsecured business loans:
- Type of Business
- Years of Operation
- Financial Results
- Growth and Profitability
- Leadership / Management
- Credit Score of Promoter
5. What are the benefits of getting an unsecured business loan?
Ans. Following are the benefits of an unsecured business loan:
- These loans are accessible as they can be availed online.
- These loans are based on your business income. The more your income, the more loan amount you can borrow.
- There is minimum documentation
- There is no need for collateral.
- This loan is beneficial for established businesses.
6. How much money can I borrow in an unsecured business loan?
Ans. Unsecured business loans are given on the basis of the applicant’s income. The higher the applicant’s income, the more amounts they can borrow.
7. Is the interest on unsecured business loan high or low?
Ans. The interest on an unsecured business loan is high. This is because there is no collateral and so to compensate, the lender gives the loan at a higher interest rate.
8. What is EMI and how is it calculated?
Ans. EMI stands for Equated Monthly Instalments (EMIs). These are monthly payments that are made to pay back a loan. It is calculated on the basis of the loan amount, rate of interest and tenure. It can also be calculated by using the EMI calculator that is available online on the Paisabazaar website.
9. What is the difference between a fixed and a floating rate of interest for an unsecured business loan?
Ans. In a fixed rate of interest, the EMI amount remains the same as the rate of interest does not change. This is not the case in the floating rate of interest. On a floating rate, the rate of interest is guided by market forces and RBI policies. This implies that the EMI amount fluctuates. The business, thus, should see what are the EMI amounts that come up for different types of interest rates. Once these numbers are clearly available, businesses can plan their repayment schedules accordingly.