5 things you must know to avail secured loans for your business
Business owners need to appreciate that the collateral is only a risk mitigation mechanism for the lenders.
Indian economy is likely to be a $5 trillion economy by 2025 and the MSME sector is expected to play an important role in this growth story. This sector has been the backbone of the economy, contributing immensely to the GDP and employment generation and with the emergence of 'Make in India' initiative, it is set to play an important role supporting the domestic companies and foreign multinationals setting a manufacturing hub in India.
Financial institutions including banks and NBFCs have also increased their focus on MSME credit, acknowledging their importance in the era of high economic growth. However, many times, entrepreneurs are not able to avail credit schemes on offer for the lack of awareness about such schemes or cost concerns.
Here are 5 key things you must know to avail cost efficient secured loans for your business, commonly referred to as collateralised credit:
What is collateralised credit?
Collateralised credit refers to the loan schemes offered by the financial institutions with tangible security backing the business loan. Such loans tend to be the most cost-effective, as lenders can offer better interest rates given reduced credit risk and availability of collateral security in case of potential default. Small business owners can offer a variety of properties like residential, commercial, manufacturing units as collateral and avail business loans at better terms. Some lending institutions may also selectively accept residential or commercial plots as collateral. While first way out is always the cash flows of the entity, collateral support to the loan makes it a more cost effective option to the MSME.
Clear and marketable title to the offered security
Lenders insist on a clear and marketable title to the security offered for the business loan, as they need to ensure that you are entitled to offer such property for a mortgage. For example, if you are seeking to mortgage your residential house property for a business loan, the legal team will seek copies of all the documents showing the change of ownership and check the authenticity of such documents. Thereafter, the lender takes the custody of the original title deed for the equitable mortgage on the property.
While the loan is essentially offered on the basis of cash flows, debt metrics and your requirements, the upper ceiling of such loan depends upon the market valuation of the security. The proportion of the security which the lender will consider granting a loan for is referred to as Loan to Value (LTV) Ratio. This tends to be the highest for the residential house property, and reduces, in the same order, for commercial property, manufacturing unit, etc. As such, the business owners must offer suitable property towards the mortgage, meeting the bank's LTV policies and also the business funding requirements.
With the evolution in the financial technology, several lending institutions have digitized many processes and thus, can offer the loan facilities with faster turnaround time. Further, the evaluation processes amongst digitally-savvy lenders tend to be on the basis of risk matrix scorecard, enabling them to offer better LTV ratios and better collateral valuations across a variety of collaterals at attractive rates of interest.
Realistic business projections
Business owners need to appreciate that the collateral is only a risk mitigation mechanism for the lenders and the loan recovery must come from the business cash flows. The availability of collateral, sans a profitable business, may not get a loan sanctioned. As such, the business projections must be realistic, so that it continues to remain profitable and stress-free and continues to hold better credit history.
Judiciously choosing the loan tenor
While the collateral loans can be availed for a longer term, the business owners must plan for its repayment terms. While negotiating the loan with the lender, MSMEs must ensure to have an enabling clause for partial or full prepayment of loans. This helps in managing the cash flow for the business since additional cash flow due to higher sales can be used to prepay the loan, effectively reducing the debt and interest costs for the business.
Similarly, several product variants are offered by the financial institutions to suit the growing needs of the MSME sector including step up and step down EMI option, Overdraft facility and more. Staying aware of various funding options available for your business can help you avail loan facilities at better terms and competitive rates. However, make sure you stay prudent and responsible while availing business loans.
(The writer is Head- SME, Edelweiss Retail Finance)