Pros and Cons of collateral-based loan
The two main loans offered by financial institutions are secured and unsecured loans. The existence or lack of collateral or security is the main distinction between these two types of loans. Loans that are disbursed in exchange for collateral or security are frequently referred to as secured loans or collateral based loans. On the other hand, unsecured loans are those that are disbursed without any form of security or collateral. A secured loan, often referred to as a collateral loan, is a type of debt financing in which the borrower establishes a charge on any asset, such as real estate, as collateral to get funds. In other words, if the borrower defaults on the loan, the lender has the legal right to take possession of the collateral and sell it to repay the unpaid obligation. Due to the lender’s lower risk, collateral loans are typically simpler to get than unsecured loans like personal loans.
Pros of collateral loans
Large Funding
For companies who need a big amount of financing, a collateral-based business loan is the most suitable. For long-term business planning, such as investing in expansion or launching significant advertising and marketing initiatives, this form of financing is usually required. Higher lending limits are more likely to be approved by lenders if the borrower pledges a highly liquid asset with significant market value as security. If the borrower defaults on the loan, this enables the lender to safeguard themselves from monetary damages. Because of this Banks/NBFCs offer a sizable amount of funding while minimising their financial risks.
Flexible loan term
The challenge of repaying a start-up loan on time can be difficult for new business owners. However, lender may benefit from holding collateral in this situation. Applicants who promise highly valuable assets as security are more likely to receive a longer repayment period from lenders. This extended payback period enables firms to pay off their obligations without experiencing financial difficulty. Additionally, a longer payback time results in a lower Equated Monthly Instalment (EMI) payment, which is advantageous for start-up businesses.
Better financing conditions
A lending institution is more likely to see a borrower as a low-risk borrower if they provide collateral. This is so that, if the borrower defaults on the loan, the lender may recoup their loss by selling the collateral. Lenders are therefore more willing to grant borrowers with collateral with better loan terms, such as reduced interest rates. Secured business loans compared to unsecured loans offer lower interest rates, which can substantially lower a borrower’s overall interest payments and support them in the long run in maintaining financial discipline.
Low Credit Score Funding
Leading credit reporting agencies in India, such as TransUnion CIBIL, assess borrowers’ historical credit behaviour and give them a credit score between 300 and 900 to indicate how creditworthy they are. Lenders will look at a business’s credit score before granting a loan request to see if they have a history of making payments on time. For loan acceptance, a credit score between 650 and 750 is desirable. However, borrowers might not have a strong credit score, particularly those looking for MSME loans for new enterprises. Rejection of the loan may further damage their credit rating, making it challenging to obtain credit in the future. These borrowers may choose secured business loans as a result. Due to the pledged collateral, which acts as a solid backup if the borrower is unable to repay, lenders may extend credit funding to borrowers even with lower credit scores.
Cons of collateral loans
Lack of Collateral
It’s vital to keep in mind that many firms run on a limited budget and capital and that they may require immediate access to funds for necessities like paying employees or buying supplies. However, these companies may lack valuable assets that could be used as loan collateral making it difficult to avail for a secured loan.
Longer time for processing applications
An application for a secured business loan is typically accepted after a lengthy waiting period. This is so that the lender may calculate the maximum loan amount that can be sanctioned by conducting an evaluation of the collateral asset to ascertain its current market worth. As a result, for a company that needs an urgent boost in operating capital, this time-consuming process may be detrimental.
High-value assets are required
The goal of a borrower pledging collateral is to shield the lenders from possible losses. The lenders will assess the market value of the collateral asset to determine whether the proposed loan amount is doable. To assure that any losses from a potential default can be compensated by selling the asset, the lender typically provides a loan amount as a percentage of the asset’s value. Therefore, for the lender to grant the loan, the asset must have a sufficient loan-to-value (LTV) ratio. A business may not be able to obtain a business loan to maintain operations if it holds assets with a lower market value.
Chola has launched the Secured Business and Personal Loan vertical to better enable this segment of customers. The offerings by Chola SBPL are best suited for self-employed, non-professionals in the businesses of trading, manufacturing and services i.e., businesses with regular cash flows that need funds for day-to-day operations and business improvements. Avail industry’s best services at Chola.