Here is How Unsecured Loans are Different from Secured Loans

Rahul Kharnokhya

Adequate funding is a pre-requisite for any business. Whether a project is at its initial stage or in the development phase, it needs ample financial backing to keep up its growth momentum. However, finding adequate funding can be a challenging process despite the market now offering a wide range of alternatives to traditional sources of finance.

In their search for funding options, start-ups and small businesses often stand at crossroads where they must choose between secured and unsecured loans. On the surface, both look “equally attractive” with their respective advantages. Borrowers are frequently perplexed as to which should be their final choice.

It is therefore important to delve more deeply into these two broad categories of loans and compare their costs with the benefits they bring. Businesses must also be aware of their own financial situation to understand clearly which loan option they will be eligible for.

Let us first understand the basic concepts of secured and unsecured business loans in India.

Secured Loan

A secured loan is always backed by assets. While applying for such a loan, the business must own something of measurable financial value, which can be offered as collateral to the lending institution. This could be an immovable property (a plot of land with or without construction), gold, a valuable investment portfolio, or any other asset that can be liquidated. Businesses can also extend their machinery, raw material or inventory stock as collateral.

The collateral has to be pledged to the lending institution. This implies that the lender will hold the title/deed to the collateral until the loan is fully paid off. However, the borrower retains the ownership of the asset and will continue to enjoy benefits accruing from it.

If the borrower fails to pay off the loan in the stipulated time, the lending institution has the right to take over the possession of the collateral and sell it to recover the outstanding debt amount. Typically, with secured loans, the end use of funds borrowed is pre-determined.

Advantages of secured loans

Borrowers are often lured to secured loans in the hope that they will be able to procure a larger loan amount than what unsecured loans can offer. The longer period available to pay back the borrowed sum is also a perceived advantage.

Another apparent benefit of these loans is the lower interest rate charged on them. This is based on the rationale of lesser risk involved, thanks to the collateral that can be sold off by the lender in case of payment defaults.

THE CAUTION – What must also be remembered is that some secured loans can have very high interest rates. There are financial agencies that charge the highest legal interest rate for business loans despite taking collateral from the borrower. Reading the fine print carefully is always recommended. In some cases, a low interest rate can also be a promotional or limited period offer that may be withdrawn after a few months.

In addition to non-banking financial companies (NBFCs), nationalised and private banks also offer secured loans to businesses, but the banking penetration in India is still low. This prevents several small and medium enterprises (SMEs) from obtaining a secured loan at a reasonable interest rate.

Another common disadvantage of secured loans is that the process of getting approval is longer and calls for more paperwork than an unsecured loan.

This brings us to the second business loan category.

Unsecured Loans

An unsecured loan is not backed by any collateral. It allows the borrower to get funds without having to offer any asset as guarantee to the lending institution. Generally, unsecured business loans come with a fixed term and fixed rate of interest.

Unsecured loans are offered based on the credit worthiness of the borrower. For an enterprise, the eligibility can be gauged in terms of years in business, its annual turnover and the primary location (city) from which it operates.

The tenure of these loans is often shorter than the long-term loans granted by banks. Most nationalised and private banks approve loans for SMEs with a payback tenure of not less than one year. NBFCs can offer immediate loans for shorter periods. At Capital Float, unsecured small business loans are offered for a tenure of one to 12 months. This gives the borrower the advantage of securing quick funds for sudden needs. Once the project begins to reap returns, the business can pay off the loan and thus avoid paying interest for prolonged terms.

Advantages of unsecured loans

When a business requires only a small amount, an unsecured loan is a better alternative than a secured one, especially if the business does not want to expose its financial assets to the risk of repossession. Also, those companies that do not possess sufficiently valued assets for the amount they require can find easy access to working capital finance with unsecured business loans.

Such loans also act as a good source of funds for companies that are already trading. Since the loan is unsecured, the lenders decide upon its amount by simply assessing the trading position of the business. Background checks are performed on credit history, cash flow position, cash reserves and balance sheet.

Unsecured business loans are quicker to obtain than secured loans. We provide funds to our clients within 3 days once they submit the necessary documents and clear the eligibility criteria. As against this, private banks take more than two weeks in forwarding the grant, while public sector unit banks can take 4-6 weeks for the same.

If your business needs immediate financial support and you are hesitant to offer any collateral to the lender, unsecured business credit will work for your best interests. By choosing Capital Float as your trusted finance partner, you are assured of a quick digital process to submit your application. The entire loan disbursal process is completed in three simple steps, given below:

  • Upload the minimum required documents on our website
  • Receive approval in minutes if your paperwork makes the business eligible for loan
  • Get the funds within next 72 hours

Do not let the long-drawn processes of conventional funding delay the pace of your venture’s development. In the digital age, unsecured corporate loans can conveniently help you accelerate your business growth.