One of the key challenges that MSMEs in India face is shortage of funds. It adversely impacts the company’s growth and expansion plans. In such situations, MSME business loans can help fulfil the company’s aspirations.
There are various kinds of loans available for MSMEs depending on the purpose, industry, etc. Though there are different kinds of loans for businesses in India, they can broadly be divided into – collateral and non-collateral loans.
What is a collateral loan?
Collateral loan is a type of secured loan wherein the borrower pledges an asset such as property, vehicle, financial securities, etc. to seek loan. The loan value depends on the value of the collateral or mortgaged asset. Lenders prefer collateral loans as the asset can be liquidated in case the borrower is a defaulter. Collateral loan’s interest rate is usually lower plus a higher loan amount can be obtained as compared to a collateral free loan as the security is involved.
Following assets can be pledged as collateral for a business loan
Commercial or personal property
Machinery or equipment
Investments such as mutual funds, fixed deposits, bonds, etc.
Additionally, there are few NBFCs that offer business loan against gold jewellery too.
Why do banks or lenders demand collateral against loans?
Collateral acts as a security against the loan amount. If a borrower does not repay loan, lender can liquidate to make up for the losses. Due to this fact, lender’s risk reduces. Therefore, banks and NBFCs demand collateral against the loan.
Advantages of collateral loan
Opting for collateral loan has various advantages:
Collateral acts as a security that further helps you to enhance your eligibility in case you have a low CIBIL score or have lesser credit history.
In case you have less credit history, you can build your credit score by making timely payments of the collateral loan
You will be able to secure more loan amount as compared to collateral free loans
You can enjoy lower rate of loan interest as compared to collateral free loan
Disadvantage of collateral loan
Foremost disadvantage is that there is chance of losing the asset pledge in case you do not make timely payments.
Since the loan procedure involves additional step of valuation of assets, it usually takes longer time compared to collateral free loans
Collateral vs non-collateral loans
Does not need collateral|
Lower interest rate|
Higher interest rate|
Tenure can be higher depending on the loan amount and collateral|
Tenure is lesser as compared to the collateral loan|
Documentation is higher as original documents related to the pledged asset need to be submitted|
Documentation is normally lesser|
CIBIL score is not the major considering factor. However, higher score adds to the creditworthiness and increases the chances of loan approval.|
CIBIL score need to be higher as it indicates creditworthiness|
Examples of collateral business loans
Property as a collateral: Many borrowers mortgage existing personal property to secure loan. Alternatively, borrowers can also secure a loan against the commercial property that they are buying. Lenders prefer real estate as a collateral because the value generally appreciate over period of time while other tangible assets depreciate. While pledging your personal property like house, you need to be extremely careful. If you default, you will lose the house too. On the other hand, if you are pledging your commercial property and if you default, the lender will seize your property. This will further lead to business losses.
Machinery as collateral: It is when you pledge a new or existing machinery or business equipment as a collateral. From the borrower’s perspective, it is safer to pledge machinery than the family house. On the other side, your loan amount may get affected depending on the condition of your machinery. If your machinery is too old, gone under wear and tear multiple times, then you many not be able to get loan against it.
Vehicle as collateral: You can pledge either your personal or commercial vehicle. Sometimes, while getting loan for buying a new commercial vehicle, the same vehicle is pledged.
Documents required for collateral loans
Here is a list of commonly required documents for loans in India (including MSME loans and loans with/without collateral). However, the documents required may vary depending on the lender and the kind of loan applied for. Some of the regular documents required for availing a business loan in India are:
Duly filled application form
ID and address proof of the business owner i.e., Aadhaar card, Passport, Voter’s ID card, etc.
IT returns documents
Last 2 year’s balance sheet of the company
Asset’s documents in original as well as photocopy
It is advisable to check with the lender on documents, accepted collaterals, loan amount, loan tenure, interest rates and other details before applying for a loan, to avoid any sudden surprises.
Here are some frequently asked questions about collateral loans.
1. Where can I get a collateral loan?
2. Do I need to have a good credit score to obtain a collateral loan?
3. What is rate of interest for collateral business loan?
4. Collateral loan or collateral-free loan, what should I choose?
Collateral loan is a suitable choice for business owners who have an asset to pledge, loan requirement is higher or need quick approval. The lower rate of interest will lower the EMI and hence repayment will be easier. However, many a times, small business owners do not have collateral to pledge, and hence opt for non-collateral loans. In case the approved loan amount does not match the required amount, business growth may get hampered.