Comprehensive Guide to Secured Business Loans

Whether you want to expand your existing business with new branch offices or open a new venture, a business loan can help achieve your goals without facing a financial crunch. When it comes to expansion or setting up new ventures, business requires a substantial amount of capital. In such cases, getting a business loan with collateral makes sense. Secured business loans offer your business the requisite capital, while providing lenders protection against possible defaults. This comprehensive guide on secured business loans helps you understand how they can contribute to the growth and expansion of your business. 

What is a Secured Business Loan?

A secured business loan is a type of business financing where the borrower must pledge assets as collateral for the loan. Unlike unsecured loans, secured loans require a collateral deposit to acquire funding. Assets like real estate, equipment, or land can be pledged as collateral to get the business loan. The pledged collateral reduces the lender’s credit risk since the lender reserves the right to sell the asset in case of a loan default. In exchange for the added credit security, the lender typically offers business owners lower interest rates and higher loan limits. Therefore, MSMEs looking to borrow a substantial amount against a competitive interest rate can consider such collateral loans. 

Eligibility for Secured Business Loan

Banks and NBFCs offer business loans with collateral to existing as well as new customers. Most offer such loans to a broad category of borrowing including start-ups, MSMEs, SMEs, and large enterprises. Depending on the lender’s policies, secured business loans are offered to proprietorship, partnership, and limited liability companies. In fact, SMEs like shopkeepers, retailers, and wholesalers can also avail of a secured business loan. 

However, to get a collateralised small business loan for your enterprise, you must meet the following eligibility criteria: 

• The applicant must be an Indian citizen.
• The applicant must meet the minimum age criteria of 21 years.
• The applicant must not be more than 65 years at the time of loan maturity.
• The applicant should have a good credit score and a strong credit history. 
• The applicant must be able to prove a business vantage of at least 2 years and profitability for the past 2 years. 
• The applicant must possess a residential, commercial, or mixed-use property. 

Note: Eligibility criteria for secured loans vary from lender to lender. 

Features of Secured Business Loan

• Collateral Requirement

Secured business loans require a collateral pledge. Businesses can pledge residential properties, commercial properties, or other assets to get the business loan. However, lenders may have restrictions on the acceptable types of collateral. 

• Loan Amount

Business loans with collateral generally offer high loan amounts. The minimum loan amount is Rs. 10 Lakhs and the maximum loan amount is Rs. 20 Crores (higher in some cases). The sanctioned loan amount depends on the business’s repayment capacity, collateral value, and requirement.

• Attractive Interest Rate

Secured business loans generally have a lower rate of interest as compared to a loan without collateral requirements. Lenders offer low interest rates against the enhanced credit risk protection from the collateral. 

• Loan Tenure

Generally, secured business loans come with a longer loan tenure. Depending on the lender you pick, it may range up to 15 years or more. 

• Usage

Secured loans have no restrictions on the purpose of the funds. Businesses can use the loan amount for various purposes like purchase machinery, equipment, plant, lease offices, pay salaries, purchase raw materials, and hire new employees. 

Types of Secured Business Loans

Depending on your funding requirements, you can choose from the various types of secured business loans available in India. Some common types of secured loans are listed below:

• Secured Term Loan: Secured term loans are pretty straightforward. You borrow a sum of money for a specific tenure, paying a fixed rate of interest on the principal amount. 
• Inventory financing: Inventory financing loans are short-term loans taken against the inventory you need to purchase. This inventory serves as collateral for the loan meaning the lender can sell the inventory if you default on the loan.
• Equipment financing: An equipment or machinery loan is one where the high-value machine bought using the loan funds is used as collateral to secure the loan. 
• Line of Credit: A line of credit is a type of loan where you can withdraw from a certain capital reserve up to a specific limit. After you repay the spent amount, the credit pool is replenished. Depending on the amount of credit required, lines of credit may be secured or unsecured. 

Benefits of a Secured Business Loan

Secured business loans offer significant advantages over unsecured business loans. Here’s a list of advantages borrowers can enjoy: 

Lower Interest Rates

The pledged collateral in a secured business loan lowers the risk exposure of the lender. This allows you to get such loans at a relatively lower interest rate. In India, secured business loan interest rates start from 9% p.a. depending on the selected lender and the borrower’s repayment capacity. Conversely, unsecured business loan rates generally start from 16% p.a. onwards.

Higher Borrowing Limits

Another key advantage of a secured business loan is the higher borrowing limit. Unlike loans without collateral where the maximum loan amount is based on the credit-worthiness of the borrower, here the maximum loan amount is determined by the collateral pledged. Typically, lenders offer up to 70%-80% of the collateral value as a loan. A higher borrowing limit allows business owners to conveniently fund their business expenses with a single loan. 

Longer Repayment Tenures

Secured business loans are often accompanied by longer repayment tenures ranging from 10-15 years. A longer tenure, plus low interest rates ensure affordable EMIs. Businesses can easily manage payments without compromising their cash flow. Moreover, it allows businesses to plan and allocate resources to clear the loan overtime rather than feel the immediate pressure of hefty short-term payments.  

Difference between Secured and Unsecured Business Loan

When getting a business loan for your enterprise, you may be confused between a secured and unsecured loan. The following table sums up the differences between the two to help you decide between a small business loan without collateral or one with collateral:

Parameter	Secured Business Loan	Unsecured Business Loan
Interest rate	Generally have lower interest rates starting from 8% p.a.	Generally have higher interest rates starting from 16% p.a.
Collateral requirement	Collateral required to lower default risk and ensure more favourable loan terms.	No collateral required.
Tenure	Longer tenures ranging up to 15 years.	Comparatively shorter tenures.
Loan amount	Higher loan amount depending on the value of the pledged collateral.	Smaller loan amount depending on the credit score and repayment history of the borrower.
Importance of credit score	Credit score is not given primary importance.	Credit score is crucial in determining the loan terms.
Risk for the lender	Low	High

Documents Required for Loan Application

The following documents are needed when you apply for a collateral business loan in India: 

• Duly filled loan application form with passport-size photographs of the applicant. 
• PAN Card (both of the applicant and the company)
• Identity proof (Aadhaar Card, Voter’s ID, Driving Licence)
• Address proof (utility bills, Aadhaar Card, Driving Licence)
• Business address proof documents like copy of property papers
• Income proof documents (bank statements from the last 6 months, ITRs of the previous 2 years, balance sheet, audited profit and loss statements for the last 2 years)
• Trade licence and sales tax registration 
• Partnership deed (if applicable)
• Copy of Memorandum of Association and Articles of Association

The above list is a general list of documents commonly required for secured business loan processing. This list can vary depending on the lender’s requirements and you may be asked to submit additional supporting documents before the loan gets sanctioned. 

What is a Secured Business Loan Against Property?

A secured business loan against property is a type of loan that’s sanctioned against pledged property. Here, the business owner pledges their commercial or residential property with the lender. The lender evaluates the value of the pledged property and sanctions the loan amount according to the LTV ratio (loan-to-value). Generally, LTV ratios are capped at 70%-80% depending on the lender’s policies. The property papers are submitted to the lender (bank/NBFC) and remain with them until the loan is repaid in full. 

How to Choose the Right Secured Business Loan

Getting a business loan for your enterprise can be a challenging task, especially with so many lenders offering attractive terms on business loans. Remember, the right secured business loan is one that matches your business’s funding requirements and your repayment capacity. Here’s a few factors you can consider to choose the right secured loan:

• Compare Interest Rates and Other Fees

The interest rates, processing fees, late penalty charges, prepayment fees, and foreclosure charges will vary from one lender to the next. These fees and charges can significantly impact your overall cost of borrowing. Therefore, to get the best terms on your secured business loan, you must assess these factors carefully before choosing a lender. 

• Identify your Business Needs

Every business has unique requirements and needs. Some may need funds to manage cash flow while others need it to finance expansion or purchase new equipment. Identify the purpose of the loan to understand which loan offers suits you best. Additionally, you should review the LTV ratio of different lenders to understand which lender is offering you the best value for the collateral. 

• Review the Lender’s Reputation

Lastly, you should also consider the reputation of the lender. Lenders with a good market reputation and strong customer support systems can make a world of difference to your loan experience. Always try to approach lenders with whom you have a working relationship first to try and get the better loan terms. 

Risks Associated with Secured Business Loans

Despite the many benefits, securing a business loan with collateral can exposure you to the following risks:

• Risk of Losing the Collateral

One of the most significant risks of getting a business loan with collateral is the possibility of losing the pledged asset. If you default on the loan payment, the lender reserves the right to seize the collateral and auction it to recoup the loan amount. 

• Long-term Commitment 

Apart from the possibility of collateral loss, secured loans also expose you to a long-term commitment. During the 15-year-long tenure of the loan, the financial standing and cash flow of your business can change affecting your repayment capacity.

Online and Alternative Small Business Loans

SMEs and MSMEs generally lack the high-value collateral required to get a secured business loan. In such cases, they can try alternative financing sources. Alternative funding is acquiring loans from sources other than traditional banks. Most alternative lending sources are accessible online and offer highly customised lending products for MSMEs. Depending on their business requirements, MSMEs can opt for a variety of loan products like term loans, line of credit, merchant cash advances, invoice factoring, and others through alternative financing portals. Apart from the absence of long processing times, lower fees and favourable loan terms make alternative financing more attractive to small businesses. 

Conclusion

Getting a business loan with collateral requirements is the best option for certain businesses. If you have valuable assets, require a high loan amount, and prioritise a long and comfortable repayment tenure, opt for a secured business loan. Factors like lower interest rates, longer tenures, and substantial borrowing limits help businesses secure the required capital conveniently. However, you should carefully weigh the current financial condition and the future health of your business before committing to a small business loan with collateral. 

Frequently Asked Questions

What type of collateral is accepted for a secured business loan?

Business owners can obtain a secured loan against different types of collateral like land, property, and equipment. Other types of collateral may be accepted depending on the lender’s policies. 

Will the collateral be sold if I fail to pay the loan EMIs?

If you fail to repay the loan EMIs over consecutive months, the lender will first remind you about the missed payments. If you still fail to respond, the lender will send you a legal notice. If all attempts at reaching out to you fail, the lender will auction off the collateral as the last resort. 

Is the loan amount equal to the collateral value?

No. Lenders usually sanction 70%-80% of the collateral’s value as the loan amount. This is called the LTV or loan-to-value ratio. 

How can I know if my collateral is sufficient?

When you apply for the loan, you need to submit the collateral papers as well. The lender evaluates the collateral to determine its worth. If the current market value of the collateral is higher than the loan amount, the loan is easily sanctioned.