Obtaining a small business loan is an excellent option to grow your business and spread your capital expenses over a long time frame instead of paying them out in bulk. If you’re concerned about the amount of collateral you need to provide, there is an alternative: a collateral-free business loan. These unsecured loans allow business owners to secure funding without offering collateral.
This article will cover everything you need to know about collateral-free loans, including their advantages and disadvantages, the documentation required, eligibility requirements, and federal schemes that offer business loan without collateral.
What Do You Mean by Collateral Loans and Collateral-Free Loans?
Collateral refers to a collection of assets that a borrower or guarantor pledges as security for a loan. If the borrower cannot repay the loan by the due date, the lender has the right to take or sell the asset(s) to recover losses incurred due to default. For example, you could pledge your office space, land, or vehicle as collateral when securing loans.
Collateral-free business loans are straightforward and offer various options to applicants. They assist borrowers in achieving their business goals, whether it’s expanding their operations, establishing a new facility, or launching a new line of products. Since these loans aren’t backed by security, they are known as unsecured loans.
Features and Benefits of Collateral-Free Loans
Collateral-free business loans come with a variety of advantages. Let’s look at them in detail:
- No collateral security required: The primary benefit of unsecured business loans is that you do not have to provide collateral. This means you won’t have to risk your valuable assets to secure funding, allowing you to meet your business requirements without sacrificing your prized possessions.
- Shorter processing time: These loans generally have a shorter processing time than loans requiring collateral. This is because determining the loan amount and the value of the collateral often takes significant time. By eliminating these processes, loan approval and disbursement can occur much faster.
- Simplified documentation: For collateral-free loans, the lender typically does not require documentation related to collateralized assets. This means the application process can be more straightforward, avoiding lengthy documentation requirements and ensuring that the approval process is as easy and stress-free as possible.
- Loan amount independent of asset value: Since you do not pledge any collateral, the amount you can borrow is not dependent on the value of any asset. Instead, various factors determine the loan amount, including your creditworthiness (assessed by your CIBIL score), financial documents, income, and the lender’s maximum loan limits.
Disadvantages of Collateral-Free Business Loans
Unsecured business loans are not without their disadvantages. Here are some drawbacks to consider:
- Higher interest rates: The main disadvantage of unsecured business loans is the cost of borrowing, which is generally higher than that of secured loans. Lenders charge higher rates to mitigate the increased risk they face when lending without collateral.
- Lower tenure: Since lenders take on more risk, unsecured loans typically have shorter tenures. The maximum tenor generally is three to five years.
- Limitations on larger ticket sizes: With unsecured loans, you usually cannot borrow more than Rs. 1 Crore. Banks and Non-Banking Financial Companies (NBFCs) typically offer loans ranging from Rs. 20 to 50 lakhs based on the borrower’s creditworthiness and business profile.
Government Schemes for Collateral-Free Loans
- Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE): Founded on August 30, 2000, by the Indian government in partnership with the Small Industries Development Bank of India (SIDBI), the CGTMSE allows businesses to avail loans of up to Rs. 2 Crore. Borrowers must be a registered business and provide a comprehensive business plan before applying for the loan. Flexible repayment plans of up to five years are available.
- Mudra Loans: The Micro Units Development and Refinance Agency (MUDRA) was established under the Jan Dhan Yojana on April 8, 2015. This agency acts as a Microfinance Institution (MFI) with a maximum loan limit of Rs. 10 lakh. MUDRA offers three types of loans:
- Shishu: Up to Rs. 50,000
- Kishore: Between Rs. 50,000 and Rs. 5 lakh
- Tarun: Between Rs. 5 lakh and Rs. 10 lakh
To learn more about Mudra loans, check out our blog post on the three kinds of Mudra Loans: Shishu, Kishore, and Tarun.
What Are the Eligibility Criteria for Availing an Unsecured Business Loan?
Before applying, make sure to check your eligibility to reduce the chances of having your application denied. While several financial institutions guarantee quick approval, here are the typical eligibility criteria for collateral-free loans:
- You must be an Indian citizen.
- You must be self-employed.
- Your age should be between 25 and 60 years, although this may vary among lenders.
- You should have been in business for at least three years.
- A high credit score is essential.
What Documents Are Required to Avail an Unsecured Business Loan?
You must provide specific documents to financial institutions to obtain these unsecured business loans. These documents typically include:
- KYC documents include an Aadhaar card, voter ID card, PAN card, passport, etc.
- Proof of residence, such as utility bills or electricity bills.
- Bank account statements for the past six months (some institutions may require statements for the past year).
- Income Tax Returns from the previous year (some institutions may also require GST returns).
- Additional documents as required by your lender, such as passport-sized photos.
How to Apply for a Collateral-Free Business Loan?
Here are the steps to follow when applying for a collateral free business loan:
- Research various lenders: Choose trusted and reputable financial institutions.
- Check your eligibility: Review the eligibility requirements listed above.
- Gather the required documents: Compile all necessary documentation to ensure a smooth application process.
- Complete the application form: Fill out the application form carefully, ensuring that all required information is accurately provided to avoid rejection due to errors.
Conclusion
The requirement to pledge collateral has often deterred long-time business owners from seeking the funding they need. Collateral-free business loans eliminate this barrier by providing entrepreneurs with necessary funds without risking their assets, albeit at higher interest rates. Furthermore, these loans allow clients to establish credit and experience a swift approval process with minimal formalities.
