What Are Collateral Requirements for Small Business Loans?
Is your loan application rejected due to failed collateral requirements? Do you know how collateral value is determined? Are you looking to apply for a collateral-free loan? Read on to know more about loan collateral requirements of financial institutions.
What Is a Loan Collateral?
Loan collateral is an asset or property you pledge against a loan issued to you by financial institutions like banks. If you fail to repay the loan, the lender can seize your asset or property to compensate for the unpaid amount. Anything that the banks/MFIs/NBFCs can sell if you do not pay your loan back is loan collateral.
What Are the Types of Loan Collateral?
Collateral can consist of business assets or personal assets. Assets such as home, land, equipment, furniture, building, gold, machinery from existing businesses and inventory (in some cases) are considered possible sources of repayment in case of loan default. You can also assume assets being financed with the borrowed money to be used as collateral for the loan. The loan amount is almost equivalent to the value of the collateral.
How Do You Determine the Value of a Collateral?
A bank/MFI/NBFC will give you a loan based on the value of the collateral you possess. To determine the collateral value, the lender conducts a collateral assessment by considering the market value of the asset. However, sometimes lenders will price your asset lower than its market value, as assets sell at a lower price than the market price during emergencies.
Deciding whether a particular asset qualifies as collateral and how much it is worth depends completely on the lender. Bank/MFI/NBFC conducts a thorough check of the collateral and associates a value based on the market price of a similar collateral to determine its worth.
Do All Business Loans Require Collateral?
Sometimes business loans are issued by lenders without a collateral. Here are a few cases where a loan is issued collateral free.
Case 1: A majority of lenders require collateral for issuing business loans, but some lenders do not require collateral to approve or release a loan. Instead, they keep the asset you will purchase using your loan amount as a collateral. For example, if you take a loan to buy new equipment or new land for your business, the lender will use the same machine or land as collateral. They will claim the machine/land if you do not pay your EMIs or repay the loan on time.
Case 2: Here, the lender evaluates a business owner’s creditworthiness to issue a loan. The lender examines the overall health of your business, your cash flow, your tax reports and your personal and business credit profile. The banks/MFIs/NBFCs might issue a business loan without collateral if they find all these aspects satisfactory.
In addition to these two cases, the Government of India also provides financial support to medium and small-scale industries and business start-ups. It offers various loan schemes, which do not require any collateral or security. The names of the schemes are as follows:
How Can You Apply for a Business Loan?
To apply for a business loan you should:
- Visit government portals and websites of different financial institutions to understand about various schemes and the loan process.
- Compare all the details before applying for any loan.
- Make a list of all the assets you have, such as real estate, machinery, equipment, inventory, gold, etc., if you are opting for a loan with collateral. Keep the documents related to these collateral ready.
- Ready the necessary documents of your business, such as Aadhaar card, PAN card, balance sheets, GST documents, etc.
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