When looking for a business loan, you have two primary options – a secured loan or an unsecured loan. A secured loan is the one, where collateral is required to obtain the funds. Attaching collateral will help increase the eligibility of the loan, and the quantum of finance you wish to receive, in case of a poor credit score, lack of business vintage, etc. The pledged collateral offers security to the lender in regards to payments. In case you default on the loan, the lender will utilize the security to recover the outstanding due.
The kind of security you put up to the bank, also is accounted for when considering your loan application. The financial institution will also evaluate your company’s financial health based on certain factors, other than the collateral you plan to pledge. In the following post, we will talk about which other factors play a role in deciding the amount of collateral you require to take a business loan.
Which Factors Determine the Amount of Security Needed for a Business Loan?
Below-mentioned are the factors that banks look into apart from collateral, to process a company loan:
- Credit History
The credit history of your company consists of track record of repayments made on previous business loans. The lender will view your company’s credit report to analyze the repayment record and the credit score. This helps the lender to understand the financial health of the company. A high credit score will encourage the financial institution to approve the application, and vice-versa. If you have a good score, then the amount of collateral will be lower.
Also, if your establishment is fairly new with not enough vintage, then your personal credit score will be checked along with the company score. So make sure both the company credit score and personal credit score are fairly good for the lender to consider you creditworthy.
- Repayment Capacity
Your repayment capacity, revenues, or profits generated by the company are three most important things banks consider when taking a lending decision. The repayment capacity is judged on the basis of any existing financial liability on the company, such as existing debt, outstanding credit card debt, etc. The lower your financial liability is, greater is the chance of getting the right loan amount and terms.
A good repayment capacity speaks well about your company’s ability in obtaining funds, and vice-versa. Thus, before applying for the loan, make sure you have a lower amount of debts, and if there are any outstanding due, repay it on time. Also, when you get the new loan, repay on time, so that a good credit record is maintained, and your repayment capacity stays unaffected.
- Existing Capital
The existing fund that you already have is known as capital. Sometimes this is the amount you want to put towards an investment, project, hiring staff, etc. However, every company needs to assure that sufficient working capital is there to run operations. The existing capital may not be enough, and in this case, a loan can help. Greater the existing capital, lower will the loan amount request be, and better will be the rate of interest offered by the bank.
A good amount of capital and a strong business plan together can convince the lender to provide the required loan amount. To keep up a consistent capital, cut down on unnecessary expenses, and check if the existing allocation of funds is perfect. If there is any cash outflow which can be restricted to add to capital, you may want to look into this option.
- Relationship with the Financial Institution
If you have had a good relationship with a financial institution then that may count as an advantage to get one of the best business loan offers. A good relationship could be established by being a loyal customer to a bank, making regular payments on any loan taken previously from the same institution, or having made a lot of investments with the respective lender, etc. Many times, existing customers get better interest rates and loan amounts other than that offered to non-customers. This is because the lender trusts you and the financial health of the company.
Types of Business Loans That Require Collateral
By the above-mentioned factors, it is evident that if you have an excellent credit history, sufficient capital, good repayment capacity, and a stable relationship with a financial institution, then you can get the best loan offer, and collateral requirement would also reduce. In some cases, you can even acquire an unsecured business loan, where no security is required. But, let’s look the different secured loans that you can take:
- Invoice Financing
- Equipment Loan
- Loan against property for business
- Secured loan of credit
- Inventory financing
- Accounts receivable
- Investment or cash
Should You Choose a Secured or an Unsecured Business Loan?
You can choose either of these loan types. Remember that opting for a collateral loan puts the pledged asset at risk. So, if you default on repayments, the bank has every right to acquire this asset to recover dues. Thus, analyze the prospect of unsecured business loans as well. These are easily available if you fit the bill and eligibility criteria of the bank in regards to annual turnover, profit margin, credit history, business vintage, etc.
If you select collateral business loan, then be sure of the type of collateral you wish to put up. Is it a commercial real estate property, equipment, or an investment? What the asset means to your company and are you prepared to pledge it to the bank over the loan tenure? What happens to your company in case you lose the asset due to a loan default? All these questions must be answered before choosing a collateral or collateral-free loan for your company.
Apart from collateral to be pledged with the bank for a secured loan, you are now aware of other factors that the financial institutions will look into when providing you funds. Keep the above-pointers in mind when going for a secured business loan. These factors are the most common ones that the bank will consider when choosing an unsecured business loan as well.