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Going for a business loan? 5 things you must know

Last updated on: November 11, 2014 16:05 IST

Nowadays, lenders offer a wide variety of loans to choose from. As a businessperson, one has to consider some basic features of a loan before deciding whether the loan is apt for the business.

Here are some features you should be looking out for if you want to opt for a business loan:

1. Low interest rate

Photograph: Simon Cunningham/Creative Commons

This is a feature everyone looks for while considering a loan. A businessperson has an option of a daily or a weekly loan provided by local lenders. However, the rate of interest on such a loan is as high as 3 per cent per month (or 36 per cent per annum; almost similar to a credit card financing).

Besides this, a lesser amount is provided due to advance payment of installment. For a loan of Rs 1000, a local financier would lend Rs 900, Rs 100 being the advance EMI, and charge interest on the entire amount of Rs 1000. This increases the interest payments enormously.

The cheapest loan a business person can avail is loan against property (LAP). The current LAP rates hover around 10 per cent. A cash credit or a bank overdraft facility carries rates ranging from 11-13 per cent, depending upon the turnover of the company, the quality of collateral and the type of business.

A personal loan is an expensive loan since it is an unsecured form of loan. Usually the interest rates applicable to personal loans vary between 16 and 18 per cent but in some cases the rate could be as high as 24 per cent.

2. Low cash outflow

Another factor that needs to be considered while opting for a business loan is the cash outflow. The minimum cash outflow is possible from the bank overdraft facility since only the interest needs to be paid regularly and that too on the amount used.

A project based term loan is also appropriate if payment deferment clauses are attached to it. This is apt for Greenfield (totally new plant) and brownfield (expanding an existing plant) projects.

A personal loan may result in a huge cash outflow. However for a start-up/new business this may be the only option, much better than approaching a local financier.

The ideal way to finance a start-up business is to avail a loan from family or friends at zero or very low interest rates.

A gold/jewel loan is also meant for financing new businesses. Such loans carry an interest rate of 1-1.5 per cent per month. The only drawback of gold loans is that the amount of loan is about 60 per cent of the value of gold.

3. Partial pre-closure without charges

In this respect too, overdraft facility fares better than any other loan.

The next best option after the overdraft facility is loan against property (LAP) as far as ease of repayment is concerned. LAP allows you to pay whenever you have excess cash even if the amount is as small as Rs 10,000, thus reducing the principal amount and the interest.

Personal loans usually do not allow partial pre-closure. Local financiers penalise borrowers for partial pre-closure.

4. Low initial processing fees

Every loan has a processing fee. A personal loan charges a minimum of 2 per cent of the loan amount as the processing fees. Processing fee in case of LAPs lies between 1-2 per cent. There may be an additional fee for legal opinion.

Bank overdraft facility will also charge 1-2 per cent excluding fee for legal opinion and encumbrance certificate.

In a chit fund loan, processing fee is in the form of initial few payments that are required to be made before the withdrawal can be made.

5. Collateral requirement

Every loan, except personal loan and loan from local lenders, require something as collateral. If a person does not have any existing asset s/he is left with the option of a personal loan only.

Among loans that need to be backed by some security, the gold loans have low interest rates and the cash outflow is also low but the quantum of loan is limited.

The second best option is the overdraft facility followed by loans against property.

A loan for a particular need cannot be best suited under all conditions. You should decide on a particular loan only after considering different variables and understanding the scenario.

Vaibhav Aggarwal