As a businessperson, there are a number of choices that one has to get loans for the business. There are some basic traits (characteristics/features) of a loan that we need to look at before deciding whether the loan is the right one for the business.
Features required in a business loan
Some of the features of loans that will influence the decision for a business loan are:
- Low Interest Rate
- Low Cash Outflow
- Partial Pre-closure without charges
- Low Initial Processing Fees
- Collateral Requirement
Let us see how different loans compare on the above features.
Low interest rate
This is a feature that anyone will look for in any loan. But every loan product will have its own characteristic hence we need to discuss this feature in detail.
The easiest loan that any businessman can get is the daily/weekly payment loans from local financiers. But the interest rate here can be very high -- in the order of 3% and above per month.
Also there is the element of getting lesser amount that the loan amount due to advance payment of EMI. A local financial will give Rs 900 for the Rs 1,000 loan (Rs 100 being the advance EMI) and charge interest for the full Rs 1,000. This method increases the interest rate tremendously.
The lowest rate among loans for business people will be the Loan against Property (LAP) -- about 10% at today's rates. Following closely will be the Cash Credit or Over-Draft facility of the Bank -- about 11% to 13% based on the turnover, quality of collateral and type of business at today's rates.
Being an unsecured loan, the personal loan will have the higher interest at about 16 to 18% (sometimes going up to 24%).
Taking cash by discounting a chit fund payment is one of the methods used for funding our requirement.
However the interest rate charged on these transactions on withdrawal typically will be above 24%; though the term interest rate is never used with these transactions.
Low cash flow
The lowest cash outflow is possible from the overdraft facility as only the interest needs to be paid on a regular basis and that too only for the amount utilized.
A project based Term Loan may also prove healthy as there may be loan payment deferment clauses related to the execution of the project. This is particularly attractive for green-field (totally new plant) and brown-field projects (expanding an existing plant).
A personal loan may be the most costly and cash consuming loan for a business purpose. However for a startup / new business this may be the only better option than the local financier. This is especially true for people starting a business after working for some time.
The ideal business loan for a startup however, is to get it from family members and friends (if they have the cash). There are 2 benefits from this for a startup first time entrepreneur. 1. Generally, if one could convince their mom on a business plan, then they could convince anyone. 2. We can get a soft loan (interest free or very low interest) from family members and friends.
Gold/jewels loan, is another of the typical startup loan. Here we get the benefits of typically low cash flow (low interest ranging from 1% to 1.5% per month) by releasing the locked up value of gold/jewels lying idle in our lockers. The limitation is in the quantum of loan as typically only about 60% of the gold value can be got as the loan.
Partial pre-closure without charges
Again the over-draft facility score better than most loans in this feature.
The second best is the loan against property where even small amounts like Rs 10,000 can be paid at irregular intervals (whenever we have excess cash) to reduce the principal and hence the interest burden.
Personal loans generally do not allow partial pre-closure. Some local financiers allow partial pre-closure but with a charge.
Initial processing fees
Any loan will have its associated processing fees. A personal loan will charge a minimum of 2% of the loan amount as processing fees. LAPs charge anywhere between 1% and 2% as processing fees. There may be additional fees for the legal opinion and the encumbrance certificate. Bank overdraft facility also will charge 1 to 2% with the associated additional fees for the legal opinion and the encumbrance certificate.
The initial processing fee for the chit fund loan (withdrawal) is typically in the form of the initial few months' payments that need to be made before the withdrawal can be made. Again the term processing fee is never used here, but is inbuilt into the system.
Except for the personal loan and the local financiers who lend through chit subscription, all the other loans require collateral in one form or the other. For those who do not have existing assets, the personal loan becomes almost the only option for a loan (unless of course one has rich relatives & friends whom we could convince).
Among those which require collateral, the gold jewelry loan is the one with the lowest interest rate and lowest cash flow too -- but limited by the quantum. The next best is the overdraft facility followed by the LAP option.
There is no way that one particular loan type can be said to be the best for all conditions. As the above discussion goes, there are so many variables that understanding the scenario is different aspects is required before a loan product can be considered for a business.