6 Biggest Collateral Free Business Loan Mistakes You Can Easily Avoid
Financing is the one issue every SME in India is facing. Despite being an integral part of the country’s economy and the availability of numerous business loans in India, it is difficult for these small units to generate funds. Traditional banks usually want collateral to extend a loan to a small business. The value of the collateral should be commensurate with the amount of loan one needs, while assuring the bank of one’s credibility. SMEs, working with limited resources often fail to arrange collateral, which nullifies their chances of getting the loan.
However, in today’s scenario, businesses not having substantial assets, expensive machinery or any other type of collateral have the option to apply for unsecured working capital loans offered by various alternate lenders and banks, who are trying to help small and medium enterprises with their business growth and development. These loans are preferably given to well run entities that require urgent funds to fulfill their immediate and diverse needs, such as running operations, opening a new office or buying inventory and equipment.
FinTech lenders have made the process extremely simple, where an SME can apply for a business loan online within 10 minutes, while submitting digital copies of the required documents. Unlike traditional banks, which take 2-3 months just to let the business know whether their loan has been approved or not, Fintech lenders are able to disburse the loan amount within 72 hours. However, it is important to know that there are some common mistakes that can cost you more than the loan repayment.
6 Collateral Free Business Loan Mistakes SMEs Should Avoid
- Not Having Clear Financial Goals
When you are borrowing finances for your business, it is necessary to have a clear business plan and see your goals practically, while also knowing the steps to achieve them. It might happen that you took a loan to buy inventory, but you end up extending your business premises with the funds instead. This is a mistake. You need to stick to a plan. Fintech lenders offer flexible, short-term loans to purchase inventory, service new orders or optimize cash cycles. A clear financial goal will help in determining the business loan requirements and the loan type best suited for your business.
- Miscalculation of Funds Required
Proper estimation of the funds required is actually the first step any business should take. In most cases, SME owners, in order to avoid overestimating their business loan requirements, tend to underestimate their needs. This might save them from paying interest on excess funds but it leaves the business needing more.
FinTech lenders offer a line of credit finance product that has a predetermined credit amount, based on the prospects of the business. SMEs are given the flexibility to use only as much funds as they currently need, while paying interest only on the amount used. Moreover, they can repay the amount whenever they feel like to restore the credit amount, making funds available for future requirements.
- Not Reading the Terms Carefully
When the collateral free business loan is sanctioned by the bank, the biggest mistake borrowers make is not reading the agreement before signing it. The legal document is filled with legal jargon, right from dealing with default to the reset clause around the interest rate. Moreover, fees, such as documentation charges, charges for change in loan tenure, late payment charges and pre-payment charges are not communicated upfront by the bank, hidden somewhere between the fine print, raising the overall loan cost.
Talking of the pre-payment charges, traditional lending institutions will charge a fee if the SME decides to pay off the loan earlier than decided, based on the remaining balance. FinTech lenders, on the other hand, do not have any pre-payment charges, where the borrower is allowed to repay the loan amount ahead of the agreed upon tenure.
- Not Having Your Documents Ready
When applying for a business loan from traditional banks, SMEs are supposed to submit a plethora documents, along with their loan application, including certified copies of their balance sheet, profit and loss accounts, cash flow statements, and income tax returns, based on which banks determine the business’ capability to repay the loan amount, before they extend the loan to them. Unfortunately, most businesses fail to get their paperwork in order and face refusal from the banks. In comparison with traditional banking institutions, FinTech lenders require lesser number of documents, which can be submitted online, after making a digital copy of them.
- Not Maintaining a Profile
Borrowers’ credit ratings play a key factor is deciding whether a bank will extend a business loan to them or not. Banks use the credit ratings or the CIBIL score in India to determine your creditworthiness. Indian banks consider SMEs that have maintained a CIBIL score of above 750 as creditworthy.
Most of the time, SMEs do not have a good credit profile, raising questions regarding their creditworthiness. Moreover, in their urge to get funding quickly, they keep on applying for loans with various financial institution, which further affects their credit rating, since every hard inquiry conducted by banks significantly reduces the CIBIL score, whether the SME gets the loan or not. FinTech lenders do not rely on the CIBIL score and use the borrower’s social media account and other unconventional data to determine their creditworthiness.
- Inaccurate Loan Tenure Estimation
The tenure is the most neglected, yet vital aspect of a business loan. Longer the tenure, the more interest the SME will end paying up which when added to the principal amount would put an additional financial burden. Traditional banks do not prefer extending loans for shorter terms. On the contrary, FinTech lenders, offering business loans in India for SMEs, allow you to choose a flexible loan tenure or repayment option, ranging from 6 months to 36 months, according to the nature of your business and your cash flow.
SMEs can avail the best business loans when they avoid making the above mentioned mistakes during loan application.