Running a business successfully requires having the necessary funding Business Loan. Without sufficient capital, a business is as good as dead. Starting or expanding a business requires a significant amount of capital. There are different ways to obtain funds. The two most common methods include venture capital and business loans. Getting funds through venture capital firms is a tough nut to crack. Most businesses rely on traditional business loans. Not every business owner has the collateral to secure a conventional secured business loan. In these cases, an unsecured business loan can be a viable option.
Let’s explore what an unsecured business loan is, the types of unsecured business loans available, and the eligibility criteria for securing one.
Understanding unsecured business loans
Broadly, loans can be divided into two categories: secured loans and unsecured loans. An unsecured business loan is a loan that is not backed by collateral, meaning the borrower doesn’t have to pledge any asset for security against the loan amount. Instead, lenders rely on the borrower’s creditworthiness to determine whether they will approve the loan. Since the lender assumes more risk, unsecured business loan interest rates are typically higher than those for secured loans.
As a result, it can be tough to get an unsecured business loan, especially for new businesses.
Types of unsecured business loans
Now that we have a fair idea of unsecured business loans let’s delve deeper into different types of unsecured business loans.
1. Line of credit
A line of credit is an unsecured loan that gives businesses access to a pool of funds they can draw from as needed. Like a credit card, companies can borrow as much or as little as they need, up to their credit limit. The interest rates on lines of credit are typically lower than those for traditional term loans, but they can be more challenging to qualify for.
2. Traditional term loans
Traditional term loans are unsecured loans that are repaid over a fixed term, typically ranging from one to five years. These loans are best for businesses with a solid credit history and a proven track record of revenue. The interest rates on these loans are typically higher than those for secured loans, but they may be a good option for businesses without collateral.
3. Invoice financing
Invoice financing is an unsecured loan that allows businesses to borrow against their outstanding invoices. Instead of waiting for customers to pay their invoices, businesses can receive immediate payment from the lender. Once the customer pays the invoice, the lender receives the payment and deducts the loan amount and interest. This type of loan can be helpful for businesses that need to improve their cash flow.
Eligibility for unsecured business loans
Before applying for an unsecured business loan, it’s crucial to check the eligibility criteria for the loan. It’s important to note that these criteria can vary from one lender to another.
Let’s take a quick look into the standard eligibility terms for an unsecured business loan.
-
Credit score
Since unsecured loans are based solely on the borrower’s creditworthiness, lenders place a high emphasis on credit scores. To be eligible for an unsecured loan, borrowers typically need a credit score of at least 650. Some lenders may require higher credit scores, depending on the size of the loan.
-
Revenue
Borrowers need to have a steady stream of revenue to demonstrate their ability to repay the loan. Lenders typically require a minimum annual revenue to qualify for an unsecured loan. You must check for this amount and match it against yours.
-
Duration of business
Lenders prefer to lend to businesses that have been operating for at least two years. This demonstrates the stability of the company and its ability to generate revenue.
-
Debt-to-income ratio
Lenders also consider the debt-to-income ratio of the borrower. This ratio measures the borrower’s ability to manage debt, calculated by dividing their monthly debt payments by their monthly income. Lenders typically prefer borrowers with a debt-to-income ratio of no more than 40%.
Final words
Unsecured business loans can be a great way to fund business activities. It can be challenging to obtain an unsecured business loan. Understanding the types of unsecured loans available and the eligibility criteria for securing one helps businesses make an informed decision about whether an unsecured loan is a right choice for them. It’s best to apply with a reliable NBFC like SMFG India Credit to quickly get an affordable unsecured loan.
Frequently Asked Questions
Q1: What are the eligibility criteria for an unsecured business loan?
A: Eligibility criteria for unsecured business loans vary among lenders but typically include a good credit score, stable business revenue, and a well-detailed business plan. Lenders may also consider the business’s industry, tenure, and cash flow.
Q2: What is the typical interest rate for unsecured business loans?
A: The interest rates for unsecured business loans vary based on the lender, the business’s creditworthiness, and the prevailing market rates. Generally, these rates are higher than secured loans due to the increased risk for the lender.
Q3: How can businesses improve their chances of getting approved for an unsecured business loan?
A3: To increase the likelihood of approval, businesses should maintain a good credit score, provide accurate financial statements, demonstrate a stable cash flow, and present a comprehensive business plan. Building a strong relationship with the lender also helps.
Q4: What are the advantages of unsecured business loans?
A: Unsecured business loans offer quick approval processes, no requirement for collateral, and flexibility in fund usage. They are suitable for businesses that lack valuable assets or those unwilling to risk their assets for a loan.\
Q5: How does an unsecured business loan work?
A: Unsecured business loans are approved based on the creditworthiness and financial stability of the business. Lenders assess the business’s credit score, revenue, and business plan to determine the loan amount and interest rate.
Q6: What happens if a business fails to repay an unsecured business loan?
A: If a business fails to repay an unsecured business loan, it can negatively impact the business’s credit score and may lead to legal action by the lender. It is crucial to communicate with the lender and explore options, such as loan restructuring, if repayment becomes difficult.
