You must know that there are several types of business loans available in the market today. Have you ever wondered how different each of them is from the others? Here is one such comparison of regular business loans and microloans with all the basic details.
What is a business loan?
A business loan is a financial support you can seek from banks, non-banking financial companies (NBFCs), government schemes, crowdfunding, and other sources. The eligibility criteria to qualify for a business loan may vary with financial institutions. However, a business must have a certain minimum annual turnover and other necessary documentation to be eligible for a business loan.
Based on meeting the eligibility criteria, the loan amount, tenure, and interest rate applied may vary. Once the loan is approved, you can use the funds to meet any business requirement, such as extending the business, fulfilling an order, widening your inventory, paying salary to employees, and purchasing machinery, without having to receive additional approval from the lender.
Since the loan amount can be a big one, the tenure to repay this will also be long enough.
Factors affecting business loan interest rates
Several factors affect the interest rate of a business loan in India. Some of them are listed below:
a. Credit score:
A good company credit score is a key factor in determining the interest rate for a business loan. If your company has a bad credit history, the credit score will also be low, and the lender may want to offer a business loan only with a high-interest rate complementing the risk of lending.
b. Type of business:
The type of business here points at the risk involved in the business. The riskier it is for the business to make profits, the interest rate charged may be high.
c. Business experience:
Generally, lenders offer business loans to businesses with a minimum of two years of experience with a certain minimum turnover limit. The higher the number of years into the business, the better it is for the lenders to gauge the potential of the business. The less specific the lender is about getting repayments on time, the higher the interest rate.
d. Revenue cycle:
The lender will take a look at the revenue you have been generating every month. They will compare this revenue with the loan amount you are willing to take and the monthly instalments you are supposed to pay in addition to all other commitments to be fulfilled. If the revenue and the margin are not very impressive, the interest rate charged may be high.
e. Business plan:
You need to provide a concrete business plan to the lender showing how you plan to generate income and expand with the help of the financing you receive. The more assured the lender is about your business, the less will be the interest rate.
f. Collateral:
Most business loans are secured loans where you have to provide collateral to back up the borrowed money. This will keep the interest rates to the lower side when you don’t provide collateral. The risk of the lender increases, in turn increasing the interest rate.
g. Lender type:
The lender type also plays an important role in deciding the interest rate. That is, banks may provide different rates as compared to non-banking financial institutions (NBFCs). Further, the other online lending agencies may offer a different set of rates altogether.
Apart from the listed factors, other external factors, such as the inflation rate, monetary policy, and global economic events, can also play an important role in defining the interest rate for your business loan.
Tax benefits of business loans in India
- Business loans come with tax benefits where you can easily write-off the interest payments as business expenses. This type of business expense is usually deducted from the total revenue generated to get the taxable income. That is, the interest paid on business loans can be considered as a tax exemption.
- The principal amount from the business loan is not eligible for a tax deduction. You don’t have to pay income tax for the principal amount.
- Principal amount of the business loan is part of the gross income of a business. It will not be considered in calculating the taxable income.
What is a microloan?
As the name suggests, a microloan is a business loan offered with a small loan amount and for a short tenure. Microloans can be offered by a community-based non-profit organisation or any organisation willing to help small entrepreneurs.
The concept of a microloan is mostly created to help small businesses that do not qualify for a conventional business loan from a recognised financial institution for several reasons.
Business loan vs microloan
| Parameter | Business Loan | Microloan |
| Loan Amount | A maximum of Rs.30 lakh-Rs.50 lakh | A small amount up to Rs.1 lakh |
| Loan Tenure | Comparatively longer tenure | Comparatively shorter tenure |
| Interest Rate | More affordable | Comparatively higher |
| Purpose | Can be used for any business purpose | Restrictions on the usage of funds |
| Flexi Pay Option | Withdraw the amount you want and pay interest only on the withdrawn amount | Flexi Pay option is not available |
Pros and cons of short-term business loans
Like microloans, regular business loans also offer short-term loans. Let us consider the pros and cons of a short-term business loan.
Pros of a short-term business loan
- Simple Eligibility Criteria:
Since short-term loans are likely only to offer a small loan amount, the eligibility criteria to qualify for such a loan are not very tough. They follow relaxed norms to assess the business credibility and that of the owner’s. Businesses with a short history can also apply for such loans.
- Online, Paperless Application:
You don’t have to visit the lender’s office every time they want you to submit papers and documents. Just express your interest in borrowing a short-term business loan on the lender’s website and upload all the necessary documents. That’s it! The application process has become online and paperless with many lenders now.
Unlike the traditional practice of taking a long time to process the application, the technology has made it possible for lenders to process the applications much faster. Some lenders may even take a maximum of 48 hours to process the applications and share their decision on loan approval.
Most short-term business loans do not expect you to provide any collaterals to receive funding. All your assets are safe while you still receive financing to complete that emergency financial need.
- Source for Emergency Cash:
A short-term business loan can be seen as a quick way of raising funds to handle your emergency cash crunch when you are sure of receiving that payment from the client within a short period but can’t wait for cash until the payment is received.
Cons of a short-term business loan
The loan term may range from 3 months up to 12 months, which is a short duration compared to regular business loan tenure. The short duration may make the instalments bigger for you and may turn out to be a burden. Apply for this loan only if you can handle the instalments without hampering your business’s cash flow.
Short-term business loans may be unsecured at times, making the lender offer the loan at a higher interest rate. This is to minimise the loss in case the borrower defaults on payments.
You might have opted for this loan to handle emergency business commitments. In case you are unable to make repayments on time, you will be at the risk of a debt spiral due to the terms and conditions of the loan, along with the high-interest rate. The consequences of being unable to fulfil your repayment commitment can bring in other kinds of threats, such as falling credit score, losing the trust of other lenders, having to borrow elsewhere to repay the current loan, and others.
Many lenders expect you to make daily or weekly repayments in the place of monthly repayments that are the norm for a longer tenure business loan. The expected frequent repayments may hamper your cash flow and make you trapped. If you fail to make payments as scheduled for any reason, penalties and additional interest may be charged.
