For any business be it small or big, timely availability of funds plays a vital role. Funding the business seems tricky at times, especially in today’s dynamic environment where business owners are very keen in looking for best possible ways to fund their particular business need. Business needs may be either purchasing assets such as land or shop or new machinery or for working capital requirement, business expansion or to meet the basic operating expenses such as overheads and salaries, etc… In India, there are different types of loan facilities available to the business owners depending upon their business needs and situation. In this blog we shall some of types of loan being offered by financial institution in India and the cost associated to raise the same.
Different Types of Loan facilities in India
1) Term Loan:
- One of the most common types of business funding is a term loan.
- A term loan is taken for specific purpose, generally for capital expenditure and it may be secured or unsecured in nature.
- It is required to be repaid in regular payments over a set period of time.
- The term loan is categorized into short-term with duration of 12 months and long-term loans up to 10 + years.
2) Loans Against Property (LAP):
- LAP is one of the most common types of secured loan
- To avail funds, the business owners might pledge any residential, commercial or industrial property
- The loan amount given varies by lender and is comparable to a particular percentage of the property’s worth
- Some lenders may provide 50-60% of the property’s worth while others may offer as much as 80%.
- Business owners avail these types of for various reasons which includes business expansion, research and development and product development, etc…
3) Cash Credit Facility:
- Cash credit is a short-term finance for businesses and companies to meet their working capital requirements.
- Cash credits are also called working capital loans as they fund the instant cash requirements of the organization.
- Cash credit is a secured form of line of credit due to the demand of collateral by the bank.
- The interest charged is on the daily closing balance instead of the upper borrowing limit, so the charge is only on the amount spent from the available limit.
- Cash credits are similar to overdraft facilities, though there are significant differences between them. Cash credit is based on Drawing power and at a significantly less interest rate than overdrafts.
4) Loans Against securities (LAS):
- Loan against securities is a loan where you pledge securities as collateral to the bank against your loan amount. Pledged securities include Shares, Mutual Fund, Life Insurance Policies, etc.…
- It helps you to avail timely finance instead of selling off the securities in a haste.
- LAS are typically offered as an overdraft facility in your account after you have deposited your securities. You can draw money from the account, and you pay interest only on the loan amount you use and for the period you use it.
- The amount of loan you are eligible for depends on the value of the securities you offer as collateral.
5) Loans Against Fixed Deposits:
- Loan Against Fixed deposit is a type of secured loan where customers can pledge their fixed deposit as a collateral and get a loan in return.
- The amount of loan depends on the FD deposit amount and this can go unto 90%-95% of the deposit amount.
- It’s essential to note that the loan tenor can’t be more than FD’s tenor and interest is 1% higher than FD rate.
6) Overdraft Facility:
- Overdraft facility is a funding type offered by a bank to its account holder to withdraw cash from his/her account even if the account balance is zero.
- The interest rate is charged only on the utilized amount from the sanctioned limit and on a daily basis.
- The credit limit that is sanctioned depends upon the account holder’s collateral value, credit history, cash flows, and repayment history if any.
- The overdraft limit is revised every year and can be used in any manner if the interest is paid on time.
- An overdraft facility is offered against collateral or securities with the bank.
7) Gold Loan:
- A gold loan is availed by pledging physical gold either in form or jewellery, gold bars or coins.
- The loan amount sanctioned is a certain percentage of the gold’s value pledged.
8) Vehicle Loan:
- A vehicle loan is extended in the form of a two or four-wheeler loan that helps you buy your dream vehicle.
- Vehicle loans are offered either on the purchase of new vehicle or used one.
- It a secured loan means if the borrower doesn’t pay the instalments in time, the bank has the right to take back the vehicle.
9) Home Loan:
- Every one desires to own their own house. Banks assist you by giving the funds to buy or build home of your choice.
- These loans generally come with longer tenures (20 years to 30 years).
- A home loan can be of different types such as:
- Loan for constructing a house
- Loan for repairing and remodeling your existing home
- Loan for purchasing a land
10) Invoice Financing:
- Invoice financing is also known as invoice discounting or invoice factoring.
- Funding is provided against the invoice amount raised.
- This type of funding is for small businesses that encounter a time lag between raising invoices and receiving payment from clients.
- The lender can finance up to 80% of the invoice amount.
- Once the business receives the payment, it clears off the debt as per the decided tenure and interest rate.
11) Loans under Government Schemes:
- The Government of India has initiated various loan schemes to promote individuals, MSMEs, women entrepreneurs, and other entities engaged in trading, services, and manufacturing sectors.
- The loans under government schemes are offered by various financial institutions, such as private and public sector banks, NBFCs, Regional Rural Banks (RRBs), Micro Finance Institutions (MFIs), Small Finance Banks (SFBs), etc.
- Some of the leading Govt. Loan schemes include Mudra Scheme under PMMY, PMEGP, CGTMSE, Standup India, Startup India, PSB Loans in 59 minutes, PMRY, etc.
12) Letter of Credit:
- Letter of credit is letter from bank guaranteeing that a buyer’s payment will be received by seller on time without dues. If the buyer, fails the bank will have to cover the amount.
- LOC is issued against pledge of security or cash and banks typically collect a fee for the same.
- Letter of credit can be utilized for both import and export purposes by entrepreneurs.
- Enterprises doing businesses overseas tend to deal with unknown suppliers, so for that, they require assurance of payment before performing any transaction.
- Therefore, a letter of credit plays a vital role in providing payment assurance to the suppliers.
13) Equipment Financing:
- It is a type of funding option offered to the borrowers for them to purchase new equipment/machinery or to upgrade the existing.
- Equipment finance is used mainly by enterprises engaged in the manufacturing sector.
- Enterprises or business owners availing equipment finance or machinery loan also enjoy tax benefits. The interest rate, loan amount, and repayment tenure offered shall vary from lender to lender.
14) Bill Discounting:
- Bill Discounting is a short-term finance for traders wherein they can sell unpaid invoices, due on a future date, to financial institutions in lieu of a commission.
- The Bank purchases the bill (Promissory Note) before its due date and credits the bill’s value after a discount charge to the customer’s account. The bank will realize the bill amount on the bill’s due date directly from the debtor.
- This helps the traders in optimizing their cash flows and business (payment) cycles without disturbing their balance sheet. Lenders usually offer tenors of up to 180 days while offering bill discounting facilities.
15) Bank Guarantee
- Bank Guarantee a promise made by the bank to any third person to undertake the payment risk on behalf of its customers.
- Bank guarantee is given on a contractual obligation between the bank and its customers. Such guarantees are widely used in business and personal transactions to protect the third party from financial losses.
- This guarantee helps a company to purchase things that it ordinarily could not, thus helping business grow and promoting entrepreneurial activity.
To conclude, in India there are many types of loans being offered by financial institution to various business and companies and the cost of raising loans may also differ from bank to bank. Before applying for a loan, it is advised to have evaluated all the available loan options based on your business profile and requirement and ensure you do have the capacity to make the on-time payments. Any mismatch in the purpose of borrowing and utilization will have long term implications in the business. Awareness on this brings in lot of clarity while borrowing the loan and facilitates in easy repayments. Fundamentally money is fuel for growth, right utilization can only lead to better return on investments for all stake holders.
In the next blog series, we shall see the various cost associated with raising a loan from a financial institution