Unsecured business loan v/s Line of credit what option should be more efficient

Unsecured business loan v/s Line of credit what option should be more efficient

A small business is often left with the question to decide upon which option to take – unsecured business loan or a line of credit. While both are extended by fintech lender targeted at the SME sector, the former has fewer conditions to be met. We shall study which the best business loan option.

A line of credit is a type of SME loan for new business units that are custom made to suit the specific business needs of the loan applicant. The advantage is that the borrower is only charged for the amount drawn and not the entire eligible limit.

The borrower can opt to withdraw only a portion of the fund granted and interest is applicable to the utilized component. Further, the amount is automatically renewed for lending again upon repayment. It works on the principle of revolving credit. The line of credit operates on secured and unsecured business models. An example of the unsecured line of credit model is a credit card.
The eligibility criteria for applying for an SME loan of this nature depends on the financial track record of the business and of the loan applicant. Some of the salient aspects of the line of credit are:

  • The lending capital ranges from Rs 5 lakh up to Rs 1 Crore.
  • The repayment tenure is flexible and extends up to 12 months.
  • The interest rate is much lower as the applicant is only charged for the capital withdrawn.

The line of credit can be availed by a business which has a fair estimate of the fund requirement and opts for the allocated credit in a revolving manner.

It works on similar lines like a credit card where a certain amount of money is sanctioned. One can utilize the limit in tranches and repay it back before the due date. In case of a default on repayment, a high interest in the nature of penal charges is levied.

An unsecured business loan online is available and offered at competitive rates by Fintech lenders. This is useful where the fund requirement for the small business is not constant and varies upon the growth of the business. If a sudden big customer contract is won, then the funds required may be much greater than on past occasions. In such a case, a line of credit will not be very beneficial. Instead, an unsecured business loan of the desired loan amount can be readily and quickly availed by the SME. Further, the penal charges on default are very high in case of a line of credit. On the other hand, in case the business hits a low, the SME can negotiate a repayment rescheduling with the NBFC lender, if the cause is genuine.

Further, due to the automatic renewal of the credit line, whether the funds are required for the business or not, may result in lack of financial discipline on part of the borrower. This may lead to irresponsible spending or putting money in a loss-making venture. In extreme cases, it can cause a vicious debt trap i.e. borrowing to pay off existing debt.

One needs to evaluate the debt options and take a decision on what is suited best for business needs. In case of a constant credit requirement, which is known in advance, a line of credit might work better. However, a constant credit requirement is rare in business scenarios and works more for individuals. For an SME, prone to changing business cycles, an unsecured business loan with varying disbursal amounts, based on business needs is the more efficient option.

Categories: Business

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