Understanding the Different Types of Business Loans in India

Starting and expanding a business in India involves numerous essential elements, including designing a solid business plan, hiring the right workforce, and ensuring smooth daily operations. All these aspects are heavily dependent on one factor: capital.

Running a business or a startup requires access to adequate and affordable capital at every stage, whether it's for seed capital, operational expenses, expansion plans, or capital investments in the business, such as acquiring new equipment. In India, companies have a range of loan options that are specifically modeled to meet the varied financial requirements of different business enterprises' needs, which can broadly be classified as secured and unsecured loans. Understanding these options and making informed decisions is critical to the success of any business.

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Secured Business Loans

Secured business loans are credit instruments specifically designed for small and medium enterprises (SMEs) that require funding while providing collateral to financial institutions as security. These loans allow businesses to leverage their assets to obtain financing for various needs, such as expansion, working capital, or equipment purchases. The collateral can encompass a wide range of physical assets, including land, real estate, physical gold, agricultural produce, and motor vehicles. Additionally, financial assets such as fixed deposits, sovereign gold bonds, stocks, and mutual funds can also be used as collateral.

Some of the most common secured loans available in India include: 

Term Loan

• Term loans provide businesses with a one-time lump sum that must be repaid over a fixed period, ideal for companies looking to finance long-term investments such as expansion, purchasing assets, or setting up new infrastructure. 
• These loans are typically secured with collateral, such as property or equipment, which allows for lower interest rates compared to unsecured financing options.
• The repayment period for term loans generally ranges from 1 to 10 years, though some loans can extend up to 15 years for large infrastructure projects.
•  Interest rates for term loans in India typically fall between 10.5% and 15% per annum, depending on the borrower’s credit history, the size of the loan, and the value of the collateral provided.

Equipment Finance

Equipment financing is a type of loan specifically designed to help businesses purchase or upgrade machinery and equipment essential for their operations. This financing option allows companies to either buy or lease equipment based on their financial capability and operational requirements. 

• The machinery or equipment being acquired serves as collateral for the loan, which simplifies the approval process and reduces the need for additional security. 
• This form of financing is particularly beneficial for businesses that rely on heavy machinery, such as those in the manufacturing, construction, agriculture, and transportation sectors. 
• Interest rates for these loans typically range from 11% to 13%, depending on the borrower’s creditworthiness, loan tenure, and the lender. 
• The loan tenure generally varies from 3 to 7 years, and some lenders offer flexible repayment schedules aligned with the business's cash flow.

Also read Equipment Financing: Tips and Eligibility for Startup Businesses  

Business Loan Against Property

These loans are secured against the borrower's commercial or residential property that serves as collateral for the credit extended. Business loans against property allow companies to harness the value of their non-revenue-generating assets, such as office spaces or homes, to secure substantial funding.

• This type of loan provides significant financial flexibility, offering tenures of up to 15 years in some cases. It is useful for businesses looking to expand operations, manage working capital, or make significant capital investments. 
• One of the fundamental metrics used by lenders to assess lending risk in these loans is the Loan-to-Value (LTV) ratio, which represents the proportion of the property’s value that can be loaned to the borrower. 
• In India, the LTV ratio for business loans against property can reach up to 70%, meaning borrowers can secure a loan equivalent to 70% of their property's appraised value.
• Interest rates for business loans against property in India generally range between 9% and 14%, depending on the lender, the borrower’s credit history, and the specific terms of the loan. 

Gold Loan Pledge 

​Indian households collectively own around 25,000 tonnes of gold, valued at USD 1.50 trillion (Rs. 126 lakh crore). This inevitably makes gold loans an extremely attractive source to be utilized in availing credit in the form of gold loan pledges. 

• These loans have fast approval times and relatively low interest rates, usually between 7% and 12%. They also have shorter tenures (typically 6 to 36 months) and flexible repayment options offered by lenders. 
• Gold loans are desirable for small businesses, traders, and individuals who need immediate liquidity for purposes like inventory purchase, working capital, or personal expenses without the cumbersome documentation and credit checks typically associated with other types of loans. 
• The minimal credit requirements make these loans accessible even to those with lower credit scores.

Project Loans

Project loans are specialized financing instruments designed to fund large-scale, capital-intensive projects that encompass the entire lifecycle—from planning and execution to completion.

• These loans are typically long-term, with tenures ranging from 5 to 25 years or more, depending on the complexity and scale of the project. 
• They are commonly used in sectors with high gestation periods, such as infrastructure development, real estate construction, energy, manufacturing plants, and significant business expansions. 
• The interest rate typically ranges from 10% to 14%, although rates can be lower for projects backed by government guarantees or public-private partnerships (PPPs). 
• A DSCR of 1.25 or higher is often required for project approval, as it indicates the project’s capacity to comfortably service its debt obligations. The debt-service Coverage Ratio (DSCR) is a key metric that measures a company's ability to cover its debt obligations with its available cash flow. 

Want to know more about how to calculate the Debt Service Coverage Ratio? Read here.  

Having understood the different types of secured loans available in India, let us now discuss Unsecured Business Loans.

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Unsecured Business Loans

Unsecured loans are financial instruments that do not require collateral, making them more accessible for borrowers, smaller businesses, or startups that may lack substantial assets. However, because these loans carry a higher risk for lenders—given the absence of collateral—interest rates for unsecured loans tend to be higher compared to secured loans. Typically, interest rates for unsecured loans in India range from 15% to 24%, depending on factors such as the borrower's creditworthiness and the gestation period of the project. 

Moreover, with the rise of fintech companies in India, such as Recur Club, accessing unsecured loans has become more streamlined. Many of these digital lenders provide quick processing times and less stringent documentation requirements compared to traditional banks. This trend has led to a growing market for unsecured personal loans and business loans, making it easier for entrepreneurs to obtain the necessary funds.

Also read: Startup business loans without collateral in India  

Some of the most common types of unsecured loans available in India include:

Working Capital Loan

Unsecured working capital loans are valuable financing tools for small—and medium-sized businesses in India. They help them manage their short-term day-to-day operational needs. 

• It’s very feasible to apply for and doesn’t require any collateral. 
• These loans are typically short-term, that is, their maturity period is less than or a maximum of 12 months. 
• Interest rates for working capital loans in India usually range from 12% to 16%, and they play a crucial role in helping businesses of all sizes grow and thrive.

 Read more about determining your business’s working capital needs here.  

Cash Credit

Cash credit is a short-term financing tool designed to meet a business’s working capital requirements. Banks offer this type of loan based on the company’s creditworthiness and financial health, assessing its ability to pay back the loan along with interest in the prescribed period.

• Cash credit loans can be utilized for various other commercial objectives, such as business expansion, acquiring capital assets such as manufacturing equipment and raw materials, storing inventory, personnel, staffing and training, salary expenses, and more. 
• Cash credit facilities allow businesses to withdraw funds from their bank account up to a predetermined limit, even if the account balance is zero. 

• These loans typically have a repayment term of up to 12 months. Interest rates incurred on these are charged only on the amount withdrawn, with rates ranging from 10% to 15%.

Overdraft Facility

An Overdraft (OD) facility is a type of short-term loan provided by banks. It allows individuals or businesses to withdraw more money from their bank account than what is available in their balance. The account holder can go "overdrawn" up to a predetermined limit. 

• The overdraft is typically used for covering short-term liquidity needs, managing cash flow, or addressing temporary financial gaps. Interest is charged only on the amount overdrawn, and the borrower is expected to repay the amount within a specified time frame.
•  The rates generally range between 9% to 12%. The overdraft limit is usually determined based on the account holder's creditworthiness and banking history.

Letter of Credit

A Letter of Credit (LC) is a formal document issued by a bank or financial institution that guarantees payment from the buyer to the seller in a business transaction. Its primary role is to provide security by ensuring the seller will receive payment for their goods or services. 

• A letter of credit is essential for businesses involved in international trade. It acts as a guarantee that the buyer's payment will be made to the seller on time and in the correct amount. 
• Letters of credit ensure smooth international transactions and are particularly useful in minimizing the risk of non-payment. Fees for a letter of credit typically range between 0.25% and 1.5% of the transaction amount. 

Factoring

Factoring is a financial strategy that allows businesses to sell their accounts receivable (invoices) to a third-party entity, known as a factor, at a discount in exchange for immediate cash. This option provides businesses with a valuable solution to enhance liquidity without having to wait for customers to pay their invoices. 

• By selling their receivables, companies can access working capital more quickly, which can be especially beneficial for covering operating expenses, investing in growth opportunities, or managing seasonal fluctuations in cash flow.
• Factoring rates in India usually range between 1.5% and 3% of the invoice amount, depending on factors such as the creditworthiness of the customer, the volume of invoices being factored, and the industry in which the business operates.
•  Factors may charge other fees, such as service or processing fees, in addition to the discount rate.

Startup Loans  

Startup loans are tailored for newer emerging business enterprises that may not have an extensive credit history or assets that they could pledge as collateral to avail loans. These loans often have flexible terms, mainly without any need for collateral, and can be secured through government schemes like the Pradhan Mantri Mudra Yojana (PMMY), which offers loans up to Rs 10 lakh for startups. 

• The interest rates for startup loans range from 10% to 17%, depending on the lender and the business’s financial profile. 
• The underlying objective of these loans is to encourage entrepreneurship and innovation by allowing them accessibility to affordable credit facilities. 

Having discussed in detail what secured loans are, their differences from unsecured loans, and their various types, here is a glance at their comparative study 

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Conclusion 

The Indian financial lending ecosystem offers businesses the flexibility to choose between secured and unsecured loans based on their financial needs. Secured loans provide higher funding at lower interest rates and are backed by collateral, making them ideal for long-term investments and expansion. Unsecured loans, though more expensive, are suited for businesses needing fast access to funds without pledging assets. 

The decision depends on a company's financial health. Those with strong cash flows but limited collateral may prefer unsecured loans for short-term needs, while established firms might favor secured loans. 

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Since 2021, we at Recur Club have been ardently committed to the vision of analyzing and curating credit according to your business's requirements and helping your business escalate its growth to the next level. 

Contact our capital experts today to understand what loans are best suited for your business.