How to Get the Lowest Interest Rate Business Loan

Updated on: 28 Dec 2023 // 3 min read // Business Loans
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Capital is an essential constituent of a business balance sheet. You keep needing funds over the years to buy new equipment or machinery to enable your business to expand. A business loan is the best way to get adequate financial support.

Banks give Business Loans to start-up enterprises as well as loan products that enable existing companies to function appropriately and expand as well. These loans come with varying interest rates depending on the nature of the business, the extent of collateral, and the credit history of the unit as well as its promoters.

Different Types of Business Loans:

There are majorly three types of business loans:

  • Term Loans – For the construction of the factory, purchase of machinery and equipment, and so on
  • Cash Credit / Overdraft – For meeting working capital requirements
  • Bills Discounting – Financing receivables

Term loans are payable in installments ranging from 36 months to 84 months. The overdraft or the cash credit facility is a running account subject to renewal on an annual basis. Bill discounting is also a short-term facility with the proceeds of the bill going towards the liquidation of the loan. The rates of interest on these loans depend on various factors.

1. Amount of loan

Generally, banks have various slabs depending on the loan amount. The bank charges interest corresponding to that slab.

2. Tenure of the loan

Banks stipulate a term premium on every term loan at the time of approving the loan.

3. Nature of the facility

The running account facilities like the overdraft and cash credit accounts have a lower rate of interest as compared to the term loan.

4. Presence of Collateral

The presence of collateral determines the rate of interest. In case the bank approves an unsecured loan, the bank undertakes a higher risk. Therefore, unsecured loans are expensive as compared to secured loans. In case collateral is available, the bank has security to fall back on in case of default. Therefore, the rate of interest is lower. Collateral can be in the form of fixed deposit, LIC policies, Government securities, mortgage of property, or even third party guarantee. Nowadays, many lenders give Business Loans up to 1 Crore without collateral. The Government of India guarantees these loans under the Credit Guarantee Trust for Micro and Small Enterprises (CGTMSE).

5. Nature of business (Priority sector or Non-Priority sector)

Depending on the activity of the company, banks classify the loan as under Priority or Non-Priority sector. Loans classified as non-priority attract a higher rate of interest as compared to the priority sector loans. Export finance is at a comparatively lower rate.

6. Financial capacity of the borrowers

The debt-equity ratio plays a critical role in determining the financial ability of the borrowers. The borrower contribution in the loan should be to the extent of 25%. It is a vital aspect while estimating Business Loan Eligibility.

7. The credit history of the firm and its promoters

The perusal of the balance sheet and other financial statements gives you an idea about the financial dealings of the business concern. The credit report gives you the credit score of the individual promoters and the company. It is a significant factor that affects the rate of interest on a business loan.

To offer collateral or not?

Unsecured loans are expensive because banks do not have any security to rely on in case of default. However, start-up businesses may not have adequate collateral. Considering this genuine difficulty, the Government of India has formed the CGTMSE to enable such industries to avail cheap finance from banks. This trust guarantees business loans up to Rs. 1 Crore for the manufacturing and services sector. Borrowers have to pay the premium (usually at the rate of 1.5% for the first year and 0.75% for each subsequent year). This trust guarantees a maximum of 75% of the loan amount depending on the category of the borrower. This guarantee is available provided there is no furnishing of collateral or third-party guarantee. It is an attractive feature, but the premiums can become very heavy. Under such circumstances, the furnishing of collateral is cheaper for the borrower. Therefore, if the borrower can furnish collateral, they should do so. They will also be able to negotiate with the banks for a lower interest rate.