SME loan stands for Small and Medium Enterprises loan and is specifically designed for small and medium-sized businesses. These loans ensure financial assistance to business owners in operating their businesses. Therefore, various financial institutions offer it to assist business owners, including banks, non-banking financial companies (NBFCs), and microfinance institutions (MFIs). However, before availing of such a loan, it is important to check the SME loan interest rate. It is only when the SME loan interest rate is feasible that one should apply for it.
Thus, to help you make an informed decision, here are the factors that affect the SME loan interest rate.
Factors Affecting SME Loan Interest Rate
The factors affecting the SME loan can be complex and varied. Yet, with a better understanding, you can increase your chances of approval. These factors are:
One of the most important factors lenders consider when approving an SME loan is your credit history. Credit history is a record maintained to track your debt repayment pattern. In simpler words, credit history helps the lender check how you have repaid your debts. Lenders prefer applicants with a strong credit history and low debt-to-income ratio. After all, a good track record of timely debt payments ensures smooth repayment. A score of 750 plus is a positive sign of a good credit score.
Loan Amount and Repayment Tenure
Lenders prefer applicants with a track record of timely loan repayment and a stable cash flow. So, if the loan amount is high and the repayment tenure is long, the lender may consider the loan riskier. Hence, they may charge a higher interest rate to compensate for the increased risk. But, smaller loan amounts with shorter repayment tenures may be less risky. So, the interest rates may be lower.
Lenders might also evaluate your business plan. It helps them determine the viability of the business and its ability to repay the loan. They examine revenue projections, market potential, management, team experience, and qualifications.
Moreover, lenders also look at the industry growth rate of which your business is a part. So, it becomes essential to have a well-researched plan to avoid potential risks. Thus, you can easily navigate the process if your business plan is presented well.
Collateral refers to assets the borrower pledges as security against the SME loan. It can be in the form of property, inventory, equipment, or any other valuable asset.
Lenders often require collateral to mitigate the risk of default. This ensures the lender can recover the money even if you cannot repay the loan. So, if you offer sufficient collateral to secure the loan, the lender may offer a lower interest rate as it reduces the risk. Moreover, the value and quality of the collateral offered may also affect the interest rate. For instance, high-value assets with good resale value are more attractive to lenders.
But, the absence of collateral or inadequate collateral may lead to a higher SME loan interest rate. After all, lenders will consider such a loan with a higher risk.
Lenders may be more cautious in lending to SMEs during a recession (temporary economic decline) or economic downturn (the falling economic growth rate). They may introduce strict criteria for loan approval during such insatiable economic conditions. Hence it is important to be knowledgeable about the external conditions of the country before applying for an SME loan.
Government and Regulatory Environment
The government policies and regulatory environment can also impact the SME loan. For instance, the Reserve Bank of India (RBI) regulates the banking and financial sector and sets guidelines on lending practices. The interest rates offered by lenders also depend on the RBI’s monetary policy decisions, such as changes in the repo rate and the cash reserve ratio. Hence, changes in these rates can impact lenders’ borrowing costs. It eventually affects the SME loan interest rate.
Tips to keep in mind before applying for SME Loan
There are a few points that you must consider before you apply for an SME loan. These are –
- Be sure to compare interest rates and fees from different lenders before choosing a loan. Do look for lenders with competitive rates and reasonable fees.
- Consider the loan amount and repayment terms that work best for your business. Choose a loan with a repayment period that allows you to manage your cash flow and maintain financial stability comfortably.
- Check the lender’s reputation and customer reviews before applying for a loan. Look for a lender with a history of providing excellent customer service and fair lending practices.
- Be aware of any hidden costs associated with the loan, such as prepayment penalties or early termination fees. These can add up quickly and increase the cost of borrowing.
Eligibility Criteria for SME loan
Before applying for an SME loan, meeting the following eligibility criteria is essential. These are –
- The minimum age for applying for an SME loan is 21 years, whereas the maximum is 65 years.
- The business must be registered in India as a sole proprietorship, private limited company, limited liability partnership (LLP), or partnership.
- Depending on the lender, the business must have operated for a certain period, typically 6 months to 3 years.
- The business must have a minimum turnover, which may vary based on the lender. For example, a line of credit loan may need a minimum turnover of 5 lakhs to meet the eligibility criteria.
- The business must be profitable, with a positive net income and cash flow, to demonstrate its ability to repay the loan.
- Many SME loans require collateral, such as property or inventory, to secure the loan.
- Owners must provide documents, such as financial statements, tax returns, bank statements, and business plans, to support their loan applications.
An SME loan is an attractive financial option for small and medium-sized businesses. Ensure that your SME loan interest rate assists your business rather than hinders it!