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Understanding Principal And Tenure Of An SME Loan

Posted: 19th October, 2021

Updated: 8th February, 2023

Written by -

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What is an SME Loan?

An SME Loan is the funding offered to Small and Medium-sized Business Enterprises (SME). This credit line is provided to the SME so that it can take care of its borrowing needs. SMEs often use the funds taken as loans as their working capital. On occasions, they also use the money to meet their long-term requirements.

The SME segment of business forms the proverbial backbone of an economy. SME units provide large-scale employment opportunities for the masses. They spearhead the industrialization of relatively backward and rural areas.

Hence, SME loans, or small business loans, which help provide the necessary funds to run the business, form an integral part of a bank's loan basket. All major banks offer loans to SMEs under various schemes.

As in all loan products, SME loans also entail borrowing money from a financial institution. The small business needs to repay the amount taken as a loan needs over a period of time with interest. Therefore, when you take a loan for business, it is advisable to understand the composition of your monthly installments.

The loan product has many components. The method of payment that you choose shall govern how you are repaying. Thus, one needs to be aware of the basic concepts of loan principal.


What is an SME Loan Principal?

In a layman's term, SME Loan Principal is the amount you borrow from the financial institution for your SME. It is frequently called loan amount. For example, if your borrowed amount or loan amount is Rs. 1 lac INR, the SME principal is also Rs. 1 lac INR. This principal is the amount that you need to pay back with interest through monthly installments.

With the payment of an installment, the outstanding principal amount goes down. The installment that you pay every month also has a component of repayment of principal. Hence, every month, the opening balance of principal that is outstanding with the bank gets reduced to that extent.

The SME Loan principal is beyond the purview of tax. The fund that you borrow is not part of your income. Rather it is construed as the money that you owe to the bank.

The lender may treat the SME Loan principals in various ways at the time of repayment. They are as under:

  1. 1. Amortized Mode of Payment

    Under this system, the installment for the month remains the same. But the outstanding principal goes down gradually. This method helps pay lesser interest in the future, as the net outstanding amount gets reduced periodically.

  2. 2. Even-Principal System

    In this system, an equal amount of principal gets struck off with payment of each installment.

  3. 3. Interest Only Loans

    Here, the initial payment of installments is only towards the interest. It is only after a predetermined repayment period that the principal amount starts getting written off.

  4. 4. Principal Payment

    Only the principal gets knocked off in the initial stages of this arrangement.

Best business loan planning is the one that reduces the quantum of accrued interest over the loan amount. For the same, you need to carry out a meticulous budgeting exercise. You have to create funds so that you can settle the loans on time. This strategy may entail mitigating business expenses and require you to go aggressive on top-line growth.

What is Loan Tenure?

As discussed above, an SME or a business loan is the fund that you borrow from a financial institution for your enterprise. You have to repay the borrowed fund with interest over a while.

The period for which a bank sanctions the SME loan is business loan tenure. The borrower is liable to service the SME loan over this period through deferred payments along with interest. Usually, you can pay off the SME loans through the means of EMI over the tenure of the loan.

As more SMEs are thriving now, leading the country’s economic growth, the requirements for SME loans are also on the rise. The two kinds of SME loans that are available are:

  1. 1. Secured Business Loan
  1. 2. Unsecured Business Loan

Under the basic terms of a secured business loan, the bank keeps collateral pledged with them against the advance made. If any untoward incident that may prove detrimental to the business happens, the borrower stands to lose the assets they keep as a security against the loan.

On the other hand, in unsecured business loans, the banks will not ask you to pledge collateral with them. So, the entrepreneur’s business assets or personal property are not at risk in cases of unsecured business loans. Moreover, many start-ups may not also have any assets to show. Therefore, this form of business loan is gaining popularity at a swift pace.

It is also true that the loan disbursement process is often faster in cases of unsecured business loans. In these loans, the borrower's credit score is the main pointer for either sanctioning or repudiating a loan application.

Technological advancement has given birth to various forms of unsecured business loans. You may avail of the loans as overdraft, line of credit, business credit card, or a term loan.

At the same time, it needs to be kept in mind that interest rates in cases of unsecured business loans are generally higher than secured loans. The financial institution may also need your personal guarantee or mark a lien on your account against the unsecured business loan. The loan tenure is also for a shorter duration than that of a secured loan.


Final Words

At the end of the day, the borrower (i.e., you) must carefully weigh the options available. Only then will you be able to zero down on the options best suited to your plans.

The eligibility criterion is one aspect that needs an in-depth study. By doing this deep market research, a borrower can negotiate the best terms having the lowest interest rates with the lending institution.

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