As a business owner, you know access to sufficient capital is key to growing your entrepreneurial dreams. Whether upgrading equipment, increasing inventory, expanding operations or entering new markets, all require an infusion of working capital. However, traditional sources of financing, like venture capitalists, angel investors, or even bank loans, can be hard to obtain or inadequate for meeting your needs. This is where a micro loan against your own residential or commercial property can open up capital resources.
By using your existing property as collateral, you get access to funds that can take your enterprise to the next level. While this route seems attractive, it also comes with risks of leverage. So before taking the plunge, you need to assess the loan against property checklist - your actual capital needs, repayment capacity, risk appetite, property valuation and loan costs.
Evaluating these key considerations will help make an informed decision on using a property-backed business loan to give wings to your business vision. The following are the key considerations before taking LAP:
1. Know Your Eligibility Criteria
One of the primary considerations before taking LAP is knowing whether you are eligible or not. Financial institutions have specific eligibility norms for giving a micro loan against property (LAP). Meeting the following loan against property eligibility criteria is essential for loan approval:
- The property must be in an approved location, with a clear title and all necessary approvals. Most lenders do not accept vacant plots as collateral; completed residential or commercial properties are generally preferred.
- Both self-occupied residential properties and commercial properties can be mortgaged. However, the property should be fully owned by the loan applicant.
- The maximum loan amount is based on the property's market value. Financial institutions may loan up to 60-75% of the property value.
- Your credit score, income stability, business financials, etc., will be evaluated to determine repayment capacity.
Thus, examine if you meet the broad eligibility parameters before applying for an LAP.
2. Analyse Interest Rates and Other Charges
Micro LAP interest rates are higher than home loans but lower than unsecured business loans or credit cards. Generally, interest rates start from 8.5% p.a. onwards. However, the rate applicable will depend on your credit score, income levels, property value and lending institution.
Also factor in processing fees (typically 1-5% of loan amount), legal charges, valuation fees and foreclosure charges (usually 2-5% of outstanding amount). Accounting for these costs will give you the true picture of the loan’s affordability.
3. Measure the Risk Profile
Using your home or commercial space as collateral can be risky in case of repayment issues, i.e. you can lose ownership rights. Carefully assess –
- Your business goals, cash flows, revenues and risks before deciding the loan amount and tenure. Avoid over-leveraging yourself.
- Potential emergencies (medical exigencies, job loss, etc.) and have backups in place so that EMIs can still be serviced.
- Whether taking a secured LAP is better than an unsecured business loan, as per your risk-taking appetite.
4. Follow the LTV and EMI Rules
Financial institutions allow micro LAP up to 75% of the property's market value, i.e. the loan-to-value (LTV) ratio. This cushion acts as their safety net.
Opt for an LTV of a maximum of 60-65% so you have an equity buffer just in case property prices fall temporarily. This will lower foreclosure risk.
Additionally, your loan EMI should not exceed 50-60% of your monthly income. Strike a balance so you have some cash flow to operate your business and meet household expenses.
5. Have a Loan Prepayment Strategy
Having a prepayment strategy helps shorten the tenure and total interest outgo. Prepaying yearly or half-yearly by 10-15% of the outstanding amount can make your LAP more affordable. Ensure there are no or minimal prepayment charges for flexible financing.
6. Use Loan Amount Judiciously
Do not splurge the loan amount and strictly use it only for justifiable business expenses – working capital, equipment, inventory or renovations. Maintain records of loan utilisation to avoid legal issues during foreclosure.
Summing Up
A micro LAP against your property can be a valuable financing tool for your entrepreneurial journey, provided you make an informed decision. Assess your repayment ability, loan costs, risks involved and structure the loan prudently. Be disciplined in using the money only for business growth so that you can repay comfortably and build assets. For those considering this route, Shriram Finance offers micro loans against property with flexible options and transparent processes, helping you align your funding choice with your business goals.
