In India, borrowing money has become an essential part of personal and business financial planning. Among the various borrowing options available, a loan against collateral security stands out as a viable and beneficial choice. Unlike unsecured loans, a loan against collateral security offers distinct advantages that appeal to both individuals and businesses. This article explores why opting for a loan against collateral security is often more advantageous compared to unsecured loans, focusing on key aspects such as interest rates, loan amounts, and repayment tenures.
Understanding loan against collateral security
A loan against collateral security is a type of secured loan where the borrower pledges an asset to the lender as security. Common collateral items include property, fixed deposits, gold, or shares. The lender holds a legal claim on this asset until the borrower repays the loan fully. If the borrower fails to repay, the lender has the right to sell the collateral to recover the outstanding amount.
By contrast, an unsecured loan does not require any asset pledge. These loans rely solely on the borrower’s creditworthiness and income proof. Credit cards, personal loans, and some business loans fall under this category.
Lower interest rates with loan against collateral security
One of the most compelling advantages of a loan against collateral security is the comparatively lower interest rate. Since the lender’s risk is mitigated by the collateral, financial institutions generally offer more attractive interest rates. In India, interest rates on loans against collateral security typically range between 8% and 12%, depending on the asset and the borrower’s credit profile.
Unsecured loans, on the other hand, usually have higher interest rates — often between 12% and 24% per annum. The higher rate compensates lenders for the increased risk due to lack of collateral.
Lower interest rates reduce the overall cost of borrowing, making loan against collateral security an economical borrowing solution.
Higher loan amounts with collateral security
Collateral offers lenders additional assurance, which enables borrowers to access larger loan amounts. For example, against residential property valued at Rs. 50 lakhs, borrowers in India may secure loans up to 70% to 80% of the asset’s value, i.e. Rs. 35 to 40 lakhs.
Unsecured loans typically have relatively low loan amount ceilings. Personal loans may range from Rs. 50,000 to Rs. 25 lakhs, depending on income and credit score, but they rarely match the amounts available through secured loans.
Thus, those seeking substantial funds for business expansion, education, or home renovation often find loans against collateral security more suitable.
Longer repayment tenures increase flexibility
Loan against collateral security generally come with longer repayment periods, often up to 15 or 20 years, especially when secured against immovable property. This extended tenure helps in reducing monthly EMI (equated monthly instalment) burden, thus enhancing repayment flexibility.
In contrast, unsecured loans have shorter tenures, usually between 1 to 5 years. This leads to higher EMIs, impacting the borrower’s monthly cash flow adversely.
Longer tenures available on secured loans help individuals and businesses manage finances better and maintain liquidity for operational needs.
Easier approval for loan against collateral security
Since assets back the loan, lenders perceive a reduced risk of default. As a result, loan against collateral security typically has higher approval rates compared to unsecured loans, especially for borrowers with imperfect credit histories.
The documentation process might seem extensive but acts as proof of security for lenders. Borrowers with stable assets but modest credit scores can utilise collateral loans to access finance, whereas unsecured loans largely depend on credit scores and may often be declined.
The availability of this loan type assists many Indian customers in satisfying funding needs that would otherwise be difficult.
Benefits of using various types of collateral security
Loan against collateral security offers diversity in collateral options, tailored to the borrower’s asset portfolio:
- Property: Houses, commercial spaces, and land are popular collateral. These enable large ticket loans with reasonable interest rates.
- Gold: Gold loan is the most classic form of collateral loan in India, offering quick and convenient fund access.
- Fixed deposits and securities: FDs and government securities can be pledged, often leading to easy approval and competitive interest rates.
- Shares and mutual funds: For investors, these financial assets provide an alternative collateral route.
Having options lets borrowers choose the most convenient collateral and loan features to meet their needs.
Lower risk of default consequences
Defaulting on a loan against collateral security has specific consequences, but also offers protection for borrowers. Since lenders recover dues via collateral sale, they usually initiate settlement discussions and restructuring options before proceeding legally.
Conversely, unsecured loans may lead to more aggressive collection tactics, damaged credit scores, and legal notices without any asset involvement.
Moreover, the value of collateral often covers part or all of the due amount, limiting the borrower’s liability. This contrasting risk profile makes loans against collateral security more manageable in tough financial periods.
Tax advantages associated with secured loans
Certain loans against collateral security, particularly home loans, offer tax benefits under the Indian Income Tax Act. For example:
- Interest paid on home loans is eligible for tax deduction up to Rs. 2 lakhs under section 24(b).
- Principal repayment can attract a deduction of up to Rs. 1.5 lakhs under section 80C.
Unsecured personal loans do not offer such tax benefits, increasing their net borrowing cost.
Tax benefits make loan against collateral security financially prudent for homebuyers and other eligible borrowers.
Flexibility to prepay and foreclose the loan
Loans against collateral security often come with flexible prepayment options. Since interest rates are lower, borrowers can plan prepayments or part payments without significant penalties, reducing total interest outgo.
Many banks and NBFCs in India allow part prepayments on secured loans with minimal or zero foreclosure charges.
Unsecured loans may have higher prepayment penalties, making them costlier in cases of early repayment.
Flexible repayment terms on secured loans encourage disciplined financial management.
Factors to consider before opting for a loan against collateral security
While the benefits are numerous, borrowers must remain cautious about certain elements:
- Risk of losing assets: Failure to repay may lead to loss of pledged collateral.
- Valuation process: Accurate assessment of asset value is vital; undervaluation can limit loan size.
- Documentation and processing time: Secured loans generally require more paperwork and longer sanction times compared to unsecured loans.
- Eligibility criteria: Proper ownership and clear title of the collateral is essential to avoid loan rejections.
Evaluating these factors carefully ensures manageable borrowing and avoids future complications.
Conclusion
Choosing a loan against collateral security over an unsecured loan offers numerous tangible benefits for Indian borrowers. The advantages of lower interest rates, higher loan amounts, longer repayment tenures, and easier approval weigh heavily in favour of secured loans. Furthermore, flexible repayment options, tax benefits, and a variety of collateral choices add to their appeal.
While unsecured loans may suit urgent and small borrowing needs, the financial prudence and cost-effectiveness of loans against collateral security make them a preferred option for large and medium requirements. Understanding these advantages helps borrowers make informed decisions aligning with their financial goals and security preferences.
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