Common Mistakes to Avoid When Applying for a Business Loan

[Richa Jain]

Applying for a business loan can be a pivotal moment for any business owner, whether it’s to expand operations, purchase equipment, or maintain cash flow. While obtaining a loan may seem straightforward, several common mistakes can hinder your chances of approval or lead to unfavourable terms. 

In India, where the business lending landscape is competitive, it's essential to approach the process with a well-thought-out strategy.

Below are some key mistakes to avoid when applying for a business loan, ensuring that you secure the right financing for your business.

1. Not Understanding the Loan Requirements

One of the most common mistakes is not fully understanding the eligibility criteria for business loans. Different lenders, including banks, NBFCs (Non-Banking Financial Companies), and financial services marketplaces, have varying requirements based on loan type, amount, and your business's financial standing.

Before applying, research the specific requirements of the lender you're considering. This includes:

• Minimum turnover

• Business vintage (the number of years in operation)

• Credit score (both personal and business)

• Documentation like IT returns, profit and loss statements, and GST filings

Failing to meet even one requirement can lead to immediate rejection or delay. It's essential to ensure that your business complies with all eligibility criteria before submitting your application.

2. Not Checking Your Credit Score

In India, creditworthiness plays a crucial role in loan approval. Both personal and business credit scores are considered. If your credit score is low, it could result in higher interest rates, less favourable terms, or outright rejection. A common mistake many business owners make is applying without reviewing their credit history.

You can check your credit score through various credit bureaus like CIBIL, Experian, or Equifax. Ensure any discrepancies are resolved, and if your score is lower than expected, take steps to improve it before applying for a loan. Improving your credit score can be as simple as paying off outstanding debts or ensuring timely payments on existing loans.

3. Applying for the Wrong Type of Loan

Not all business loans are the same. There are various types of loans available in India, including working capital loans, term loans, equipment loans, and lines of credit. Each serves a different purpose. One common mistake is applying for the wrong type of loan, which may not align with your business’s financial needs.

For example, if you need to purchase new machinery, an equipment loan might be more suitable than a working capital loan. On the other hand, if your business requires liquidity for day-to-day operations, a line of credit might be more beneficial. By choosing the right loan, you can ensure that your business gets the funds it needs without unnecessary complications.

4. Failing to Create a Detailed Business Plan

A detailed business plan is crucial when applying for a business loan, as it helps lenders understand the viability of your business and how the funds will be used. Many business owners overlook this, believing that financial statements alone will suffice. This is a mistake.

A good business plan should include:

• A clear description of your business

• Market analysis and potential growth opportunities

• Financial projections

• A clear repayment strategy

Lenders want to ensure that the loaned amount will be used effectively and that you have a robust plan for repayment. A well-prepared business plan increases your chances of approval and may also lead to better loan terms.

5. Overlooking the Total Cost of the Loan

Another mistake many borrowers make is focusing solely on the interest rate, while overlooking the overall cost of the loan. In India, business loans often come with additional fees such as processing charges, prepayment penalties, and insurance costs. These can significantly increase the loan's overall cost.

It's essential to calculate the total cost of borrowing, considering not just the interest rate but also other charges. Using a loan app or online loan calculator can help you estimate the EMI (Equated Monthly Installment) and total repayment amount. Understanding the total cost upfront will ensure you don’t end up with an unaffordable loan.

6. Borrowing More Than Necessary

Taking out a loan for more than your business needs can lead to unnecessary financial stress. While it may be tempting to borrow a larger sum, especially if a lender offers it, doing so can result in higher EMIs and a longer repayment tenure.

Instead, carefully calculate the exact amount required and borrow only what is necessary for your business operations. This will help maintain a healthy cash flow and prevent you from taking on an unnecessary debt burden.

7. Not Comparing Loan Offers

Many business owners apply for a loan with their existing bank or the first lender they come across without comparing offers. However, loan terms, interest rates, and repayment options can vary significantly across lenders. Failing to compare these options could mean missing out on better deals.

By exploring financial services marketplaces, you can compare different business loan offers from multiple lenders, ensuring you find the best deal for your business. Always compare interest rates, processing fees, and flexibility in repayment before making a decision.

8. Ignoring Repayment Flexibility

While most businesses focus on securing the loan, few consider how they will repay it. Ignoring the repayment terms can lead to complications later on. It's essential to choose a loan with flexible repayment options that suit your business’s cash flow.

Some lenders offer the flexibility to make prepayments without penalties, while others may provide a moratorium period (a temporary break from payments). These options can make a significant difference in your ability to manage loan repayment.

9. Inadequate Financial Documentation

When applying for a business loan, the lender will ask for a range of documents, such as bank statements, IT returns, and GST filings. Inadequate or incomplete documentation is one of the leading reasons for loan rejections.

To avoid this, ensure that all financial documents are up to date, accurate, and organised before applying. Proper documentation not only speeds up the approval process but also builds confidence with lenders.

10. Not Considering the Impact on Cash Flow

Lastly, many business owners fail to consider how repaying a loan will impact their cash flow. While the loan may provide a short-term boost, it’s important to ensure that your business can sustain regular EMI payments without putting too much strain on day-to-day operations.

Before applying for a loan, calculate your business’s projected cash flow and ensure it can comfortably cover the loan repayments. This will help you avoid a situation where the loan becomes more of a burden than a benefit.

Conclusion

Securing a business loan can be a significant step towards growth and success, but it requires careful planning and attention to detail. By avoiding these common mistakes, you can improve your chances of getting a loan with favourable terms that align with your business needs.

Remember, the key is to be prepared, understand your options, and choose a loan that works best for your situation. Whether applying through a bank, NBFC, or using a loan app, the goal is to make informed decisions that will benefit your business in the long run.