Loan against Property for Business Setup/Expansion – Why it makes sense?

Loan against Property for Business Setup Expansion

The year was 2018, and Mr. Siraj, who was 34 years old and had been married for two years was leading a reasonably comfortable life. This was when the idea of starting his own business struck him. Till then, he was working in a garment manufacturing firm that sold the bulk of their readymade dresses locally, though they did export some of their products as well. He worked in their marketing section and his primary role was to get in touch with local wholesalers and retailers to market his company’s products. He had good knowledge of exporting readymade dresses too. He knew which licences were mandatory for becoming an exporter and he had often visited trade fairs and exhibitions on behalf of his company to get in touch with visiting buyers and import-export companies.

Siraj felt that it was the right time to set up his own garment manufacturing unit. He was quite confident in handling the marketing side. His wife was also ready to help him. Of course, his wife did not have much expertise in stitching, but she could design clothes well. Right patterns and colour combinations came easily to her and she was also a smooth-tongued marketer with great selling skills. Together, they soon set up a unit in a rented room not far away from their home. Initially, they had only two sewing machines. But their business prospered fast and in a span of six months, they had six sewing machines and employed six tailors. Siraj’s wife worked full-time at the unit, taking measurements, and helping in hand-sewing, etc., while he handled the marketing job well.

For two years they did well. The business provided enough for them to improve their living standards. They were also able to save some money. Siraj’s wife wanted to look for a place of their own for shifting the production unit to a better place from the present one-room tenement. But Siraj was not very keen on it because he had a younger unmarried sister. His parents had delegated to him the responsibility of her marriage. So, he wanted to have some savings to fall back upon in case a suitable groom was found.

Then, without warning, disaster struck. A tiny virus called coronavirus, invisible to the naked eye, invaded the human world and started turning things upside down for everyone. In March 2020, when the first lockdown in the nation came into force, there were bundles and bundles of readymade dresses in their unit, ready to be dispatched to different locations. Because of the total restrictions on movements, these could not be transported to their planned destinations. Anyway, no shops wanted the dresses as well because there were no customers allowed to any of these shops. Both the demand and supply chains had been broken down completely, leaving millions of traders devastated.

All of a sudden, their world turned topsy-turvy for Siraj and his wife. The tailors they had employed could not commute to Siraj’s production unit. However, two of them insisted that they be paid because they had a family to look after. Siraj refused to pay simply because he could not afford to. For almost a year from March 2020, they had to shut down the unit because there was no way they could keep it open. They were forced to dig into their savings to survive.

After almost a year, they reopened their unit because the pandemic appeared to be under control at least partially. Their workers also came back as they too wanted the job badly. There was at least intermittent demand for clothes so that they were able to get rid of some of their older stock even though only at a discounted rate. But all this soon turned out to be only short-lived happiness. The second wave of COVID-19 struck worse than the first wave in the way it spread and the number of causalities it caused. Again, Siraj had to stop production and close the unit down.

During the first wave, the owner of the room in which Siraj did the entire work was quite lenient and had not charged any rent for the period when it remained locked. But he was no longer ready to rent it out free of charge. So, Siraj had to vacate the room and remove his machines from there. Yet again, there was a prolonged period of inactivity before things started moving again. Coronavirus or no coronavirus, authorities started easing restrictions. People started waking up from their stupor. Offices reopened, restaurants had customers, marriages and other functions started, and since people were becoming mobile again, there was a renewed demand for clothes. Siraj decided to restart production.

A groom was found for his sister, and so there was the question of marriage expenses as well. Siraj had no choice other than to take a loan. First, he considered taking a business loan, but his credit score was not good because of the circumstances of the past 18 months. Further, a business loan could be used only for business purposes while he had to think about his sister’s wedding expenses as well. So, his friends advised him to go for a loan against property or LAP which worked out fine for him.

Advantages of LAP over Business Loan

For a person like Siraj, taking a loan against property is bound to be much more beneficial than taking a loan exclusively for improving his business. Some of the benefits of LAP over other types of loans are listed below:

  • Getting a large amount sanctioned

When a property is pledged as collateral for the loan, the lender typically sanctions an amount that is between 75% and 90% of the prevalent market value of the property. Depending upon the location of the property and the likely market appreciation of its value, some lenders may offer even a couple of crores as the loan amount.

  • Lower interest rate

A loan against property carries a lower interest rate compared to other types of loans. Lenders also do not charge penalties if the borrower wants to close the loan early by repaying the full amount.

  • Longer tenure for repayment

The loan repayment tenure of a LAP is generally longer than other types of loans. When the loan can be repaid over a longer number of years, this would lead to smaller EMIs.

  • Easily available

Because it is a secured loan and lenders get a guarantee for the money they give, an LAP is more easily sanctioned than unsecured loans.

  • Borrower can occupy the pledged property

Though the documents relating to the pledged property will remain in the possession of the lending bank, the borrower will be free to occupy the property during the entire tenure of the loan.

  • Loan can be used for different purposes

With a LAP, the borrower will have the freedom to use the loan amount for various purposes like marriage, education, medical aid, or business development, based upon his requirement. With a business loan, the bank will insist on the money being used only for the business for which it is being borrowed.

  • Tax benefits

If he takes a LAP, the borrower will enjoy certain tax benefits on the processing fees and the interest paid. However, there are conditions attached to such benefits.