5 Disadvantages Of Securing Loans From Financial Institutions

At some point, every business needs an outside source of capital to grow the business. There are various means to outsource funds and one of those methods is bank loans, which in the right circumstances, can benefit a business in the short and long-term. A loan is an amount of money borrowed for a particular period within an agreed repayment schedule. The repayment amount is agreed between the parties involved and it is dependent on the amount and duration of the loan and the rate of interest.

Paying for assets – e.g. vehicles and computers

Start-up capital

Instances where a business is about to fail

Instances where the amount of money you need is not going to change

Different types of loans include:

Working capital loans

Fixed asset loans

Factoring loans

Hire purchase loans

However, there are certain disadvantages that come with securing loans from financial institutions, some of which includes:

One of the major disadvantages of a bank loan is that banks can be cautious about lending to small and medium scale businesses, thereby making it particularly difficult for start-ups and newer businesses to be accepted for a loan, as they don’t have the financial or trading history to back up their application. This simply means that loans are for already established businesses with a good credit history and good growth prospect.

2. Interest Rate Risk

Almost all loans come with interest rates that you must pay when you want to repay the loan, even before the end of the loan term. Most of these interest rates are fixed and even when you repay the loan early (before the due time), the interest rate would not be reduced.

For some very big and successful businesses that plan their projects or venture for long terms, say 10 years, 20 years, the interest rates could be floating rates. However, there is a very important assumption of the cost of their funds throughout their project tenure and with floating rates, this assumption becomes floating and in drastic economic situations where the interest rates rises, the cost of funds would also rise, making these projects unviable and unattainable.

3. Strict Repayment Schedule

Financial Institutions provide a very strict repayment schedule to the borrower, which must be adhered to and failure to adhere to it may reduce borrowers’ credit scores and future credibility. The severity to stick to the repayment schedule sometimes creates a burden on the borrower, thereby, placing the borrower in a state of confusion and frustration.

4. Complications

A loan is a simple process, whereby someone gives you money and you pay it back with interest after a period. A personal or business loan should be simple to understand and process, however, most financial institutions do not understand this as obtaining a loan is extremely tedious and time consuming

You will be required to fill out excessive paperwork, you will also need to provide a business plan, your account history, and your financial forecasts to show your business is a viable lending prospect and the terms of interest will be quite complicated for easy understanding. On the other hand, the process will not be quick either and might take several months to qualify and obtain capital from a bank.

5. Collateral

It is very difficult to obtain a bank loan unless there is a sound credit score or valuable collateral. Loans are secured against the assets of the business or your personal possessions, e.g. your home or business. This means that your assets or home could be at risk if you cannot make the repayments.

Financial institutions are careful to lend money, and they only give loans to borrowers who have the ability and willingness to repay the loan. Small businesses that are new to the business and have not taken any bank loans in the past find it even more difficult to obtain a bank loan.