Understanding business loan types
Running a business—whether it’s big or small—often means needing extra money to manage daily expenses. The amount of funding required depends on the type of business, how much investment it needs, and what stage it’s in—whether it's just starting out, growing, or already well-established.
Most businesses need the most support during the early stages or when they are looking to grow.
In this article, we’ll take a look at the different types of business loans that banks and financial institutions in India offer to support businesses at various stages.
Different types of business loans in India
In India, business financing is broadly categorized into eight main types of loans:
- Working Capital Loan: Provides funds to cover everyday business expenses such as salaries, rent, and utility bills.
- Term Loan (Short-term and Long-term): A fixed-duration loan—short-term for immediate financial needs and long-term for major investments like expansion or asset acquisition.
- Letter of Credit: Commonly used in import-export businesses, this facility ensures that the bank guarantees payment to suppliers on behalf of the buyer.
- Bill or Invoice Discounting: Enables businesses to access instant funds by submitting unpaid customer invoices to the bank for early payment.
- Overdraft Facility: Allows withdrawal of funds beyond the current account balance, up to an approved limit, to meet short-term liquidity needs.
- Equipment or Machinery Loan: Helps businesses purchase new machinery or upgrade existing equipment to improve productivity.
- Loans under Government Schemes: Includes special financing options backed by the Indian government, such as MUDRA Loans and the Stand-Up India Scheme.
- POS Loan or Merchant Cash Advance: Offers funding based on daily card transactions through POS machines—ideal for retailers and small businesses with consistent sales.
1. Working capital loan
Working capital loans are taken by individuals, small business owners, startups, and MSMEs to handle everyday business expenses. These loans help with things like improving cash flow, buying raw materials, increasing stock, paying staff salaries, or hiring new employees.
Since these loans are for short durations, banks and NBFCs usually charge higher interest rates compared to long-term or regular business loans.
In this loan type, the lender sets a borrowing limit, and the money can only be used for specific business-related purposes.
Check your business loan eligibility before applying to ensure you meet the necessary criteria and choose the right type of loan based on your working capital needs.
2. Term loan
A term loan is a type of business loan that you repay in fixed instalments over a set period. These loans are divided into three types based on the loan duration — short-term, medium-term, and long-term.
Short-term loans usually have a repayment period of up to 12 months.
Long-term loans can go up to 5 years or more, depending on your business needs.
Businesses can get collateral-free loans of up to Rs. 2 crore, and in some cases, even more, based on the lender’s assessment.
The repayment period for a term loan is decided by the lender at the time of approving the loan application.
3. Letter of credit
A letter of credit is a type of credit facility mainly used by businesses involved in international trade. In this setup, the bank or lender promises to pay the seller on behalf of the buyer, giving assurance that the payment will be made.
It is commonly used for both imports and exports, especially when businesses deal with new or unknown suppliers in other countries. Since international trade often involves risk, suppliers usually want a guarantee before sending goods.
A letter of credit helps build trust by ensuring the seller will receive payment, making it an important tool for businesses trading overseas.
Check your pre-approved business loan offer to see if you already qualify for financing options that can support large transactions like imports secured by letters of credit.
4. Bill discounting
Bill or invoice discounting is a type of business funding where a seller can receive money in advance from the bank or lender by using unpaid invoices. The bank gives this money at a discounted amount and charges interest or a fee for the service. This allows the seller to maintain cash flow without waiting for the buyer to make the payment.
Example:
Let’s say you’ve sold goods to Mr. Singh, and he has given you a letter of credit promising payment after 45 days. But if you don’t want to wait that long, you can go to the bank and ask for early payment. The bank will give you the money right away, but after deducting a certain amount as interest.
Suppose the payment due is Rs. 10 lakh, and the bank charges Rs. 50,000 as interest or fee. You’ll receive Rs. 9.5 lakh now, and the bank will collect the full Rs. 10 lakh from Mr. Singh on the 45th day.
This way, you get early access to your money, and the bank earns through the interest or discount.
5. Overdraft facility
An overdraft is a type of loan where the bank allows you to withdraw more money than what is available in your account—even if your balance is zero
You only pay interest on the amount you actually use, and the interest is calculated daily.
The loan limit depends on your relationship with the bank, your credit score, cash flow, and repayment history (if any). This limit is usually reviewed once a year.
As long as you pay the interest on time, you can use the overdraft amount however you like.
Overdrafts are usually given against some form of security, like a fixed deposit (FD) with the bank.
6. Equipment finance or Machinery loan
An equipment or machinery loan is a type of business loan that helps you buy new machines or upgrade the ones you already have. This kind of funding is mostly used by large businesses or companies involved in manufacturing.
Business owners who take an equipment machinery loan may also get tax benefits.
The interest rate, loan amount, and repayment period can differ from one lender to another, depending on your business profile and loan terms.
7. Loans under Govt. schemes
The Government of India has launched several loan schemes to support individuals, MSMEs, women entrepreneurs, and businesses in the trading, services, and manufacturing sectors.
These loans are offered through different financial institutions, including private and public sector banks, NBFCs, regional rural banks (RRBs), microfinance institutions (MFIs), and small finance banks (SFBs).
Some of the well-known government loan schemes include:
Mudra Loan under PMMY
PMEGP (Prime Minister’s Employment Generation Programme)
CGTMSE (Credit Guarantee Fund Trust for Micro and Small Enterprises)
PMRY (Prime Minister’s Rozgar Yojana)
These government loan schemes for business aim to make funding more accessible and promote business growth across the country.
8. Point-of-sale (POS) loans
A POS loan, also known as a Merchant Cash Advance, is a type of business funding where the loan is repaid through your daily credit or debit card sales. It’s mainly used by shop owners or small businesses that take payments through card-swiping machines (POS machines).
Sometimes, small business owners face a shortage of cash for day-to-day needs. To manage this, they take a POS loan, which helps maintain cash flow during slow periods.
The loan is repaid automatically from your daily card sales, and it's commonly used in retail shops, grocery stores, supermarkets, and shopping malls.
Keep in mind, the interest rates on POS loans are usually higher than regular business loans because they’re meant for short-term needs and quicker access to funds.
Conclusion
In conclusion, understanding the various types of business loans available in India can help entrepreneurs make informed financial decisions that suit their specific needs. Whether it’s managing daily expenses with a working capital loan, expanding operations through a term loan, or opting for a secured business loan to access higher funding with collateral, each option serves a unique purpose. Choosing the right loan type depends on your business goals, stage of growth, and repayment capacity. By evaluating these factors carefully, business owners can secure the right funding to sustain operations, drive growth, and achieve long-term success.
Helpful resources and tips for business loan borrowers
Frequently Asked Questions
There are various types of business loans to suit different needs. A business term loan, one of the most common types in India, offers a specific amount with fixed repayments over time. The loan amount depends heavily on the business’ credit history. When applying for a term loan, you must define the purpose of use. Other types include overdrafts, invoice financing, equipment loans, lines of credit, and merchant cash advances. Each serves different purposes, so choose one aligning best with your business needs.
The most common type of small business loan is a term loan. With a term loan, you borrow a fixed amount of money and repay it over a set period, usually with interest. This loan helps cover various business needs, like purchasing equipment, expanding operations, or managing cash flow. Repayment terms and interest rates can vary, so it's essential to compare options and choose what's best for your business.
The two main types of business loans are secured loans and unsecured loans. Secured loans require collateral, such as property or equipment, to secure the loan. They usually offer lower interest rates. Unsecured loans don't require collateral but may have higher interest rates to compensate for the increased risk to the lender. Depending on your business needs and financial situation, you can choose between these options. Remember to carefully consider the terms and conditions of each type before making a decision.
