Loans – Meaning, How They Work, Types, and Features: It is possible that we don’t always have the funds to do certain things, or to purchase certain goods. In such situations, individuals and businesses/firms/institutions go for the option of borrowing money from lenders.
A lender may lend money to an individual or organization with a guarantee that they will repay the money.
A loan is made up of three parts: the principal amount or borrowed amount, the rate of interest, and the tenure or term for which the loan is used.
Many people prefer to borrow money from a bank or a trusted, non-banking finance company (NBFC), as they are accountable and trustworthy. Lending is a key financial product that any bank or NBFC offers.
Loans – Meaning, How They Work, Types, and Features
Different types of loans
1) Based upon the Security Provided
Secured loans
For these loans, the borrower must promise collateral. If the borrower cannot repay the loan, the bank has the right to use the pledged collateral as security to recover any pending payments. This loan has a much lower interest rate than other unsecured loans.
Unsecured loans
Unsecured loans don’t require collateral to make loan payments. The bank reviews the borrower’s past relationships and credit scores to decide whether or not the loan should go ahead. Because the borrower can’t recover the loan amount if they default, the interest rate on these loans may be higher.
2) Based on the Purpose
Education Loan
Education loans are financing tools that allow borrowers to pursue higher education. The course can either be an undergraduate degree, a postgraduate degree, or any other diploma/certification course from a reputed institution/university. The institution will provide you with an admission pass to allow you to apply for the funding. Both domestic and international courses are eligible for financing.
Personal Loan
Personal loans can be taken out when you have liquidity issues. Personal loans can be used for anything, including to repay an old debt, go on vacation, pay down a car/house, or fund medical emergencies. They can also be used for big-ticket purchases such as furniture and gadgets. Personal loans are available based on the applicant’s credit score and past relationships.
Vehicle Loan
Vehicle loans are used to finance the purchase and financing of four-wheeler or two-wheeler vehicles. The four-wheeled vehicle may be either a brand new or used. The lender will decide the amount of the loan amount based on the current vehicle price. Because the loan doesn’t provide 100% financing, you might need to pay a down payment to obtain the vehicle. The lender will take ownership of the vehicle until it is fully repaid.
Home Loan
Home loans are used to obtain funds to purchase a property/flat, to construct a house, to renovate/repair a existing house, and to purchase a plot to build a house/flats. After repayments have been made, the lender will take possession of the property.
3) Based upon the Pledged Assets
Gold Loan
Lenders and financiers often offer cash to borrowers who pledge physical gold. The lender weighs and calculates the amount of the offered money based upon several tests for purity. The money can be used for any purpose.
The borrower can take back the gold by paying monthly instalments to repay the loan. Lender reserves the right to seize the gold if the borrower is not able to repay the loan on time.
A loan against assets
Businesses and individuals can pledge their property, insurance policies or FD certificates as well as mutual funds, shares and bonds to lend money. This is similar to pledging gold. The lender will provide a loan with some margin depending on the assets pledged.
Borrower must pay the loan on time to be allowed to take custody of the pledged assets. In the event that the borrower does not make the required payments, the lender has the right to sell the assets in order to recover the debt.
How Lenders Will Consider Your Credit Score When Approving your Application.
This is especially true when you are applying for unsecured loans.
1) Credit score
Credit scores are a measure of credit history. Lenders analyze the repayment history of borrowers to determine if they can repay their loans on time and if they will default on payments. After performing the necessary analysis, the lender makes the decision about loan approval.
2) History of Income and Employment
The loan approval process is also affected by your income and work history. The lender will assess your income and stability through consistent and steady work history to determine if you are able repay the loan.
Even if you’re self-employed the lender assumes your business is in good standing for the last few years, and that your company’s turnover is satisfactory.
3) Ratio of debt-to-income
Your debt-to income ratio is just as important as your income. A new loan will not be granted if you earn more than Rs.15,000 per month or if you have outstanding debt repayments that exceed Rs.75,000; you will still need to make payments to cover your domestic expenses.
Therefore, regardless of your income, it is important to have a low debt/income ratio. This will allow lenders to see that you have enough cash each month to pay off the loans and handle family expenses.
4) Collateral
Lenders may determine the interest rate applicable for your loan based upon the collateral you provide as well as its current market value. Lenders will trust collateral more, and may offer a lower interest rate. Unsecured loans are known for their higher interest rates.
5) A down payment
You will earn the lender’s trust by the amount you have saved and how well you execute your savings plan for a downpayment. The lower the down payment requirement, the lower the loan amount.
Advantages and features of loans
There are many types and categories of loans. Each type is categorised according to different factors.
1) You can choose the type loan you want to take, based on your eligibility.
2) The lender has the final power to determine the loan amount they want to offer you. This will be based on many factors like repayment capacity and income.
3) Each loan comes with a repayment period and an interest rate.
4) Every loan could be subject to multiple fees and charges from the bank.
5) Many lenders offer instant loans that can be disbursed in as little as a few hours.
6) The lender decides the interest rate based on the Reserve Bank of India guidance.
7) The lender decides what security is required.
8) Sometimes, security can be replaced by a third party guarantee.
9) You must repay the loan in equal monthly installments over the loan tenure.
10) It may be possible to make partial or full prepayment.
11) Lenders and loan types may impose a penalty for late payments.
Eligibility to Loan
The criteria for obtaining a loan vary depending on what type of loan it is. These are the most common criteria you can use to determine your eligibility.
1) A decent credit score
2) Constant income flow
3) Age between 23- and 60 years old at the time you enter
4) A few assets like FDs, investments and immovable property.
5) Establishing a good relationship with your bank
6) Reliable debt repayment history
Documents required
Salaried Applicants
1) Apply form with photograph
2) Identification and address proof
3) Statement from the bank account for the past 6 months
4) Recent Salary Slip
5) Form 16
Self-employed applicants
1) Apply form with photograph
2) Identification and address proof
3) Last 6 month’s bank account statement
4) Evidence of business
5) Profile of a company
6) The income tax returns for self and business (self and business) over the last three years
7) Balance sheets and profit/loss statements for the past three years
How to apply for a loan
The process of applying for a bank loan can be simpler than you think. It is easy to apply for a bank loan, but you need to be aware of your financial situation before applying. The loan amount will need repayment later.
It is important to first understand your requirements. You can talk to a loan manager at the bank or apply online.
Step 1: After doing your research, find the lender that is most suitable for you and confirm your eligibility.
Step 2: To apply for a loan, visit the bank branch.
Step 3: Submit/upload all documents and proofs.
Step 4: After processing your application, the bank will get in touch to let you know their position within the given time frame.