A loan in simple terms is an arrangement between lenders (someone who lends money) such as a bank or digital lending platform and a borrower (a salaried professional in need of money) like you and me. You as a borrower agree to repay the money along with interest to the lender based on a determined time period or tenure. The lender can ask for collateral to be included to bear the risk in case you default in repaying the loan. If no collateral, then the lender would look at your credit history information to estimate whether you are capable of fulfilling your loan EMI payments responsibly.
The terms of a loan are agreed to by both the lender and the borrower before any money exchanges hands. The terms of a loan specify the tenure, loan amount, the interest that the lender will levy, monthly EMI repayment amount and any collateral if required by the lender. The interest rates charged for availing a loan can either be fixed (remains constant for the tenure) or variable (changes over time). If you cannot avail the loan due to low income, then a co-applicant can furnish his/her income information to get the loan. In case the primary borrower doesn’t pay the loan back, the co-applicant is liable to pay the loan back to the lender.
Loans can be taken for a number of purposes such as buying a vehicle or a home, to start a business or cover personal expenses towards home improvement, travel holidays, wedding or medical expenses,.
Loans come with a repayment schedule which tells you when and how much you need to pay till the loan is cleared. You can choose from a number of repayment options depending upon your circumstances. You could do an accelerated repayment, step up or step down repayment or balloon repayment. Digital lending platforms allow you to clear off the penalty ahead of the tenure completion. Banks however charge a prepayment penalty to do the same. Tracking the loan EMI payments is important to know how much you have already paid and how much is still pending.
Loans typically are of two types, secured and unsecured. Let’s take a closer look at the two.
These are loans that are protected by an asset or collateral. The purpose for the loan can itself be used as collateral. The bank will hold the title or deed for the collateral until the loan is paid in full, including interest. A large amount of money can be availed using a secured loan because the lender feels safe to approve the loan with the collateral in hand. You as a borrower will try to clear off the loan as quickly as possible to get the complete ownership of the asset or collateral. Secured loans are generally offered with low interest rates due to decreased risk involved and higher borrowing limits with longer repayment terms. Some more examples of secured loans are Gold loan, loan against insurance policies, loan against bank FDs, loans against PPF and EPF, loans against shares etc.
Advantages of Secured loans
- Larger loan amount: due to the presence of collateral.
- Interest rates: lower given the collateral cover.
- Tenure: medium to long term.
- EMIs: amount is less due to the longer tenure.
For unsecured loans, bank or lenders do not ask for collateral. An example of unsecured loan is Personal loans. Some more types of unsecured loans are credit cards, student loans and P2P loans. As there is no collateral, banks or digital lending platforms look at the borrower’s credit worthiness by evaluating their credit bureau report.
The borrower has to be a salaried professional. Banks do not approve a personal loan if the borrower has never availed of a loan before (no credit history). Digital lending platforms will still provide a loan for a borrower with no credit history but the borrower has to be working for at least the last 3 months. The loan application process for a personal loan is fastest for digital lending platforms. With loan application, document upload and disbursement happening online, it is the best option for a personal loan.
Advantages of Unsecured loans
- No collateral required: since loans are approved by evaluating borrower’s credit worthiness
- No stress: with no collateral involved, there is any fear of losing your assets.
- Simpler process: Credit worthiness is evaluated and loan processed.
- Easily availed for multiple purposes: You can get a personal loan for a number of reasons such as relocation, travel, home improvement, wedding and medical expenses.