Loan: Meaning and types of loans

Opting for a loan is a wise decision when planning to make huge purchases or an investment. A loan refers to money borrowed from a bank or any lending institution in return for repayment within a specified period. In this article, we will discuss the types of loans and the process of availing a loan.

What is a loan?

A loan refers to money, property or any material given to an individual or entity by another party in exchange for repayment of the amount along with the interest in future. A loan may be a one-time amount, or it can be availed as an open-ended line of credit up to a certain limit.

Reasons for availing a loan

A borrower may opt for a loan for a number of reasons, such as:

• Purchasing a property, vehicle or any item
• Manage expenses, such as a wedding, vacation, renovation, etc.
• Funding education of children
• Debt consolidation
• Investment or a business venture

See also: How many home loans can one person have?

Classification of loans

Loans are broadly classified into the following categories based on the purpose they are availed for:

Secured loans: In these types of loans, the borrower provides an asset as collateral or security against which he receives the loan. In the event the borrower fails to repay the loan, the lender has some means to retrieve money. Secured loans tend to have lower interest rates than the other type of loan, known as unsecured loans, as there is a lower risk to lenders.

Unsecured loans: These types of loans are offered to the borrower based on their past association and credit history, without any collateral. However, these loans have a higher interest rate. Borrowers with high credit score find it easy to avail of unsecured loans.

Types of secured loans

Home loan

Home loans are secured loans and the most popular way of financing a house purchase or construction. Some of the common types of home loans are:

• Land purchase loan for buying a piece of land, building a home
• Home construction loan for building a house
• Home loan balance transfer of existing home loan
• Top up loan as additional loan for renovation or upgrade of new house

Loan against property (LAP)

In this type of secured loan, a borrower can pledge a residential, commercial or industrial property to obtain loan. The amount of loan disbursed is equivalent to a specific percentage of the property’s value. This percentage will depend on the lender and vary from 50-60% to 80%. A Loan Against Property can be availed if one has a fully constructed residential or commercial property without any other encumbrances. It is also beneficial for those looking to finance higher education needs for children, marriage, etc. Companies avail such loans for business expansion, product development, etc.

Loan against insurance policies

A borrower can obtain a loan against certain insurance policies. That is, policies with a maturity value, such as endowment and money-back policies, can be used to obtain secured loans. However, one can take advantage of these policies after they have acquired a surrender value.

Loan against securities

It is a type of loan where the borrower can pledge his shares or mutual funds as collateral to the bank. An investor can obtain funds with a loan against securities by pledging his existing investments, including equity or hybrid funds, to the lender. This loan facility is suitable for long-term investors. To avail of such loan, one has to write to the financier and execute a loan agreement. The financier will notify the mutual fund registrar and put a lien on the specific number of units, which is typically 60-70% of the value of units to be pledged.

Gold loan

Gold has been a preferred asset class. One can obtain a loan by pledging gold ornaments or coins as collateral. These are usually short-term loans and have a short repayment period. The amount of loan sanctioned is a specified percentage of the gold’s value pledged.

Loan against fixed deposits

A borrower can also avail a loan of up to 70%-90% of their fixed deposit’s value. However, this may vary from lender-to-lender. Moreover, the loan tenure is usually the same as the FD tenure, as it cannot exceed the FD’s tenure.

Types of unsecured loans

Personal loan

This type of loan is the most popular unsecured loan, which allows a borrower to get instant liquidity. As it is an unsecured loan, the interest rates are higher. The lender provides the loan by considering factors such as employment history, profession, credit history, income level, repayment capacity, etc. It is also known as multipurpose loan as it can be used for meeting expenses, such as a new business venture, child’s education, consolidate all debts in a single loan, home renovation, etc.

Flexi loan

A flexi loan enables a borrower to avail funds from his approved limit and withdraw the amount when required. They have to pay interest only on the amount used and as EMIs. One can withdraw his loan limit any number of times and prepay when there is additional cash, without any additional cost.

Short-term business loan

These types of loans include different types of financing by lenders to businesses for a variety of purposes. It helps a business meet its urgent or short-term business needs, including working capital needs, business expansion, business acquisitions, renovations, managing cash flow, covering operational costs, etc.

How does the loan process work?

When an individual or business is in need of money, he/she can approach a bank or non-banking financial company (NBFC) for a loan.

Before applying for a loan, it is essential to determine the type of loan based on their requirements and assess the amount. Similarly, one should understand if he/she will be eligible for the loan. For this, one can use online tools, such as a personal loan eligibility calculator to find out the amount they can borrow.

During the loan application process, the borrower must provide details, such as name, contact information, employment type, etc., along with supporting documentation. He/she must specify the type of loan and the amount he/she is seeking.

The lender will review the application and approve or sanction the loan. If the loan application gets rejected, the lender must specify the reason. In case the application is approved, an agreement is signed between the lender and the borrower. The lender transfers the loan amount to the borrower’s account. The contract should specify the terms of the loan agreed upon by the two parties.

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