Introduction to Loans
A loan is a financial arrangement where a lender provides money or resources to a borrower with the expectation of repayment over a specified time, often with interest. Loans play a critical role in both personal finance and business operations.Example:
Suppose Mr. Ravi needs ₹5,00,000 to buy a car. He doesn't have the full amount, so he approaches a bank. The bank agrees to lend him ₹5,00,000 at 10% annual interest for 5 years. This is a loan.
1. Types of Loans
1.1 Personal Loan
A personal loan is an unsecured loan that individuals can use for personal expenses like weddings, vacations, or emergencies.Example: Neha borrows ₹2,00,000 from a bank to fund her wedding. Since it’s an unsecured loan, no collateral is required.
1.2 Home Loan
This is a secured loan provided to buy, construct, or renovate a house.
Example: Amit takes a ₹25,00,000 home loan at 7% annual interest for 20 years to purchase a new flat.
1.3 Auto Loan
Auto loans help in purchasing a new or used vehicle.
Example: Rahul takes a ₹6,00,000 car loan to buy a Maruti Baleno and agrees to repay it over 5 years.
1.4 Education Loan
Education loans are taken to finance higher education in India or abroad.
Example: Priya takes a loan of ₹10,00,000 to pursue her MBA in the UK.
1.5 Business Loan
This loan is used to start or expand a business.
Example: A small bakery borrows ₹5,00,000 to upgrade its kitchen equipment and expand operations.
1.6 Gold Loan
Individuals can pledge gold ornaments as collateral to obtain short-term loans.
Example: Shalini pledges her gold bangles to get a ₹1,50,000 gold loan to cover a medical emergency.
2. Secured vs Unsecured Loans
2.1 Secured Loans
These loans require collateral like property, vehicle, or gold.
Pros:
- Lower interest rates
- Higher loan amounts
- Longer repayment tenure
Example: A home loan is a secured loan where the house is mortgaged.
2.2 Unsecured Loans
No collateral is needed.
Pros:
- Faster processing
- Less documentation
Cons:
- Higher interest rates
- Lower loan amounts
Example: Personal loans and credit card loans are unsecured.
3. Loan Terminology Explained
3.1 Principal
The original sum borrowed from the lender.
Example: If you borrow ₹10,00,000, that’s your principal.
3.2 Interest
The cost of borrowing the principal, expressed as a percentage.
Example: On a ₹10,00,000 loan at 10%, annual interest is ₹1,00,000.
3.3 EMI (Equated Monthly Installment)
The fixed monthly payment to repay the loan (includes interest + principal).
Example: A ₹5,00,000 loan over 5 years at 10% might result in a monthly EMI of ₹10,624.
3.4 Tenure
The period over which the loan is to be repaid.
Example: A car loan may have a tenure of 5 years.
3.5 Collateral
An asset pledged against a secured loan.
Example: Gold ornaments in a gold loan.
4. Loan Application Process
- Determine Your Need
- Check Eligibility Criteria
- Compare Loan Options
- Fill Out Application
- Submit Required Documents
- Loan Approval
- Disbursement
Example:
Amit wants a business loan. He compares options, applies with proper documents, and gets ₹5,00,000 sanctioned within 5 days.
5. Loan Repayment Options
5.1 EMI-Based Repayment
Fixed EMI is paid monthly.
Example: ₹10,000 per month for 60 months.
5.2 Bullet Repayment
Entire loan and interest are paid at the end.
Example: Used in short-term gold loans.
5.3 Step-up EMI
EMI increases with time, useful for young professionals with growing income.
Example: Start at ₹5,000, rise to ₹8,000 after 2 years.
6. Loan Interest Types
6.1 Fixed Interest Rate
The rate remains constant during the tenure.
Example: 9% fixed for 5 years.
6.2 Floating Interest Rate
The rate changes with market fluctuations.
Example: 8.5% now, may go to 9% next year.
7. Credit Score and Loans
A credit score (300–900) determines your creditworthiness.
7.1 Importance of a Good Score
Easier loan approval
Better interest rates
Example: Ramesh with 800 score gets a personal loan at 10%, while Suresh with 600 gets it at 14%.
8. Loan Default and Its Impact
8.1 What is Default?
Failure to repay EMIs on time.
8.2 Consequences
- Credit score drops
- Legal action
- Asset seizure (for secured loans)
Example: If you miss 3 EMIs on a car loan, the bank may repossess the vehicle.
9. Loan Prepayment and Foreclosure
9.1 Prepayment
Paying part of the loan before time.
9.2 Foreclosure
Paying the full outstanding amount early.
Example: Ravi forecloses a personal loan after 2 years instead of 5.
Benefits:
- Lower interest paid
- Debt-free sooner
Note: Some banks charge a prepayment penalty.
10. Government Loan Schemes in India
10.1 Mudra Loan
For small business owners
Example: A vegetable vendor takes a ₹50,000 Mudra loan to buy a new cart.
10.2 PMAY (Pradhan Mantri Awas Yojana)
Subsidy on home loans for low-income groups.
10.3 Education Loan Subsidy
For economically weaker students under the Padho Pardesh scheme.
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