Loan, credit, mortgage in finance is the process where individuals, organisations, banks, etc. lend money to other persons or entities.
A loan can either be money, property, or other commodities given to a person or an entity. And, in exchange the receiver must repay the principal amount with interest and loan charges. The loan principal is the value of the loan or the amount of money borrowed.
Depending on the purpose, amount, and terms, it could either be a one-time loan or an open-ended credit-line. Credit cards are the example of the latter where there is a predefined borrowing limit, also known as the ceiling amount.
How does a loan work?
Typically, financial institutions like banks, governments, corporations, and private money lenders offer loans. Loans areissued at not just individual level. Loans can be issued to corporations and jointly to one or more persons for business purposes as well.
Individuals may require loan for making big purchases or for investing in education, bonds, to name a few. Corporations, on the other hand, use it for expanding their operations, starting new businesses, etc. Reasons for borrowing money could be anything. However, the sole purpose for the lenders to issue the loan is earning revenue in the form of loan interest.
While you raise an application for a loan, the lender processes your request by considering certain factors. It could be the borrower’s net worth or income, assets or property that could be used as collateral. In some instances, the lender requires the borrower to sign on a mutually agreed-upon loan contract.
Before issuing the loan, the borrower must go through the binding loan document and agree to the conditions stated. The certificate or agreement also specifies the terms and conditions of loan repayment.
Typically, some lenders like banks fix a timeframe where the loan can be repaid in Equated Monthly Instalments or EMIs. The EMI paid will thus include both the principal and the interest amount along with loan charges.
Secured vs unsecured and term vs revolving loans
Fundamentally, there are two types of loans, secured and unsecured loans. Secured loans are often secured by collaterals. Loans lacking collaterals are the unsecured loans like signature loans and credit cards generally issued by banks.
Generally, unsecured loans have a higher rate of interests. Although secured loans have low-interest rates, the lender can cease or repossess the collateral on the failure of repayment. Hence, before deciding, the borrower must weigh the pros and cons of both secured and unsecured loans.
Apart from secured and unsecured loans, you must also be aware of revolving against term loans. The former is a loan where you spend it, repay the same and spend it again. Term loans as the name suggests involves a term period for loan repayment. It means that the borrower can repay the loan as fixed EMIs for a specific period.
Revolving and term loans are types of both unsecured and secured loans. While credit card is an example of a revolving, unsecured loan, a home-equity line of credit is a revolving secured loan.A car loan is a term and secured loan while a signature loan is a term and unsecured.
Key loan terminologies
Rate of interest and monthly payments are some basic terms you must be aware of before opting for a loan. Interest rate is the additional amount along with the loan value or principal amount you pay. Thus, it is imperative to choose a lender offering credit at a low-interest rate.
They are certain factors that determine the rate of interest. It could be the loan amount, or the term of the loan, or the yearly earnings of the borrower. Loans with higher interest rates take longer to repay as you need to pay the loan’s interest as well. Also, such loans have a higher EMI or monthly payment amount.
Interest rates thus play a significant role in loan repayment. Hence, it is wise to choose a lender offering the lowest rate of interest. You can apply for a loan with multiple lenders and sign the loan agreement that has the lowest interest rate.
Things to consider before applying for a loan
Opting for any loan is one of the most significant financial decisions you make. Thus, it is recommended to consider some aspects before taking that plunge. Making an informed choice is also imperative to take a loan.
Your credit score which is your credit record or repayment record of previous borrowing is one such crucial element. For your loan to get approved, you must have a good credit score. The processing fee is yet another element that adds on to your loan value or principal amount. Typically, the loan processing fee varies from one lender to another.
Apart from the processing fee, you may incur a late payment penalty. It is charged when you fail to make a monthly payment at the agreed date. Thus, before signing on the loan agreement, make sure that you are comfortable with the monthly payment date.
Financial experts often recommend to research and compare the interest rates offered by two or more lenders.
Certain types of big purchases require down payment apart from loans. It means that you need to pay some amount excluded from the loan value. For instance, if you are purchasing a car worth Rs.5,00,000 lakhs, you may make a down payment of Rs.1,00,000 while opting for a loan for Rs.4,00,000 lakhs.
Tenure is the period allotted for repayment of your loan. Make sure that you are comfortable with the tenure suggested by the bank. It is crucial because, in certain instances, it affects the rate of interest.
There are specific tools like EMI calculators available online that you can refer to determine the tenure, rate of interest, principal amount, etc. Such tools are available on the lender’s website where they express your eligibility once you feed your information.
Loans offer you financial assistance to reach your life goals that could be higher education, house, car, etc. Loans today are processed quickly and sometimes within 72 hours or less. Thus, they are handy to meet your immediate financial emergencies. Whatever the reason, repayment of loan taken is the key to your peace of mind.