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Loan is a financial arrangement in which a lender provides money to an individual or business with the agreement that it will be repaid over time along with interest. Understanding what is loan and its role is important, as loans are widely used to meet personal needs like buying a house or funding education, as well as business needs such as expansion and working capital.
Loan extends to enabling access to funds for individuals across income levels, subject to eligibility and repayment capacity. In this blog, we explain meaning of loan, how loan works, and lone types.
What is Loan?
Loan refers to funds provided by a bank, financial institution, or lender to an individual or business for a specific purpose. The borrower is required to repay the amount over a defined period, usually through scheduled instalments.
When a loan is taken, both parties agree to clear terms covering interest charges, repayment duration, and other conditions. Loans are commonly used to manage expenses, acquire assets, or support business activities.
Components of a Loan
Every loan has a few basic elements that determine how it works and how much the borrower needs to repay:
- Principal: This is the original amount of money borrowed from the lender.
- Loan Tenure: Total time period within which the loan must be repaid.
- Interest Rate: The rate charged by the lender on the borrowed amount, usually expressed as an annual percentage.
- Repayment Amount: Amount paid regularly (monthly or weekly) to repay the loan, calculated based on the principal, interest rate, and loan tenure.
Types of Loans
Following are the main types of loan in India
1. Personal Loan: When you need money for various purposes like paying off debts, going on a vacation, buying a house or car, handling medical emergencies, or purchasing expensive items, you can apply for a personal loan. To qualify for a personal loan, lenders consider your previous financial dealings with them and your credit history.
2. Home Loan: A home loan is taken when you want to buy your dream home/construct a new home, or renovate or repair an old house. You repay the borrowed money along with interest in monthly installments within a specified time frame. Your house is used as collateral until you fully repay the loan.
3. Vehicle Loan: If you need funds to buy a two-wheeler or four-wheeler vehicle, you can opt for a vehicle loan. You pay back the borrowed amount, along with interest, through monthly installments. The lender may require a down payment, and they hold ownership of the vehicle until the loan is completely paid off.
4. Education Loan: When you require financial support for your education, whether it’s pursuing an undergraduate or postgraduate degree or any other diploma or certification course, an education loan is a suitable choice. Typically, you need proof of admission to obtain this loan. It covers expenses such as tuition fees, books, and living costs while you’re studying. This type of loan can be used for both domestic and international courses.
Based on the Pledged Assets
1. Gold Loan: Many financial institutions and lenders offer cash when you use your physical gold as collateral, whether it’s in the form of jewelry or gold bars/coins. The lender assesses your gold’s value and purity and offers a loan accordingly. To pay back the loan, you make monthly installments to reclaim your gold. And, if you don’t make the repayments on time, the lender has the right to take possession of the gold to cover their losses.
2. Loan Against Assets: Similar to pledging gold, individuals and businesses can use assets like property, insurance policies, FD certificates, mutual funds, shares, bonds, and more as collateral to borrow money. In this case, the lender will offer a loan amount based on the value of these pledged assets. To reclaim your assets, you need to make timely repayments as per the agreed schedule. If you fail to do so, the lender may sell the assets to recover the unpaid money.
Benefits of Loan
Before deciding on a Loan, let’s take a look at loan benefits:
- Loan Choices: There are various types of loans available for different needs and situations. You can choose which fits your requirements.
- Manageable Repayments: Loans typically come with fixed EMIs (Equated Monthly Installments), making it easier for borrowers to budget and manage repayments.
- Quick Disbursement: Some lenders offer fast loan processing, and you can get the funds within a few minutes to a few hours.
- Support for Education and Homeownership: Loans like education loans and home loans make it possible for individuals to pursue higher education or own a house, fulfilling long-term dreams.
- Tax Benefits: Some types of loans, like home loans, offer tax benefits to borrowers, reducing their overall financial burden.
- Third-Party Guarantee: In the cases of unavailability of collateral, the option of a third-party guarantee can help individuals access loans.
- Prepayment Option: Some loans allow you to make full or partial prepayments, although penalties may apply with certain lenders and loan types.
What Are the Documents Required For Loan?
Following are the documents required for salaried applicants:
- Application form with a photo
- Proof of identity and address
- Bank statements (6 months)
- Your most recent salary slip
- Form 16
For Self-Employed Applicants:
- Application form with a photo
- Proof of identity and address
- Bank statements (6 months)
- Proof of your business
- Business Profile
- Income tax returns for both yourself and your business for the last three years
- Profit and loss statements and balance sheets for your business for the last three years
Factors Lenders Consider for Loan Approval:
When you’re applying for a loan, it’s like a two-way street – you want the money for a home, a car, or any other financial need, and the lender wants to be sure you’ll pay it back. So, what are the things they look at to decide?
- Good Credit Score: You should have a decent credit score, which reflects your past financial responsibility.
- Income & Job History: Lenders like to see a consistent stream of income, so you should have a job or a stable income source before you apply for a loan.
- Age: You should be between 23 and 60 years old when you apply for the loan.
- Bank Relationship: You should have had a good relationship with your bank in the past, which will work in your favor.
- Debt-to-Income Ratio: It's not just about how much you make; it's also about how much you owe. If your debts are too high compared to your income, they might not give you more. They want to make sure you can handle your existing expenses and the new loan.
- Collateral: If you have something valuable to offer as collateral, like a car or property, lenders feel more secure. This can lead to lower interest rates. Unsecured loans usually have higher interest rates because there's no collateral.
- Timely Payments: If you've been good at repaying previous debts on time, it's a positive factor.
How to Apply for a Loan?
To get a loan you can follow mentioned steps:
Step 1: Choose the Right Lender
First, you need to do some research and choose a lender that suits your requirements. Ensure that you meet the eligibility criteria.
Step 2: Apply
You have two options: you can either visit the bank in person and talk to their loan manager, or you can directly apply online on their official website.
Step 3: Document Submission
Next, you’ll need to provide all the necessary documents and proofs required by the bank.
Step 4: Application Processing
The bank will review your application and reach out to you to inform you if your loan request has been approved or not.
Tax Benefits on Loans
Here are some tax benefits of taking loan:
- Personal Loans, although not taxable, may qualify for deductions if used for specific purposes like business investment, home renovation, or asset acquisition.
- Home Loans, which come with substantial amounts and lengthy repayment periods, offer significant tax benefits to encourage homeownership. If you take a loan to buy a house from any Indian financial institution, you might be eligible for income tax benefits under Section 80EE.
- Car Loans usually don’t provide tax advantages unless the vehicle is used for business purposes and eligible for a tax deduction under Section 80C of the Income Tax Act.
- Education Loans have extended tax breaks under Section 80E of the Income Tax Act to support higher education.
- Gold Loans, however, typically don’t offer tax benefits unless the loan amount is used for home improvements or residential property purchases, where deductions under Sections 80C and 24 may apply.
FAQS on What is Loan
What is a Secured Loan?
Secured loan requires the borrower to pledge an asset such as property, gold, or a vehicle as collateral, which the lender can seize if the borrower fails to repay.
What is an Unsecured Loan?
An unsecured loan is given without any collateral. Approval depends on income, credit score, and repayment capacity, making it riskier for lenders than secured loans.
How Do Loans Work?
A loan works through a formal agreement where the lender provides funds, and the borrower repays the amount in instalments over a fixed period with interest.
What are the Benefits of a Loan?
Loans provide quick access to funds, help manage large expenses, support personal or business growth, and allow repayments to be spread over a manageable period.
How to Reduce Your Total Loan Cost?
You can lower loan costs by choosing shorter tenures, maintaining a good credit score, comparing interest rates, and making part-prepayments whenever possible.
What is a Loan Amortisation Schedule?
A loan amortisation schedule details each repayment, showing how much goes toward principal and interest, helping borrowers track outstanding balance and total interest paid.
How to Improve Your Loan Eligibility?
Loan eligibility can be improved by maintaining a high credit score, stable income, low existing debt, timely repayments, and accurate financial documentation.
Happy investing and thank you for reading!
Disclaimer:
This website content is only for educational purposes, not investment advice. Before making any investment, it’s important to do your own research and be fully informed. Investing in the stock market includes risks, and you should carefully read the Risk Disclosure documents before proceeding. Please remember that past performance doesn’t guarantee future results, and due to market fluctuations, your investment goals may not always be achieved.
