Loans play a significant role in the financial landscape, providing individuals and businesses with access to capital from banks and other lending institutions. They are capital advances that come with interest charges for a specified period of time. Bank loans serve various purposes, acting as a lifeline during emergencies for some borrowers and fueling growth opportunities for others. The type of loan and its purpose determine its impact on borrowers. In India, borrowers have a wide array of loan options to choose from, offered by lending organizations. This comprehensive guide explores the different types of loans available, both secured and unsecured, to help borrowers make informed decisions and effectively manage their personal finances.
Different Types of Loans in India:
Secured Loans:
Loans that are given in exchange for a security are known as secured loans. When applying for secured loans, the borrowers must provide security. Lenders have a decreased chance of a default by the borrower with secured loans. If the borrower cannot pay back the loan, the lender may sell the asset to recoup its losses. This is the primary factor for secured loans’ lower interest rates than those of unsecured loans.
Types of Secured Loans:
1 Home Loans:
These are the secured loan categories that borrowers most frequently use. Home loans are, as their name implies, obtained by borrowers to buy or build homes. Here, the property itself serves as a guarantee for the lender. Despite the fact that the house is the principal security, the lender may nevertheless ask the borrower to provide collateral security depending on the borrower’s background and the home’s value. This could be a fixed deposit or another kind of asset. Home loans include a long-term repayment schedule that might last for up to 25 years. They are typically the most economical loans, with high-ticket amounts that can reach lakhs. Starting from 7% to 7.5% annually, house loan interest rates are variable. Equated Monthly Installments (EMIs) are required to repay the loan. 80% is the typical Loan-to-Value (LTV) ratio. It indicates that the borrower may obtain a loan for up to 80% of the value of the property.
2 Gold Loans:
Gold owned by the borrowers is pledged as collateral for gold loans. The borrower can use gold as collateral to get credit from the lender in this circumstance since it acts as security for the lender. Up until the loan is repaid, the gold is the lender’s property. The interest rate for gold loans begins at 7.50% annually. In this case, the majority of lenders demand that the borrowers pay only the interest on the loan balance each month. The borrowers can take back ownership of the gold and repay the principal at any moment. Interest must be paid on the outstanding principal each month until it is paid in full. Additionally, gold loans have a maximum LTV of 90%.
3 Vehicle Loans:
These loans were obtained to buy the automobile. A vehicle may be a two-wheeler, a four-wheeler, a heavy vehicle, a passenger or commercial vehicle, or all of the above. In this instance, the car serves as the lender’s main security. The lender has the right to seize the car if the loan is not repaid. Vehicle loans may have interest rates that range from 7% to 7.5% annually. According on the kind of vehicle, the LTV varies. A loan of up to 100% of the value of the car may even be made available by the lender for some types of auto loans.
4 Loan against Property:
In order to obtain money, the borrowers must mortgage their property with the lender, which is a type of mortgage loan. Both business and residential property are eligible for loan against property options. For loans secured by property, the administrative fees are higher than for loans for homes. The lender is free to spend the money anyway they see fit, whether for themselves or their business. LTV ranges from 65% to 70% in the case of a loan secured by real estate. In addition, compared to mortgage interest rates, loans secured by property have a little higher interest rate. Starting at 8% annually, the interest rate in this area.
5 Loan against Securities:
Frequently, investors buy shares and other securities. Shares, mutual funds, bonds, and debentures are examples of this. These securities may be used as collateral for loans from banks and other financial institutions to the investors. However, because of the volatile nature of the securities, the LTV for loans secured by securities is only 50% of the security’s value. This serves to safeguard the lender against any risk associated with a decline in the security’s value. Additionally, the interest rate for loans secured by securities varies according to the type of security. It may begin at any rate between 7.50% annually.
6 Title Loans:
When a borrower applies for a title loan, the lender lends money against the borrower’s car. By providing their vehicles as collateral security to the lenders, the borrowers are able to borrow up to 25% to 50% of the value of their vehicle. The borrower still retains ownership of the vehicle, but the lender has the right to confiscate it in the event of default. These loans can be taken out for as little as 30 days, and their typical tenure is quite short. The extremely high interest rate on title loans is one of its biggest disadvantages. Usually, there is a monthly interest rate of 25%. It’s 300% annually, according to that.
7 Non-recourse Loans:
Non-recourse loans are under the category of secured loans wherein the borrower may offer the lender collateral as security in exchange for the loan. The lender has the right to take the collateral security if the borrower defaults. A non-recourse loan’s ability to prevent collection actions against the borrower in the event that the collateral security fails to fully recoup the lender’s losses is one of its main advantages. Following the receipt of the collateral security’s proceeds, the lender must forfeit the outstanding loan balance. The non-recourse loan is not personally reimbursable by the borrower. In the event of a non-recourse loan, the LTV might range from 60% to 80%.
8 Loan against Fixed Deposits:
In this case, borrowers receive loans from banks and other financial organizations in exchange for fixed deposits. The lender’s main security is provided by the fixed deposits. Additionally, since a fixed deposit is equivalent to money, banks are not at great risk when making loans secured by FDs. Loans against FDs are available to borrowers for a sum between 60% and 75% of the FD’s value. While some banks charge a flat interest rate, other banks may charge interest that is 1%–2% greater than the FD rate. Currently, depending on the amount and tenure, the FD rate ranges from 5% to 7.5% annually. Thus, it can be claimed that loans secured by FD are some of the least expensive secured loans.
9 Loan against Insurance:
The loan against insurance is one of the most popular kinds of secured loans in India. Many people have life insurance plans, but they hardly ever realize that these policies might serve as a security for loans. The insurance policy must have a surrender value in order to be eligible for a loan against it. The LTV for a loan against insurance ranges from 85% to 90% annually. In this situation, the interest rate may range from 10% to 12% annually.
10 Working Capital Loans:
Banks and other financial organizations offer working capital loans to businesses to help them with their working capital requirements. The amount of the loan, sometimes referred to as Cash Credit, depends on the creditors, debtors, and stock that the company owns, which also serves as the working capital for the company. Each lending institution has its own working capital ceiling. Additionally, the interest rate for working capital loans might begin at 12% annually. For working capital loans, the stock and debtors serve as security; nevertheless, the lending institution may also ask the borrower to provide collateral security.
Unsecured Loans:
These operate in total opposition to secured loans. Unsecured loans are made based on the borrower’s current or potential earning potential. In the case of unsecured loans, the borrowers are not required to provide any collateral. Based on the documentation submitted by the borrower, their potential income, and their CIBIL history, the lenders grant unsecured loans. Unsecured loans raise the risks for the lender because, in the event of a borrower default, there is no collateral on the lender’s end from which it can recoup its losses. Due to this, lending institutions charge unsecured loans a higher interest rate.
Types of Unsecured Loans:
1 Personal Loans:
These bank loans are among the most popular in India. Banks and other financial institutions will provide personal loans without any type of collateral security. In essence, the borrower is getting a loan secured by their income. The main benefits of personal loans include the lack of a requirement for collateral security and the lack of restrictions on how the borrowed cash may be used. The borrower is free to use the borrowed funds for whatever purpose, including paying for travel or other expenses or for situations involving their health. According to the borrower’s income and CIBIL score, they can borrow up to a certain amount of money for a personal loan. Additionally, personal loans may have interest rates that range from 8% to 10% annually.
2 Short-term Business Loans:
Any period can bring uncertainty to the workplace. A company may seek for short-term business loans if it is in need of money. These bank loans are set up to support companies through short-term financial difficulties and uncertainties. Simple requirements must be met in order to be eligible, and the amount of the loan that can be issued relies on the borrower’s profile and the profitability of the firm. The interest rates for short-term company loans might range from 1% to 1.5 percent every month, or 12% to 18 percent annually. There is a possibility of losing the borrowed money in the firm, which is why business loans have higher interest rates than personal loans. Lenders in these situations are responsible for taking on the risk.
3 Education Loans:
Education is getting more expensive very quickly. Spending thousands of rupees is necessary if one wishes to pursue a great education. A student loan can offer financial support in these situations. The amount of the loan is based on the cost of the school, and the interest rate on student loans starts at 8.85% annually. Usually, 12 months after the end of the educational process, the loan repayments start.
4 Credit Cards:
Numerous banks provide credit cards. These are excellent tools since they allow for credit card spending without really using cash. The grace period gives the credit card holder the opportunity to make a repayment. On the other hand, credit cards are often unsecured. Additionally, if the cardholder wants to, they have the option to turn the unpaid debt into a loan. This converts to an unsecured debt for the borrower. The fact that credit cards have a relatively high interest rate is one of their main disadvantages. The annual percentage rate for credit cards can range from 18% to 36%. Additionally, credit cards, like any other debt, have a significant impact on the CIBIL score.
Conclusion: Loans are crucial financial tools approved by banking companies and lending organizations to fulfill diverse borrowing needs. It is vital to make timely payments on all debts to maintain good financial health. Before applying for various loans in India, it is important to examine the advantages and disadvantages of secured and unsecured loans. Secured loans, including home loans, gold loans, and vehicle loans, offer lower interest rates due to the collateral provided. Conversely, unsecured loans like personal loans, short-term business loans, and education loans do not require collateral but come with higher interest rates. By carefully considering the pros and cons of each loan type, borrowers can choose the most suitable option for their specific financial requirements and ensure sound financial management.
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The above article has been written by Mr. Omkar Bandivdekar (CMA Aspirant) and reviewed by Mr. Suyash Tripathi (Chartered Accountant) and they can be reached at mdomkarnitinbandivdekar@gmail.com and tripathi.r.suyash@gmail.com.
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