What Is a Loan - Types and How It Works in India

When individuals and businesses lack the funds needed for specific purposes or purchases, they often resort to borrowing money from lenders to meet their needs. In such situations, individuals and businesses/firms/institutions choose to borrow money from lenders.
Loans are financial instruments that enable individuals and businesses to access funds for a variety of purposes ranging from personal expenses to business investments. Understanding the different types of loans available can empower you to make informed financial decisions. In this guide, we'll explore the basics and different types of loans to help you effectively navigate the borrowing landscape.

What is loan?

A loan is a sum of money borrowed from a lender, usually a financial institution such as a bank, credit union or online lender. The borrower agrees to repay the loan amount with interest over a specified period, as per the terms and conditions outlined in the loan agreement. Loans can serve a variety of purposes, including purchasing property, consolidating debt, financing education, or covering unexpected expenses.

Types of Loans

There are many types of loan. Read the below for details.

Secured loans

Secured loans are granted with collateral. Borrowers must provide security to obtain secured loans. With secured loans, lenders encounter reduced risk of borrower default. If the borrower cannot repay the loan, the lender has the option to sell the asset to reclaim their funds. This is the primary reason secured loans typically have lower interest rates compared to unsecured loans.

Unsecured loans

Unsecured loans are those which do not require any collateral to be given. Instead, the bank looks at the borrower's history, their credit score, and other factors to decide whether they should get the loan. Because the bank has no guarantee if the borrower is unable to repay the loan, the interest rates for these loans can be high.

Education Loans

Education loans, also known as student loans, are specifically designed to assist individuals in financing their higher education expenses including tuition fees, books, accommodation and other related costs. Education loans may be offered by government institutions or private lenders. They typically have lower interest rates compared to other types of loans and offer flexible 
Before choosing an education loan, explore scholarships, grants, and work-study programs as alternative funding sources. Evaluate the terms and conditions of different loan options, considering factors such as interest rates, repayment plans and borrower benefits.

Personal Loans

When you are short on cash, you may consider taking a personal loan. People use personal loans for many things such as paying off old debts, going on trips, putting money down on a home or car, dealing with medical emergencies, or buying expensive things like furniture or electronics. Whether you can get a loan depends on how you have treated the lender in the past and what your credit score is. Personal loans generally do not require collateral, making them unsecured. They offer fixed or variable interest rates and flexible repayment terms ranging from a few months to several years.

Vehicle loans

Vehicle loans cover the cost of purchasing both a motorcycle and a car. Vehicle loans, commonly known as auto loans or car loans, enable individuals to purchase vehicles including cars, trucks, motorcycles or recreational vehicles. Auto loans are secured by the vehicle purchased, making them less risky for lenders. They offer fixed or variable interest rates and repayment terms that typically range from two to seven years.
Determine your budget and preferred vehicle type before applying for the loan. Consider factors such as down payment requirements, interest rates, loan terms and total borrowing costs. To get the best deal, compare loan offers from different lenders and find the most competitive rates.

Home loans

The mortgage is designed to obtain funding to purchase a home/apartment, build a home, renovate/repair an existing residence, or acquire land to build a home/apartment with the lender providing collateral. They offer fixed or adjustable interest rates and various loan terms.
Assess your financial readiness for home ownership, including saving for a down payment and maintaining a good credit score. Compare mortgage options including conventional loans, FHA loans, and VA loans to find the option that best suits your needs and financial circumstances.

Features and advantage of loan

You can select the loan type to suit your needs and eligibility.

There are many types of loans classified according to different criteria.

Some loan types and lenders may impose penalties for early loan repayment.

Many loans offer flexible repayment terms, allowing borrowers to choose from different repayment schedules such as monthly, bi-weekly or quarterly payments, depending on their financial situation and preferences.

Loans come in both secured and unsecured forms. Secured loans require collateral such as a home or vehicle, which can lead to lower interest rates and higher borrowing limits. Unsecured loans do not require collateral, but they may have higher interest rates.

Loans may offer fixed interest rates that remain constant throughout the loan term, providing predictability in monthly payments.

Lenders set interest rates based on guidance from the Reserve Bank of India.

Some types of loans, such as home mortgages and student loans, may offer tax benefits, such as the deduction on mortgage interest or student loan interest, reducing the borrower's overall tax liability.

Some loans, especially loans offered by government entities or regulated financial institutions, come with borrower protections, such as grace periods, forbearance options, or loan forgiveness programs, which provide peace of mind to borrowers.

Eligibility for loan

Lenders use your income to assess your ability to repay the loan.

A good credit score.

You generally must be of legal age to enter into a contract to qualify for a loan.

Having a steady job can improve your eligibility for loans. Lenders often prefer borrowers with stable employment records.

Document required for loan

Proof of identity (government issued ID)

Proof of Address

Bank Statements

Salary slip

Loan Application Form

Employment Verification

credit report