Are you considering applying for a loan but feeling overwhelmed by the process? Understanding loans is important before applying for one. A loan is essentially borrowed money you must repay with interest over time.
This introductory guide explores the basics: What is a loan? How does it work? We break down the essentials from different types of loans to key terms to help you understand the fundamentals before taking that financial leap. So, let’s get started!
What is a loan?
A loan is like a financial handshake between two parties: a lender who provides money and a borrower who receives it, agreeing to repay it later with a bit extra called interest. Loans are lifelines for businesses and individuals, offering a way to access funds when needed.
They come in different types, like secured loans (where you put up something valuable as a guarantee) or unsecured loans (granted based on your credit history). Whether it's a small business aiming to expand or an individual covering unexpected expenses like medical bills or home repairs, loans provide crucial support.
Components of a loan
After understanding the loan definition, getting familiar with the terms of a loan is essential for borrowers to manage their finances wisely. Here are some key terms you should know:
- Principal: This is the initial amount of money borrowed.
- Loan Term: The duration within which the borrower must repay the loan.
- Interest Rate: This indicates how fast the borrowed amount grows over time, typically expressed as an Annual Percentage Rate (APR).
- Loan Payments: This is the regular amount paid (monthly or weekly) to meet the loan terms, calculated based on principal, loan term, and interest rate. An amortisation table provides this information.
Lenders may also add extra charges like origination fees, servicing fees, or penalties for late payments. They might also demand collateral for significant loans, such as property or a vehicle. If the borrower fails to repay, the lender can seize these assets to cover the outstanding debt. Understanding these terms empowers borrowers to make informed financial decisions.
Must Read: Types Of Personal Loans Available In India
How do loans work?
Applying to a bank, corporation, government, or other lending entity starts the loan process. Borrowers provide information such as the purpose of the loan, financial records, and any other required data. The lending institution then analyses this information and the debt-to-income ratio to determine the borrower's ability to repay.
Upon reviewing the applicant's creditworthiness, the lender may approve or deny the application. If the application is denied, the lender may also give reasons. If the agreement is approved, both parties sign a contract that stipulates all the conditions of the deal. The lender supplies the loan amount, which the borrower must return with other added fees, such as interest.
The first stage is signing the contract, in which the borrower and lender agree on the conditions of the loan. If collateral is required, it will be listed in the loan documents. Loan agreements also include details on the maximum limit for the interest rate and the other covenants, including the repayment period.
Types of Loans
Now that you have understood what loans are, you must know that there are different types of loans you can apply for. Let’s have a quick look at what these types are:
Loans Based on the Security Provided
Secured Loans
These loans require deposits as collateral, which could be used as a safety net for lenders. If the borrower defaults, the lender can use the collateral deposit to recover the outstanding debt. Since the risk-bearing is less, the rate of interest is also lower in secured loans.
Unsecured Loans
Unsecured loans do not require collateral; lenders review the past credit history and assess their relationship to understand the borrower's creditworthiness. Since there is no tangible property to repossess in case of default, interest on unsecured loans is usually higher.
Loans based on purpose
Education loan
Education loans let students pursue various training programs such as undergraduate and postgraduate degrees, diplomas or certification programs. These loans are for domestic and international programs and need a proof of admission letter from the respective institution.
Personal loan
Personal loans are mainly used to meet cash needs. They can be used for multiple purposes, such as debt consolidation, vacations, down payments for houses or cars, medical emergencies, and purchases of high-value items like furniture or gadgets. The borrower's credit history and relationship with the lender affect the loan approval. If you wish to take a loan and want to calculate the EMI beforehand, using a Personal Loan EMI Calculator can be highly beneficial. It is easily available on our website.
Vehicle loan
People can buy new and used motorcycles, cars, or even business vehicles through vehicle loans. The loan amount is calculated based on the vehicle's on-road price and requires a down payment. The remainder is divided into monthly EMIs. After the loan, the lender still owns the vehicle until the borrower pays off the loan.
Home loan
Home loans help people invest in various housing needs, be it to buy a house or a flat, to construct a new property, carry out some renovation works or repairs in existing structures or to acquire land for future construction. During the mortgage, the lender takes possession of the collateral property. The property is returned only after the borrower makes full repayment.
Loans based on the pledged assets
Gold loan
Borrowers can use their physical gold (jewellery, bars, or coins) as collateral to secure money from a cash lender. They bring their gold to the lender, who weighs and analyses its purity to decide the loan amount.
Loans can be repaid through monthly instalments. This means the lender and borrower can decide on a repayment period to clear the loan amount. Should the borrower fail to repay, the lender claims the gold to recover losses.
Loan against assets
People and companies can use their property, insurance policies and FD certificates to obtain loans and other credit facilities, such as gold. Assets are the main factor that lenders use to offer loans.
Timely repayments will ensure borrowers regain their assets at the end of tenure. Failure results in the lender disposing of assets to recover losses.
As a leading financial institution in India, Kotak offers a range of loan options tailored to your needs. You can explore their loan offerings based on your purpose, assets and security provided for your needs. To understand the eligibility criteria and further details, visit the specific loan page or contact customer care for assistance.
Must Read: Personal Loans vs. Credit Cards: What's the Difference?
Things you should consider before applying for a loan
When considering a loan, several key factors should guide your decision:
Credit score
A good credit score is crucial, especially for unsecured loans. It reflects your repayment history and influences loan approval.
Income and employment history
Lenders assess your income stability and job tenure to ensure you can repay the loan. For self-employed individuals, a steady business turnover is essential.
Debt-to-income ratio
Ensure your existing debts don't overwhelm your income. For example, if you earn Rs.1 lakh monthly and already owe over Rs.75,000, you may face rejection due to repayment capacity concerns.
Collateral
Providing collateral can secure better loan terms, including lower interest rates. Unsecured loans typically have higher rates due to the absence of collateral.
Conclusion
Loans are one of the fundamental components of the financial system. Lenders help economic activity by lending money and receiving interest compensation to mitigate risk. From the smallest student loans to giant corporate debts, lenders provide an essential service in the economy. Kotak811 Loans are an excellent option for responsible borrowers. Effortless application and competitive interest rates make them a perfect option to secure funds. Visit the loan section to understand more and apply right away!
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This Article is for information purposes only. The views expressed in this Article do not necessarily constitute the views of Kotak Mahindra Bank Ltd. (“Bank”) or its employees. Bank makes no warranty of any kind with respect to the completeness or accuracy of the material and articles contained in this Newsletter. The information contained in this Article is sourced from empanelled external experts for the benefit of the customers and it does not constitute legal advice from Kotak. Kotak, its directors, employees, and contributors shall not be responsible or liable for any damage or loss resulting from or arising due to reliance on or use of any information contained herein.
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