What Is a Loan?

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What Is a Loan?

A loan is an amount of money that one party (the lender) lends to another party (the borrower) in return for the borrower’s promise to pay back the money, usually with interest, over a set period of time. Individuals, businesses, and governments use loans to make big-ticket purchases, invest, or pay for expenses they are not able to afford at the time.
Types of Loans

Loans are generally categorized on the basis of different parameters such as purpose, collateral, repayment schedules, and so on. The following are the principal types:

  1. Secured Loans

These loans are guaranteed by collateral (e.g., house, vehicle).

Examples: Home loans, auto loans, gold loans.

Advantages: Lower interest rates.

Disadvantages: Fear of losing the asset in case of default.
  1. Unsecured Loans

No collateral is required; approval is based on credit score and income.

Examples: Personal loans, credit cards, student loans.

Pros: No asset risk.

Cons: Higher interest rates.
  1. Personal Loans

Unsecured loans used for any personal need (wedding, travel, emergency).

Flexible use

Fixed EMIs
  1. Home Loans

Used to purchase or construct a house.

Long-term tenure (10–30 years)

Lower interest rates (secured)

  1. Auto Loans

To purchase vehicles such as cars or bikes.

Repayment in 1–7 years

Typically secured by the vehicle
  1. Education Loans

To finance higher studies.

Can pay for tuition, hostel, books

Typically has a moratorium period
  1. Business Loans

For expansion of business, purchase of equipment, or working capital.

May be secured or unsecured

Flexible repayment terms

  1. Payday Loans

Short, high-interest loans, normally until payday.

Instant access

Extremely high interest and charges

Features of a Loan

  1. Principal Amount

The initial amount borrowed.

  1. Interest Rate

The price of borrowing cash, stated as a percentage. Types:

Fixed – does not change.

Floating – varies with market conditions.

  1. Tenure (Loan Term)

Duration to pay the loan back – can be short (months) or long (years).

  1. EMI (Equated Monthly Installment)

Fixed amount paid monthly consisting of principal + interest.

  1. Collateral

Asset used as security in a secured loan.

  1. Processing Fees

Upfront charge for processing the loan application.

  1. Prepayment Option

Facility to repay the loan ahead of time, often with a charge.
How Do Loans Work?

  1. Application

You apply by filing documents such as proof of income, ID, bank statements.

  1. Evaluation

The lender verifies:

Credit score

Income

Debt-to-income ratio

Employment status
  1. Approval and Disbursal

If approved, the loan is sanctioned, and the amount is credited to your bank account.

  1. Repayment

You repay the loan in monthly EMIs, which consist of interest + principal.

  1. Closure

When all EMIs are repaid, the loan is “closed.” For secured loans, collateral is returned.
Conclusion

Loans can assist you in meeting large financial requirements without exhausting savings, but they need to be used carefully. Always compare interest rates, verify your repayment capacity, and read the terms before taking a loan.

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