Requirement for money may arise at any time. One may need money for starting a business, purchasing a vehicle, or building a house. If one has the required amount in his or her hand then the needs can be met. However if one does not have the requisite amount, one can opt for a loan.
What is a loan?
The term refers to the process of lending of money to someone on the stipulation that it will be repaid within an agreed time period. They are extended to meet short term money requirements while the payback time may vary depending on the amount borrowed, the agreement reached etc. Loans can be extended by banks, non banking financial institutions and individuals.
The rate of interest is the additional amount that a borrower has to pay to the lender over the principal amount. It is a factor that varies with market conditions, state of the economy, demand for money etc. This rate is often a percentage of the principal amount.
Not everyone can take a loan as most lenders do a check on your financial status before approving a loan. If you have maintained a good credit together and have a regular job, you could be eligible for a loan with a small down payment of 4 percent (in case of big loans). If you are married and if your spouse is also employed, you will be able to secure a loan easily. The amount provided as loan is referred to as the principal.
Loans taken from institutions come with a processing fee which has to be paid at the time the loan is released. Loans can extend anywhere from 1 year to 30 years. It should be understood that if the repayment period is more, then one may end up paying more than the principal amount in interest. Thus generally the period of repayment is also important as longer time means more payment sometimes upto 3-4 times more than the principal amount.
Types of Loans
Based on the nature of the borrower, following are the various types:
Personal loan: these loans are provided to cover expenditure incurred by an individual. This loan is often used for meeting expenses for purchasing vehicles, electronic equipment, education, building\refurbishing home and for travel.
Corporate Loans: these refer to the money extended to small business or institutions for meeting their financial needs. These often have higher rate of interest and the time for repayment may also be quite less as compared to personal loans.
Agriculture Loans: are provided to farmers and institutions engaged in agriculture related activities. These loans are often subsidized by the government and are provided on easy terms including very low or no rate of interest, no collateral and longer repayment periods.
Country Loans: money borrowed by governments for financing various schemes like improving infrastructure etc. Money is borrowed from international institutions like the World Bank or the International Monetary Fund.
Based on the type of rates:
Fixed rate: this is a repayment option in which the rate of interest payable remains fixed til
l the end of the term of repayment. This means that the rate of interest will not be altered even if there is an economic boom or there is recession and there is demand for money in the market. This is the best option if one is considering repayment in the long term. In order to derive the full benefit of this, one will have to go in for loans when the interest rates are low or wait for such a time. There are some variants of this in the market through which, one can repay at a fixed rate for upto 7 years and then pay the reminder at floating rates.
Floating rates: if one wants to repay the loan in a short period of time, it is advisable to go in for the floating rate or adjustable rate Loans. The rates charged under this option are decided by market forces, state of the economy, strength of the currency etc. The benefit of this option is that initially, lower interest rates are charged when compared to fixed rate loans. This means that the entry load is quite low and this may be attractive for people who want to borrow for short term. However, with the passage of time, these initial low rates are replaced by higher or lower rates depending on the market. In the long run, when one counts inflation, it becomes clear that the interest rates will go up in the future. Some lenders put a ceiling on the amount of variations both up and down so that the final figure remains in reasonable territory.
Mixed type: this is a combination of the two previously mentioned options. The lender gives the borrower an option for repaying the loan for a specified period of time at variable rates and then at a fixed rate.
Sometimes the lender may ask the borrower to provide collateral as a measure for security. Collateral is often a property owned by the borrower. In case one does not have sound financial background, this becomes all the more important and the lender may not oblige unless collateral is provided.
In the market, at any given time, there will be thousands of schemes and rates and it becomes quite difficult to make a decision. This quagmire however should not worry the inquiring and investigative customer who can analyze the options and decide on what’s best for him. However for those who are not so much gifted and do not have the time needed, a broker can do this service for you. He will guide you through the diverse portfolio of schemes and help you in making a sound financial decision by understanding your needs and short and long term plans. Brokers will however charge you for their services. The rates charged may be independent of the final loan amount or may be a percent of the same.
Before opting for a loan, one must clear about the repayment conditions. The period of repayment and the annual load that this may add to your finances are to be considered here. Going by the book, your annual repayment obligation for the loan should not be more than 27 per cent of your gross income. It is also essential that one should also set aside around 2 per cent the gross income to cover unexpected costs. This ensures that under all circumstances you will be able to repay the loan and the chance of a default will not arise.