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What is a Loan?

Any lending of money by a person or an organization to the recipient (borrower) in exchange for future repayments of the loan value (principal amount) along with interest charges. Typically, a loan has a fixed term but flexible term loans are also available. [1]

Loans

Factors our recommendation engine looks for selecting right loan product for you

There are multiple criteria in our proprietary algorithm that we look at even before recommending any financial product. For example, your demographic, geographic, bureau data, etc as explained here.

For loan recommendation, we majorly focus on 5 factors for our customers, which are:

1. Interest Rates – This is the actual cost of borrowing money and it directly affects your EMIs. There is a large spectrum of loan types offered at different rates by banks. Your loan repayment is highly dependent on the interest rate charged. Recently, a majority of banks have started giving loans with floating interest rates. On these, loans your payable interest is calculated by adding a credit spread over a reference rate. Otherwise, fixed interest rate loans are also available. 

In a decreasing interest rate environment, it is advised to apply for a floating rate loan as the loan will be cheaper when the reference interest rate goes down. Consequentially, in an increasing interest rate environment, applying for a loan with a fixed interest rate would prove to be beneficial. However, it is difficult to estimate whether the interest rates would increase or decrease. 

2. Prepayment charges – these are charges or penalties which have to be paid by you (the borrower) when the loan is repaid earlier than the loan tenure or term. This factor is important as you will have to pay this charge when you would like to close your loan early or refinance your existing loan because you are getting a cheaper loan from some other source. 

3. Processing Fees – These are one-time fees charged for your loan approval. Processing fees are non-refundable in case of loan rejection. However, processing fees are typically charged on high loan amounts like Home loans, etc. This fee varies for different banks. 

4. Late Payment Charges – As the name suggests, these charges are levied when you (the borrower) are unable to pay EMIs on time. There are explicit and implicit costs attached to late payment. The explicit component is the extra charge you pay in case of delay and the implicit component is that your inability to pay on time is reported to credit bureaus. 

5. Mis-selling of complementary products – When you apply for a loan, generally bank employees claim that some sort of insurance or credit card is necessary for loan approval. They try to mis-sell their other products to customers to meet their sales targets. 

Our mandate is to recommend a loan where you pay the least amount of total effective costs. After, get some insight about your financing needs and re-evaluating them with respect to the above-mentioned factors, we will suggest the best sort of loan that is suitable for you.  

Why does a lender lend money?

Any lender lends money for the interest they charge on the principal or loan amount. This provides incentive for the lender. 

What is the Repayment capacity?

It is a measure for assessing the borrower’s ability to repay a loan by comparing income to monthly debt repayments or EMI. The Debt-to-income (DTI) ratio of the borrower is how the Lender estimates their repaying capacity. 

 

It is calculated by adding all monthly debt payments and divided by the total gross monthly income of the borrower. The lower the ratio the better it is for loan approval. Generally, lenders prefer a DTI of 35% or less before approving any loans.

How does a loan work?

In a formal loan, a contract is signed between both parties (lender and borrower), which states all the terms and conditions of the loan. Generally, loan terms and conditions like principal amount, the interest charged, installment details and repayment dates are all mentioned in the contract. If the lender requires collateral, then this will be outlined in the loan documents. [1]

Categories of Loans

Secured vs Unsecured loan

Secured loan:

It is a type of loan where a collateral is pledged to reduce the risk of default associated with lending which the lender bares. If the borrower defaults (i.e. the borrower is unable to repay the loan principal and interest on time) then the lender seizes the ownership, sells the asset to pay back the debt. [2]

For example, home loans or car loans are backed or secured by collateral. In case of no repayment, the lender can take-over the asset which backs the loan. 

Unsecured loan:

A loan that is not backed by an asset or collateral. If the borrower defaults, then the lender might not be able to recover the debt. [3]

For example, credit cards, unsecured personal loans are not backed by a particular asset.

Unsecured loans are considered riskier as compared to secured loans. The interest rate charged on unsecured loans is always higher than secured loans, all else being equal. [3]

Revolving vs Term Loans

Revolving loans or credit

It is a line of credit where the customer or borrower pays a commitment fee to a bank or line of the credit provider to borrow money whenever it is needed. The mainly utilized for operating expenses and the amount withdrawn changes depending upon the borrower’s cash flow needs. [4]

Term Loans:

It is a loan for a specific amount that has a stated repayment schedule. Generally, it has a fixed interest rate and a fixed maturity date. These types of loans require collateral and are approved after a thorough approval process. [5] Based on the life-span of loan they are divided into 3 types which are as follows:

  1. A short-term loan – usually runs less than a year. 
  2. An intermediate-term loan – ranges from 1 year to 3 years.
  3. A long-term loan – ranges from 3 years to 25 years.

Types of loans:

Home loan:

Is a loan given to a borrower to purchase a house or residence? The homeowner (borrower) transfers the title of the house to the lender on the condition that it is transferred back to the owner once all loan installments are meet per under mortgage/loan terms and conditions.  

Auto loan:

It is a loan where the borrower’s automobile is used as collateral. The title of the collateral is transferred to the lender for the duration of the loan, and upon repayment, it is transferred back. 

Education loan:

A borrowing which is undertaken to finance school or other education-related expenses. Education loans can either be secured or unsecured. 

Secured Personal loan:

A type of loan where the borrower gets a lump sum amount to be used at his/her discretion. These are secured with some collateral and are offered at lower interest rates relative to unsecured personal loans (all else being equal).

Unsecured Personal loan:

A sort of borrowing where the lender lends money to the borrower without any collateral to be used completely at their discretion. These unsecured loans are offered at higher interest rates relative to secured personal loans (all else being equal).

Loan against property:

A loan given to a borrower where the mortgage is secured by property as collateral. However, the proceeds from these loans can be used to finance anything, unlike Home Loans. 

Consumer durable:

A loan given to a borrower for the purchase of consumer durable products. These loans are generally short-term and are offered at low-interest rates. 

Payday loan:

A short-term borrowing where the lender gives money based on borrower’s income and creditworthiness. These provide short-term immediate credit and can be thought of as a cash advance loan on your salary.