In finance, a loan means a type of credit in which an agreed amount of money is lent to another party. The loan conditions like the interest rate, repayment period, other charges etc., are mutually agreed upon by the lender and borrower before the money is paid.
Broadly speaking, loans are of two kinds, personal loans and Business loans. It is a personal loan when you borrow money to purchase a home, a vehicle, or consumer durables. In addition, loans for educational purposes or to meet medical emergencies are also personal loans. On the other hand, a business loan is a credit facility to meet the financial requirements of a business, from the self-employed category to large corporations.
Banks, financial institutions, NBFCs and private financiers are the usual source of loans.
Types of Loans
Loans can be categorized into:
1. Secured and Unsecured Loans
Loans supported by some form of collateral, like the documents of ownership of an asset, are secured loans. The records remain in the lender’s custody until the repayment is complete. Mortgages, home and auto loans are typical examples.
Conversely, the borrower does not offer collateral security in an unsecured loan. However, lending agencies clear the loan only after a thorough credit-risk analysis of the borrower. Credit card purchases are unsecured loans.
2. Open-end and Closed-end Loans
You can borrow money up to a sanctioned credit limit in an open-ended loan without clearing the earlier amount. Credit Cards and Line of Credit are examples.
The borrower cannot draw an additional amount in closed-end loans until the earlier loan is repaid, like auto loans and mortgages.
Categories of Business Loans
Several loan products exist for a business, some specially designed for the MSME sector. Examples of Business loan types are:
A term loan is a commercial credit the lender provides to a borrower against specific terms. Usually taken by small or medium businesses, term loans have a predetermined loan period, interest rate and repayment terms.
Types of Term Loan
- Short-term: Typically, short term-loan have a payback period of one year to a maximum of two years.
- Intermediate or Mid-term: These loans usually run from one to three years.
- Long-term: Loans which last between three to twenty-five years.
Loan against POS
A loan against POS is an alternative credit option for small enterprises, mainly in the retail sector, using a POS device for receiving customer payments. The process operates as a merchant cash advance, where a lender, upon approval, offers an upfront payment. Then, the merchant borrower clears the loan through automated debits against their credit/debit card sales. The payback time is usually between 30 to 90 days.
Line of Credit Loan
A line of credit is an agreement between the lender and the borrower to provide a particular sum of money. The differentiating feature of this type of loan is that the borrower can withdraw funds as per requirements (up to the agreed limit) over some time. In addition, the interest applies to the amount borrowed and not the total sanctioned credit.
Vendor financing is lending money by a vendor of a particular business to that business itself. The business establishment employs the capital to buy the vendor’s products as part of the deal. Technically, vendor financing is a deferred loan and may also involve security in share transfer by the borrowing business to the vendor.
Today several fintech platforms/NBFCs have unique products tailor-made for a business. For example, the online lending platform, Flexiloans have value-added loan products to suit the specific needs of SMEs and other borrowers.