What is a Loan?
A loan, in simple terms, is a specified amount of money borrowed with an agreement to return it within a defined period of time.
- Banks act as lenders.
- Banks charge a certain rate of interest on the borrowed money.
- The borrower repays the amount along with the interest in installments, as per the agreement with the bank.
- Loan = Specific amount of money + Assurance of return + Specified interest
Essentially, a loan is a sum provided by one party to another for a certain duration, with interest. This interest serves as the profit for the lender.
Types of Loans
There are primarily two types of loans:
- Secured Loan
- Unsecured Loan
Secured Loans
Secured loans are those that require a collateral.
- Collateral: An asset that you provide to the lender as security.
- The bank requires something to be pledged as a guarantee.
- If the borrower fails to repay, the bank can recover the amount by selling the pledged asset.
- Example:
- Rate of interest in secured loans is comparatively lower than in unsecured loans. This is because the bank’s risk is reduced due to the collateral. The bank can be more confident in lending because it holds an asset that can be sold to recover the funds if the borrower defaults.
Types of Secured Loans
Secured loans can be further categorized, including:
- Mortgage
- Hypothecation
- Pledge
Let’s explore these in detail.
Mortgage
When a customer pledges an immovable property against a loan as collateral, it’s a mortgage.
- Immovable property examples:
Hypothecation
When a customer pledges a movable property against a loan as collateral, it’s hypothecation.
- Movable Property: Property that can be moved.
- The borrower retains possession of the asset.
Pledge
When a customer pledges a movable property against a loan as collateral, it’s a pledge.
- Movable Property: Property that can be moved.
- The borrower gives possession of the asset to the bank.
| Type | Property Type | Possession with |
| Mortgage | Immovable | Bank |
| Hypothecation | Movable | Borrower |
| Pledge | Movable | Bank |
Types of Secured Loans
There are three main types of secured loans:
- mortgages
- hypothecation
- pledge
Mortgages
A mortgage involves borrowing money against immovable property such as land, a home, or a store.
- Mortgage: Taking a loan by pledging immovable property like land, house, or shop.
- Home Loan: You’re buying a house, and the house itself acts as collateral. If you can’t repay the loan, the bank sells the house to recover the money.
- Loan Against Property: Taking a loan for any purpose (business, etc.) by pledging existing property (land, building) as security.
In both cases, the loan is secured by the property.
Hypothecation
Hypothecation involves taking a loan against a movable property (typically a vehicle), but the borrower retains possession of the asset.
- Hypothecation: Taking a loan by pledging movable property, but without handing it over to the bank.
- When taking a vehicle loan, the car is hypothecated to the bank. You keep using the car, but the bank has the right to seize and sell it if you default on the loan.
Pledge
A pledge involves handing over movable assets, such as gold, to the bank as collateral for a loan.
- Pledge: Taking a loan by pledging movable property and handing it over to the bank.
- When you take a gold loan, you physically give the gold to the bank. They hold it until you repay the loan.
Summary Table
| Loan Type | Collateral Type | Possession of Collateral | Example |
| Mortgage | Immovable (land, house) | Borrower | Home loan |
| Hypothecation | Movable (vehicle) | Borrower | Vehicle loan |
| Pledge | Movable (gold, jewelry) | Bank | Gold loan |
Home Loans Explained
A home loan is used to borrow money from banks, and falls under the category of a secured loan. The loan is given against the house a person wants to buy or build.
- Home loans typically have lower interest rates compared to unsecured loans. If the borrower defaults, the bank can sell the house to recover its funds.
Loan Against Property Explained
Loan against property is a secured loan where a borrower provides residential, commercial, or industrial property as collateral to get funds. This is used for any reason, not just for buying property.
Gold Loans Explained
With gold loans, gold jewelry or biscuits are used as collateral. This is a secured loan because the gold is pledged to the bank (falls under pledge category).
Vehicle Loans Explained
A vehicle loan is a secured loan that allows you to purchase a vehicle. The vehicle itself acts as a security for the loan. If the customer fails to repay the loan, the bank can take possession of the vehicle and sell it to recover the outstanding amount. This falls under the category of hypothecation.
Secured vs. Unsecured Loans
Let’s dive into the world of loans, focusing on the difference between secured and unsecured loans from a bank’s perspective.
Secured Loans
- Definition: Loans that are secured are a lower risk for banks.
- Secured loans mean that the bank has some form of collateral. If the borrower fails to repay the loan, the bank can seize and sell the asset to recover the funds.
Unsecured Loans
- Definition: Loans that do not require any collateral.
- Because there’s no collateral, the bank is taking on more risk. If the borrower defaults, the bank has no asset to seize and must rely on other means to recover the funds.
- Requirements: To offset the risk, banks usually require the borrower to have a good credit score and credit history.
- Interest Rates: Unsecured loans typically have higher interest rates compared to secured loans.
Types of Unsecured Loans
Here are some common types of unsecured loans:
- Personal Loans
- Short-Term Business Loans
- Education Loans
Personal Loans
- Definition: Loans taken for personal needs or requirements.
- Common Uses:
- Requirements:
- Credit Cards: Credit cards are also a form of an unsecured loan.
Short-Term Business Loans
- Definition: Loans that help meet daily expenses in a business.
- Typical Borrowers:
- Common Uses:
- Key Point: Short-term business loans are unsecured.
Education Loans
- Definition: Loans taken for educational purposes, especially higher education.
- Coverage: Education loans typically cover tuition fees, accommodation, and other educational expenses.
- Loan Types:
- Assessment Criteria:
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