Navigating the world of loans can be complex, especially with the numerous terms and concepts involved. Understanding these terms is crucial for making informed financial decisions. In this blog, we will explore various loan-related terms and their significance.
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1. Fixed Rate Loans
Fixed rate loans are loans where the interest rate remains constant throughout the entire duration of the loan. This enables the borrower to know the exact cost over the entire loan period. Fixed rate loans are beneficial when interest rates are low, allowing borrowers to lock in these rates.
2. Variable or Floating Rate Loans
Variable rate loans, also known as floating rate loans, have interest rates that change periodically based on a benchmark rate. This benchmark can be an external rate like the repo rate or an internal bank rate like the Marginal Cost of Lending Rate (MCLR). These loans are often preferred for long-term borrowing when borrowers expect interest rates to fall.
3. Home Equity Loan
A home equity loan, also known as a loan against property (LAP), uses the borrower’s home or other real estate as collateral. The loan amount is determined by the value of the property and the lender’s policies. These loans can be used for various purposes, such as home renovations, education, or medical expenses.
4. Hire Purchase
In a hire purchase agreement, the borrower agrees to buy an asset by paying installments over time. After an initial payment, the borrower makes regular installments and becomes the owner of the asset once all payments are made. This differs from a lease, where ownership remains with the lessor.
5. Lease
A lease is a contractual agreement where the owner (lessor) allows another person (lessee) to use an asset for a specified period in exchange for payments. Commonly leased assets include property, vehicles, and machinery. Unlike hire purchase, the lessee does not gain ownership of the asset at the end of the lease period.
6. Amortisation
Amortisation refers to the process of repaying a loan over time through regular, fixed payments, known as Equated Monthly Instalments (EMIs). Each EMI includes both interest and principal repayment. Initially, the interest component is higher, but it decreases over time as the principal repayment increases.
7. Refinancing
Refinancing a loan involves taking a new loan to repay an existing one, usually to extend the loan duration or reduce the interest cost. This is beneficial when the new loan has a lower interest rate, leading to overall savings. Refinancing is common for long-term loans like home loans.
8. Prepayment
Prepayment allows borrowers to repay their loan partially or fully before the scheduled time. This reduces the outstanding principal and can shorten the loan tenure. Some loans may have restrictions or penalties for prepayment, but the RBI has mandated no prepayment charges for home loans from banks.
9. Pre EMI Interest
Pre EMI interest refers to the interest payments made before the full loan disbursement. This is common for home loans on under-construction properties, where the borrower pays only the interest until the full loan amount is disbursed and the regular EMI schedule begins.
10. Moratorium
A moratorium is a temporary suspension of loan repayments due to extraordinary circumstances, such as a crisis or war. During the moratorium, missed EMIs are not considered defaults, and the borrower’s credit score is unaffected. However, interest continues to accrue, and the missed EMIs are added to the loan tenure.
11. Mortgage
A mortgage is a loan secured by real estate property. The borrower uses the property as collateral and repays the loan over a specified period. Mortgages allow individuals to purchase property without paying the full amount upfront.
12. Pledge
A pledge is a security arrangement where an asset is held by the lender until the loan is repaid. The asset, usually movable, can be sold by the lender if the borrower defaults. This is different from a mortgage, which involves immovable assets.
13. Hypothecation
Hypothecation creates a charge against an asset while the asset remains with the borrower. In case of default, the lender must take possession of the asset before selling it. A common example is a car loan, where the car remains with the borrower but can be repossessed by the lender if necessary.
Conclusion
Understanding these loan-related terms can help you navigate the complexities of borrowing and make informed financial decisions. Whether you are looking to buy a home, finance a business, or manage personal expenses, knowing these terms and their implications is crucial. Always consider the terms, interest rates, and repayment schedules to choose the best loan for your needs.
