Types of Loans in India Provided by the Bank
Types of Loans in India provided by the Bank and what is loans are discussed in this article. Before we go there, here is some intro about loans.
What is Loan?
A loan is money taken by a person or company from any bank or financial institution to fulfill their personal needs, in which case they repay that money with some interest to that bank or financial institution. It is called a loan.
Examples of loans: personal loans, house loans, vehicle loans, education loans, etc.
|Types of Loans in India provided by the Bank|
Types of Loans in India provided by the Bank
We will categorize loans in two ways, allowing us to determine the types of loans provided by the banks.
- Fund Based: Fund-based loan is exactly the loans where transaction of the amount is involved.
- Non-Fund Based: Non-Fund Based loans in which banks only give guarantees and no exact involvement of money is there.
1. Fund Based Loans
Fund-based loans can be further classified as
- Term Loan
- Working Capital Loan
- Cash Credit
- Over Draft
Let's see one by one what all these types of Loans in India provided by the Bank specify and what they mean.
1. Term Loan
- These are the loans that come with a longer repayment period and a set payment schedule. These loans are fund-based, and exactly the fund is given to the borrower by the lender.
- Normally, these loans are extended for 3 years to 20 years.
- Since the duration involved is long, the risk for the bank is on the higher side in terms of default made by the borrower.
- Interest is charged on a fixed or floating basis.
- A fixed basis is where the interest rate is fixed by the bank, and a floating basis is where the interest will vary according to the banking base rate in the market.
- Examples of some term loans are housing loans, vehicle loans, personal loans, and business term loans.
Let us now look at some of the other types of Loans in India provided by the Bank.
2. Working Capital Loan
- Working capital loans are fund-based, and the funds are provided to the borrower by the lender.
- A Working Capital Loan is a fund granted to companies to meet their operational requirements for business activity.
- Some of the factors influencing the working capital requirement of a business are the nature of the business, production process, conversion rate, working capital cycle, etc.
- Before providing a working capital loan, the bank uses access to determine whether there is a requirement for a working capital loan in the business or not. It depends on various factors like the nature of the business, the production process, whether it is on an order basis or a sales forecast basis, conversion basis, and how quickly the business can convert the raw material back into cash after moving through the whole working capital cycle.
- Working capital loans are for short durations and are also referred to as short-term loans.
- Working capital is required for various purposes, like payment of wages, purchase of raw materials, overhead expenses, etc.
- As we mentioned above, day-to-day activities involved in any particular business could be about the payment of wages to the workers or laborers, the purchase of any raw material which is involved in the production process, or paying the overhead expenses like electricity bills, rent, and any other kind of bill which is used in the company.
3. Cash Credit
- Cash credit is a fund-based facility offered by banks to businesses based on their working capital cycle.
- This is also a type of working capital loan given to a business that lacks operational funds.
- Cash credits are generally allowed against pledges or hypothecations of inventory. receivables, etc. An example of cash credit is a secured loan.
- It was obvious that the bank would provide a loan against the security, which could be in the form of a pledge or hypothecation of inventory.
- A pledge or hypothecation of inventory occurs when a company uses its inventory or receivables as collateral for a loan.
- The limit extended is generally a percentage of collateralized security value (normally it's 65% to 75%).
- Security/collateral value in terms of short-term assets like inventory, stocks, and receivables. The business is keeping with the bank to get the loan amount, so the limit would be extended as the percentage of that, which would be about 65% to 75%, and the rest of the business owner would have to be by himself, which is called the margin required.
- A cash credit account is opened with no limits on the transaction, so whenever you take cash credit, which is a fund-based loan, a separate cash credit account would be opened by the bank that has no limit on the transaction. This is because business day-to-day operational activities will involve a lot of transactions, so it is provided with limitless transactions where business could be involved.
- The short-term loan is generally for up to 1 year, so we already mentioned above that cash credit is a short-term loan.
4. Over Draft
- Overdraft services are available to individuals and businesses who have a current account with a bank.
- An overdraft is a fund-based facility allowed to individuals or businesses running current accounts where they are allowed to withdraw the limit of the account balance.
- Overdrafts could be classified as secured or unsecured. Secured overdrafts are secured against securities such as fixed deposits, mutual funds, LIC policies, shares, and debentures.
- Unsecured overdrafts are facilitated based on net worth and credit history, which is called a credit score.
- The interest rate charged on unsecured overdrafts is higher as compared to secured overdrafts.
2. Non-Fund Based Loans
- Bank Guarantee
- Letter of Credit
- Deferred Payment Guarantee
1. Bank Guarantee
- Due to the lack of sufficient funds to make immediate payment to the seller, the buyer requests a bank guarantee. Bank would serve as a link of trust between both seller and buyer.
- Bank issue guarantee on behalf of the customer in favor of seller to pay the guarantee sum of money in the event of default by the customers. The seller would deliver the goods on receiving the bank guarantee.
- Banks assess the financial viability and credit history of customers before issuing such guarantees in favor of a third party.
- Bank guarantees are given against collateral such as fixed deposits, shares, mutual funds units, etc.
2. Letter of Credit
- LCs are assurance given by the bank to the seller of goods that on the due date he will receive the payment.
- It is a kind of guarantee or assurance which is being given by the bank to the seller.
- The buyer applies for LC where it already holds the line of credit (account).
- The bank issuing LCs hold payment on behalf of the buyer until it receives confirmation of goods being shipped.
- After shipment, the bank pays the due amount as per the contract of sales.
- LCs are generally used in international trade.
3. Deferred Payment Guarantee
- The Deferred Payment Guarantee is a non-fund-based facility.
- It is a guarantee given by the bank to the seller for a payment, usually in installments, which has been deferred or postponed by the buyer.
- A Deferred Payment Guarantee is issued by the bank at the request of the customer when he purchases capital goods from a creditor on the terms of payment after a specified time.
- It is the guarantee that the buyer takes that he will make the payment to the seller, but after a specified period, because for some reason, the transaction has been postponed, the project is not completed, or the buyer does not have sufficient funds to make the payment.
If you are thinking of taking a loan, then, first of all, understand your needs, how much a loan is required for you and your company, and which loan is best for you. Read this article very carefully. We discussed all the types of Loans in India provided by the Bank and how to use these loans for you and your business. If you have any questions or suggestions related to loans and the types of loans, please comment below. We will definitely reply as soon as possible.
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