- What are loans?
- Types of loans
- Important aspects of a loan
- EMI calculation
- Credit cards – a type of unsecured loans
- Personal loans – the most popular loans
- Credit score – an important aspect
- How does loan impact your credit score?
What are loans?
Loans are a source of funds which you can avail from financial institutions like banks and non-banking financial companies. The loan allows you a lump sum fund at a specific rate of interest which is fixed by the lender. Thereafter, you can choose the repayment tenure over which you can repay the loan in small and affordable instalments.
Types of loans
Banks and financial institutions offer a range of loans which can be availed for different financial needs. Loans can be broadly divided into two categories –
Secured loans are secured against an asset while unsecured loans are not. Unsecured loans are offered based on your financial status and secured loans are offered based on the value of the asset against which they are secured.
Some of the commonly available secured and unsecured loans include the following –
|Type of loan||Meaning|
|Personal loan||Unsecured multipurpose loan for financing various personal or commercial financial needs|
|Vehicle loan||Secured loan to buy a vehicle|
|Education loan||Secured loan to fund higher education|
|Consumer loan||Secured loan to finance the purchase of consumer durables|
|Home loan||Secured loan to purchase a home or a plot of land|
|Business loan||Secured or unsecured loan to meet the financial needs of a business|
Moreover, loans can be categorized as good loans or bad loans. Bad loans are those which have a high interest rate and severely impact your credit score in case of defaults. Good loans, on the other hand, are those which build up a good credit score and also offer tax benefits.
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Important aspects of a loan
Here are some of the main components of a loan which you should know about –
- Loan amount or principal
This is the amount of loan which you borrow from a lender.
EMI means Equated Monthly Instalment. This is the amount of money which is payable every month to repay the loan. The EMI consists of a part of the principal amount of the loan and the interest payable thereon. With each EMI paid the loan amount reduces.
- Repayment cycle
The loan that you avail should be paid back within a specified duration. This duration, over which the loan is repaid, is called the repayment cycle of the loan. The lender specifies the minimum and the maximum repayment tenure that is available for the loan. You, as a borrower, then, can choose the repayment cycle as per your affordability.
- Rate of interest
Rate of interest is the interest charged by the lender on the loan amount that you have availed. The interest is calculated on the outstanding balance of loan and the amount reduces after each EMI payment.
The EMI of the loan is calculated taking into consideration the principal, the rate of interest and the repayment cycle of the loan. Here’s how these factors impact the EMI –
- Principal – Higher the principal of the loan, higher would be the EMI
- Rate of interest – Higher the rate of interest, higher would be the EMI
- Repayment cycle – Longer the duration of the repayment cycle, lower would be the EMI
You can choose the principal and the repayment cycle but the rate of interest is determined by the lender. You can calculate the EMI before availing the loan to ensure that the EMIs are affordable and can be repaid easily.
Use our FREE EMI Calculators that will help you to calculate the EMI and it’s easy to understand.
Credit cards – a type of unsecured loans
Credit cards are quite popular among individuals for financial transactions. But did you know that credit cards are a type of personal loan?
Credit cards allow you to buy first and then pay later. There is a billing cycle and the entire transactions done within the cycle are payable within a due date. If you pay the entire outstanding amount within the due date, no interest is charged. However, if you don’t pay the amount or pay partially, interest is charged on the outstanding balance as well as on credit transactions done in the next billing cycle too.
Credit cards have high interest rates and can prove to be a bad loan if you don’t pay your bills on time. However, on the positive side, credit cards allow reward points and other benefits on your transactions. So, if you use a credit card wisely, it can prove to be a good tool.
Management of credit card debts
To ensure that credit cards give you the best benefits, you need to manage their usage. Let’s understand how –
The concept of MAD and revolving credit
Credit cards allow you a revolving credit facility wherein you can carry forward your outstanding credit card balance to the next subsequent months. For this revolving credit benefit, there is a limit of Minimum Amount Due (MAD). MAD signifies the minimum credit card due which you should pay in the current billing cycle to avail the revolving credit facility. Once the MAD is paid, the remaining credit card bill can be revolved to the next month.
Paying off MAD, though convenient, is not recommended. It is because the amount that you carry forward to the next cycle attracts interest. Since credit card interest rates are high, you tend to accumulate considerable interest expenses on the revolved credit. Moreover, if the credit is revolved, you also attract interest on the amount spent on the card in the next billing cycle from the first date of the cycle. This is also disadvantageous. Thus, you should not revolve your credit and pay the entire amount of your credit card debt within the due date.
To pay off your credit card debt, here are some tips which you can use –
- Using your income and/or your savings
- Converting the debt into affordable EMIs
- Availing a personal loan
- Using your investments
Personal loans – the most popular loans
Personal loans are quite popular among individuals as they are unsecured, easily available and allow funds for different uses. However, these loans have a high interest rate and affect the credit score adversely. So, here are the best practices and mistakes of availing a personal loan –
Read a complete guide on personal loan for salaried individual
Credit score – an important aspect
The credit score is a measure of your creditworthiness. It tells the lender how likely you are to repay a loan that you avail. The score ranges from 300 to 900 and the higher the score you have, the better would be the chances of getting a loan easily.
Your credit score is calculated by authorized credit bureaus like Equifax, CIBIL, etc. It is calculated taking into consideration the following factors –
- Repayment history – if you have no repayment defaults, the score would be high
- Credit mix – if you have a good mix of secured and unsecured loans, your score would be high
- Credit utilisation – the lower the credit that you have availed, the higher would be your score
- Credit history – if you have a good history of credit, your score would be high
How does loan impact your credit score?
The availability of loans solely depends on your credit score. The score tells the lender of your repayment risk and thus they consider the score before sanctioning the loan. Loans are usually allowed if you have a credit score of 600 or 650. For lower scores, loans are rejected. A score of 750-900 is the best score to get a loan easily.
Understand the loans available, how they work and how you can manage them to your advantage. Loans can prove to be a good source of funding your needs and if you manage them well you can avail and repay the loan easily. For a complete guide on management of debt, you can go through this financial planning course and get the complete knowledge on how to manage your liabilities to the best of your advantage.