Financial Institutions provide capital in the form of business loans to various entities. Loans can be broadly classified into the following:
- Unsecured Loans
- Secured Loans
When a financial institution asks for collateral to sanction a loan, it is known as a secured loan as the money offered is secured against an asset of equal or larger value. On the contrary, certain types of loans are offered without any collateral. Loans that are offered solely based on the credit-worthiness of the borrower and do not require any collateral are known as unsecured loans. Unsecured loans are riskier for lenders and hence are designed differently.
- Higher Interest Rate: Different lenders offer loans at different interest rates. Irrespective of the lender, unsecured loans are offered at a slightly higher rate than secured loans.
- Higher Credit Scores: The credit-worthiness of the borrower is the most important parameter for getting an unsecured loan. Lenders rely on the credit history of the borrower, so, one requires a relatively higher credit score to get an unsecured loan.
The acceptance of unsecured loans is on the rise in India. Financial institutions are tapping first-time borrowers with an aim to expand their loan books. As per a report by TransUnion CIBIL, credit cards and personal loans were two of the fastest-growing loan categories in the country in the second quarter of FY 21. One of the reasons for the growing popularity of unsecured loans is the variety of options available.
Types of unsecured loans
Revolving Loans: A revolving loan is a type of unsecured loan that offers borrowers an unsecured credit limit. The limit is the maximum amount a borrower can avail of at any given time. It is also the maximum capital that the borrower can withdraw over a specified time. The borrower is allowed to make partial or full repayment and borrow again within the tenure of the loan but the outstanding amount cannot exceed the credit limit.
Term Loans: Term loans are structured like traditional loans. Typically, term loans are offered at fixed interest rates and the repayment has to be done as per a pre-decided schedule. Term loans are ideal for long-term investments or purchase of fixed assets.
Consolidation Loans: A consolidation is a special category of unsecured loan. Any loan that is availed to pay back an existing unsecured loan is known as a consolidation loan.
Types of loans based on utilization
Revolving loans, term loans, and consolidation loans are broad categories. Unsecured loans can also be categorized based on the end-use of the capital.
Wedding Loan: A wedding loan is essentially a revolving loan that can help one take care of random expenses during a wedding.
Vacation Loan: Different types of unsecured loans are available to cater to various vacation-related expenses.
Home Renovation Loan: As the name suggests, a home renovation loan is availed for the modification in the look of your house. There are certain conditions for the utilization of the funds. Generally, the purchase of new appliances and furniture is not allowed through home renovation loans.
Top-up Loan: Any amount availed over and above a pre-existing loan is known as a top-up loan. Many borrowers seek additional amounts over an existing personal loan to take care of fresh needs. Lenders consolidate the additional amount with the pre-existing loan and the borrower has to pay a single EMI amount for both the borrowings instead of two installments every month.
Bridge Loan: These are extremely short-duration loans. Tenure of a bridge loan may extend up to 12 months only.
Agricultural Loan: One needs to make many investments during a crop cycle. From buying the seeds and pesticides to packaging and transportation of the agricultural produce, there are a variety of expenses.
Consumer Durable Loan: One of the most popular types of unsecured loans, consumer durable loans are used to fund the purchase of a new gadget or appliance.
Business Loans: Business loans come with varying tenures. Typically, a business loan is revolving credit with the borrower required to pay interest only on the utilized amount. Different lenders use different methods to provide capital to businesses. The dominant practice is to offer capital against outstanding invoices, also known as receivables financing.