Individuals and businesses must have sufficient capital. A loan from a bank or a non-banking financial institution (NBFC) can provide capital. There are two types of loans: unsecured and secured.
A secured loan is a loan granted in exchange for an asset. As security for the loan’s non-payment, the financial institution holds the borrower’s asset. Banks also offer loans with no collateral. Unsecured loans (or collateral-free loans) are approved after considering various factors such as the borrower’s creditworthiness. Unsecured loans are riskier than secured loans from a lender’s point of view.
These are the two most important differences between secured and unsecured loans:
- Higher interest rates
Although the interest rate can vary from lender to lender and may be different, unsecured loans tend to have a higher interest rate than secured loans. Lenders are more likely to make unsecured loans. Higher interest rates can help offset the risk at a quicker pace.
- Higher credit scores
Lenders don’t ask for collateral when offering an unsecured loan. Instead, they collect as much information as possible about the creditworthiness and creditworthiness of the borrower. Many data points must be analyzed before an unsecured loan can be approved. Borrowers need to have a good credit score to get a loan. Although unsecured loans are available to those with poor credit scores, the interest rates can be significantly higher.
Types of unsecured loans based on tenure and repayment
Unsecured loans have seen a rise in demand due to the growing population and increased economic mobility. Unsecured loans are in high demand because of the variety of loans available. An unsecured loan can be used for education and marriage to farming and business.
They can be divided into three types:
This financial instrument allows borrowers to borrow money, repay it, and then withdraw the amount again. The revolving loan gives the borrower a credit limit and allows them to borrow as much as they need without exceeding that limit. This flexible loan can be used multiple times and is quick to repay.
A revolving loan of INR 15,000 is available to individual ABCs for two years. The amount outstanding to ABC must not exceed INR 15,000 during the two-year term. ABC can withdraw INR 1 lakh every day and pay INR 50,000 each month. After the repayment, she will be eligible for INR 50,000.
The borrower must repay the principal amount and the interest at the end of the term. This type of unsecured loan can meet working capital requirements or temporary cash needs. Borrowers don’t have to worry about fixed repayment dates. Revolving loans generally have variable interest rates.
Revolving loans offer borrowers the ability to make flexible payments. Term loans, on the other hand, are not flexible. Term loans are different types of loans. They have a fixed rate and a set term. Term loans are best for those who need funds to purchase fixed assets or long-term investments.
A lot of people accumulate loans due to the easy availability of finance. Consolidating loans are often used to repay existing loans. A consolidation loan is a loan that consolidates existing loans.
Types of Unsecured Loans based on Use
You can refine the categorization for unsecured loans based on the end-use.
Most people consider a wedding an important milestone in their lives. One’s savings can be strained if a child is married. A wedding loan can be used to cover wedding-related expenses.
As vacation loans, you can get a variety of loans. To finance your entire trip, a term loan is available. A revolving loan is better for expenses such as shopping and dining. You can also use a credit card to pay for vacation expenses.
A home renovation loan can improve the look of a house. A home renovation loan can be used to make various purchases and modifications. However, it is not permissible to purchase furniture or appliances.
Sometimes, borrowers need to borrow an additional amount on top of an existing loan. A top-up loan is a loan that provides additional funds. A top-up loan is where the borrower combines the existing and additional loans. The borrower pays one monthly installment instead of two.
Bridge loans are designed to meet short-term fund needs. Bridge loans are generally for less than one year.
Durable consumer loan
Gadgets and appliances are a necessity in today’s digital world. The purchase of appliances or gadgets can be made possible by a durable consumer loan. Although many lenders offer durable consumer loans, they also offer revolving credit. The buyer has the option to overuse the funds and repays them.
Lending to businesses
Lenders offer loans to help businesses finance infrastructure projects or meet working capital requirements. A business loan is similar to a revolving credit loan. Interest is only charged on the amount outstanding. While there are many ways to finance businesses, receivables funding is the most popular.
While some businesses depend entirely on cash sales, others must deal with lengthy credit cycles. How can a business run smoothly if it suddenly has to offer credit for many customers at once? It will require capital to function.
A business loan is another option. However, processing business loans can take time, and applicants may need collateral. Many businesses choose to finance trade receivables rather than a business loan.
Account receivables are the total amount a company owes for services and products but has not yet received payment. Trade receivables financing is when a lender uses the company’s account receivables to provide unsecured financing.
Two ways are available to obtain trade financing:
- Factoring is an internationally accepted method of financing trade receivables. Factoring companies can purchase the entire receivables account of businesses to raise capital. Factoring companies pay the business upfront and take over the trade receivables accounts. Along with the ownership of trade receivables, the risk of default shifts over to the financier.
- Invoice discounting: Unlike factoring, invoice discounting does not involve the company owning the trade receivables accounts. To provide funds for the business, the financier uses the account receivables to secure the loan. The disbursed amount is usually less than the outstanding balance of the account receivables.