Organisations around the world function on the basis of funds and credit. Businesses must ensure that expenses of all the materials needed for production, as well as the administrative and operating costs, are met on time. But that is not all that the funding is used for. Companies need money to keep investing in their products or services to make them better than those of their competitors.
People need money to meet a wide range of needs and to go about their business with minimal interruptions. But no business or person has access to a large supply of money on demand. This gap in funding can be bridged by loans and advances.
What is a loan?
A loan is a form of debt financing in which one party (the lender, who is generally a financial institution or a bank) lends money to another party (the borrower), who is then obligated to pay back the loan plus interest. The borrower may or may not be required to put up collateral when applying for a loan, depending on whether the loan is secured or unsecured.
The interest rate, fees, and repayment tenure of the loan can vary from one lender to the next and even from loan to loan. A loan can be used to pay for everything from a car to home renovation expenses to higher education to running a business.
What is an advance?
Advances are a form of funding that lenders give to businesses to cover their short-term needs. The central bank (RBI in India) and the institution lending the money make the decisions about the terms of the advances.
The various kinds of advances include:
Short-term loan: The full amount is disbursed to the borrower at once in this type of loan. The tenure of payback is typically shorter, and hence this loan type is used by businesses to cover their operating expenses.
Overdraft: An overdraft is a bank service that lets a customer take out more money than they have in the account, up to a certain limit.
Bill purchase: Loans given by the bank in exchange for securing the bills/ invoices to be paid to you are known as bills purchase.
Cash credit: This is a feature offered by the bank that allows customers advance funds up to the value of a pledged asset.
What is the difference between loans and advances?
Both individuals and businesses frequently use loans and advances as financial instruments to get funding. While both can be used to access money, loans and advances differ in several significant ways. These are four points of difference between loans and advances:
- Loan amount:
When a corporation or an individual makes a loan application, it is usually for a considerable sum of money. This can be used to set up commercial operations, buy inventory, or put money into research & development. When people take out loans, for example, a personal loan, they usually use the money for expensive things like renovating their home, paying for higher education, or planning a wedding.
On the other hand, advances given to individuals or businesses are for much smaller amounts and are used to meet immediate or short-term financial goals.
- Repayment duration:
Personal loans, car loans, education loans, and home loans all have longer repayment terms. A personal loan may have a maximum term of 8 years, whereas a home loan could have a maximum term of 30 years. Equated monthly instalments (EMIs) are the preferred method of repayment during the loan's specified tenure.
Advances have much shorter periods for paying them back, usually between 3 months and a year at most. The agreement between the lender and the borrower will determine the terms of repayment.
- Interest rates:
Financial institutions charge interest on loans, which is added to the principal when the loan is paid back. The interest component is proportionately spread across the repayment tenure and is calculated based on the principal amount borrowed. The purpose of the fee is to cover the risk of approving the funds and the value of money over time.
Advances, on the other hand, are usually paid back in less than a year, and the interest is usually not very high. Hence, both the risk and the financial worth are substantially lower.
- Collateral requirements:
Financial institutions may request a collateral deposit at the time of loan acceptance if the amount of the loan is substantial. This serves as a form of security that can be taken by the bank or NBFC if the borrower fails to make loan repayments for a specified period of time. Land, property, gold, fixed deposits, certain types of shares, and other items can be used as collateral.
When it comes to advances, you usually do not have to put up anything as security. Lenders may sometimes ask for a fixed deposit or a guarantee as the main security.
It is important for the person taking out a loan or an advance to know how each one works and what the main pros and cons are. Therefore, you should be very selective in the organisation you choose to collaborate with on this venture.
Bajaj Finserv Personal Loan could be the best option for all your personal loan needs. You can get a loan of up to Rs. 40 lakh with a flexible repayment period of up to 96 months. With the help of a personal loan EMI calculator, you can also figure out how much your monthly payments will be. This will help you make a good plan for your money and let you pay back the loan on time.