Your Easy Guide to Understanding Loan Repayment & Its Methods
The first step to obtaining a loan is to research and gather essential information about loans. So, if you are here to know more about the process of loan repayment and its methods because you or someone you know is considering applying for a loan – welcome! You have taken the first step in the right direction. Getting the requisite information beforehand enables borrowers to assess their options and build their applications to ensure approval. Here is a detailed view of loans, their repayment process, and the different methods of loan repayment that you can choose –
What is a Loan?
A loan is a debt an individual or organisation borrows from a lender, bank, or financial institution. The debt is repaid over a predefined period, with interest. You can take a loan for a specific purpose, such as buying a house or car or paying for higher education. Some other loans allow the borrower to use the funds for general expenses at their discretion, such as personal loans and credit cards.
Salaried individuals may find personal loans for employees suitable for their needs. These unsecured loans can support large expenditures like wedding parties, home renovations, and overseas trips. For small business owners, personal loans for the self-employed are a better choice. These loans are also unsecured and can be used to finance business or personal expenses.
What is Loan Repayment?
As the name suggests, loan repayment refers to repaying the loan amount to your lender. It involves making periodic payments towards the principal amount and loan interest. Usually, when you avail of a loan, the lender or bank will allow a grace period. After the grace period is completed, the borrower is required to start the repayment in instalments. The amount of the instalments and the repayment schedule is decided at the beginning of the loan tenure.
How Does Loan Repayment Work?
Lenders, banks, and financial institutions strive to make the loan repayment process as simple and convenient as possible for their customers. Loan repayment instalments are decided at the start of the loan tenure. Each equated monthly instalment, or EMI, comprises principal and interest. The borrower must pay the monthly instalment on a fixed date every month until the loan amount is repaid in full.
In the initial years, the EMI has a more significant component towards interest and a smaller principal amount. As the tenure progresses, the EMI composition changes to have a larger part dedicated to principal repayment and a smaller one for interest.
Different Types of Loan Repayment
There are different types of loan repayment methods based on the type of loan you avail. Here’s a look at some of the most common ways –
- Equated Monthly Instalment (EMI) – As the name suggests, EMIs are monthly instalments that must be paid to the lender over the loan tenure in lieu of the loan amount and interest. Your lender may give you the following options in combination with the EMI –
- Part Prepayment Facility – If you have some extra cash and wish to pay more than your fixed EMI amount, it is known as a part prepayment. The additional payment is treated as a repayment towards the outstanding principal amount of your loan.
- Foreclosure – It is known as a loan foreclosure if you wish to repay your loan in one payment before the set due date. A personal loan usually has a one-year lock-in term, after which you may foreclose your loan by paying the outstanding principal amount.
- Variable Payments – The monthly payment fluctuates based on the interest rate and income variations in this method. Usually, borrowers choose variable monthly payments in adjustable-rate mortgages.
- Graduated Payments – When the monthly instalments for loan repayment increase over time, it is known as graduated payments. Typically, graduated payments are used to repay student loans.
- Bullet Payment – In this method, you only pay monthly instalments towards the interest amount, and in the end, you pay the entire principal amount in one bullet payment.
- Interest-Only Payments – You can pay interest-only payments for a specific period during your loan tenure while the principal amount remains unchanged.
Loan repayment is the first thing borrowers should consider. Before applying for a loan, find out your credit score, estimate the loan amount, calculate your EMI, and try to determine how much you will need to spend in a month to repay your loan. It will enable you to understand the affordability of your loan. Once you understand your mode of repayment options, choose the most suitable loan according to your income and expenses.