Difference Between Loans and Advances
Loans and advances are two common types of credit provided by financial institutions such as banks, credit unions, and other lending institutions. While these terms are often used interchangeably, the two have some important differences. Let’s explore the topic further to know the definitions of loans and advances and the major differences between them
A loan is a financial product offered by banks and other financial institutions to individuals and businesses, assisting them in their personal and professional journeys which require financial assistance. Simply put, banks provide a lump sum to pursue education, buy a vehicle or house, start or expand a business, etc. The borrowers repay it in easy monthly instalments, popularly called EMIs, which include both principal and interest, in a certain period of time, called repayment tenure.
However, not everyone having the desire to buy or start something is eligible for a loan. Every bank or financial institution has a list of parameters to decide the eligibility of an individual or a business to avail of a loan. Based on the creditworthiness of the borrower, their income and financial history, and other factors, the bank will decide the loan amount, interest rate and repayment tenure.
Advances are a type of credit usually granted to meet short-term funding requirements. Advances may be granted to businesses, individuals, or organisations for various reasons, including working capital, inventory financing, or to cover temporary cash flow shortages. Advances can take many forms and may be used for various purposes, such as working capital, inventory financing, or to cover temporary cash flow shortages.
Various financial institutions can grant advances, including banks, credit unions, and other lending institutions. They are often granted based on the borrower’s creditworthiness and ability to repay the advance within a short period.
Difference Between Loans and Advances
Purpose: Loans are typically granted for long-term requirements, whereas advances are to cover short-term cash flow needs. Loans may be restricted to specific purposes, such as home loans or car loans, while advances may be granted for a broader range of purposes.
Repayment Period: One of the key differences between loans and advances is the repayment terms. Loans are typically repaid over a longer period of time, often several years, while advances are generally repaid over a much shorter period, often just a few months.
Interest Rates: Loans typically have lower interest rates than advances, as they are seen as less risky and have a longer repayment period. On the other hand, advances are often granted at higher interest rates, as they are seen as riskier due to their shorter repayment period.
Collateral: Loans may require collateral, such as a house or a car, to secure the loan. Advances may not require collateral but may require a personal guarantee or other forms of security.
Disbursement: Loans are usually disbursed in a lump sum at the beginning of the loan term, while advances may be disbursed in multiple instalments as needed.
Flexibility: Advances may be more flexible than loans in terms of repayment terms, interest rates, and other conditions. For example, advances may have a more flexible repayment schedule that can be adjusted based on the borrower’s cash flow needs.
Application process: Loans may have a more rigorous application process than advances, as they often require more documentation and a more detailed review of the borrower’s financial situation.
Creditworthiness: Loans are often granted based on the applicant’s creditworthiness and ability to repay it over time, while advances may be granted based on the borrower’s current financial situation and short-term cash flow needs.
Types of Loans
Individuals and businesses can obtain several types of loans from banks and other financial institutions. Some of the most common types include:
Personal Loans: These are unsecured loans that individuals can obtain for personal use, such as to pay for a wedding, a vacation, or to consolidate debt.
Home Loans: These loans are used to purchase a home or other real estate. They are secured by the property itself and typically have a long repayment period.
Business Loans: These loans are used by businesses to finance their operations, purchase equipment, or expand their operations. They can be secured or unsecured and have various repayment periods.
Auto Loans: These loans are used to purchase a car or other vehicle. They can be secured or unsecured and have varying repayment periods.
Student Loans: These loans are used to pay for education expenses. They typically have a long repayment period.
Types of Advances:
There are several types of advances that banks and financial institutions offer to their customers, including:
Cash credit: This is a type of short-term loan facility that is extended to businesses to meet their working capital needs. The borrower can withdraw funds as per their requirement within the sanctioned limit.
Overdraft: This is a facility the bank provides to its customers where they can withdraw more money than the balance in their account up to a certain limit. The interest is charged only on the amount utilised, and the borrower has to repay the amount within a specified period.
Demand loan: This type of loan is payable on demand by the bank. It is a short-term loan facility generally used to meet unexpected expenses.
Export credit: This loan facility is provided to exporters to finance their working capital needs. The loan is sanctioned against the export order and is repayable after the shipment of goods.
Import finance: This loan facility is provided to importers to finance their import transactions. The loan is sanctioned against the import order and is repayable after the shipment of goods.
Letter of credit: This is a letter issued by a bank guaranteeing the payment of a buyer’s payment to a seller. It provides a secure mode of payment in international trade.
Whether you apply for a loan or an advance will depend on your specific financial needs and circumstances. Loans are typically more suitable for larger, longer-term funding requirements, while advances are more suitable for short-term cash flow needs. It is important to carefully consider your options and choose the type of credit that best meets your needs and financial situation.