Loans – Meaning, How They Work, Types, and Features

Q: What is the loan formula?

EMI = [P x R x (1+R)^N] / [(1+R)^NP is the principal loan amountR is the monthly interest rate (annual rate divided by 12),N is the loan tenure in months.

By Jinta Jacob

Updated on: Jun 25th, 2025

6 min read

Whether you're planning to buy a house, fund your education, or manage unexpected expenses, loans can help you get there without depleting your savings. Today, loans come in many forms, such as secured, unsecured, personal, home, education, and more, all designed to meet different financial goals.

This guide will walk you through what a loan is, the various types of loans available in India, how the loan process works, eligibility criteria, documents needed, and how to calculate your EMIs, so you can make an informed decision.

What is a Loan?

When a sum of money is borrowed from a bank, financial institution, lender, or friend and there is an agreement to repay it over time with interest, it is referred to as a loan. Loans allow individuals or businesses to meet their financial needs without using their savings upfront. Different types of loans are tailored to suit various needs, such as personal, home, education, and business. A loan has three components – principal or the borrowed amount, interest rate and tenure or duration for which the loan is availed.

Types of Loans

Based on the Security Provided

Secured Loans
These loans require the borrower to provide collateral for the money being borrowed. If the borrower cannot repay the loan, the bank can utilise the given collateral to recover the pending payment. The interest rate for such loans is much lower than that of unsecured loans.
Unsecured Loans
Unsecured loans do not require collateral for loan disbursement. The bank analyses the borrower's past relationship with the bank, the credit score, and other factors to determine whether the loan should be given. The interest rate for such loans can be higher, as there is no way to recover the loan amount if the borrower fails to pay off the loan.

Based on the Purpose

Education Loan
Education loans are financial aid that borrowers can use to pursue education. The loan is only valid when the course is an undergraduate degree, a postgraduate degree, or any other diploma/certification course from a reputed institution/university. You must have the admission pass provided by the institution to get the financing. The financing is available for both domestic and international courses.
Personal Loan
You can go for a personal loan whenever there is a liquidity issue. A personal loan can range from repaying an old debt, going on vacation, funding for the downpayment of a house/car, and medical emergency to purchasing big-ticket furniture or gadgets. These loans are offered based on the applicant’s past relationship with the lender and credit score.
Vehicle Loan
Vehicle loans finance the purchase of two-wheeler and four-wheeler vehicles. They can be used to purchase both new and second-hand four-wheelers. The lender determines the loan amount based on the vehicle's on-road price. You may need to make a down payment, as these loans rarely offer 100% financing. The lender retains ownership of the vehicle until the loan is fully repaid.
Home Loan
Home loans provide funds to purchase a house or flat, construct a house, renovate/repair an existing house, or purchase a plot for the construction of a house or flat. The lender will hold the property until the rightful owner has completed their repayments.
Business Loan
Business loans are made to fund business-related needs, such as working capital, expansion, equipment purchases, or operational costs. The amount sanctioned depends on the business's financials and the applicant’s credit profile. Both secured and unsecured variants are available.
Top-up Loan
Top-up loans are offered in addition to an existing home or personal loan. These loans do not require additional documentation and are processed faster than fresh loans. The top-up amount can be used for any personal or professional purpose.

Based on the Pledged Assets

Gold Loan
- Many financiers and lenders offer cash when the borrower pledges physical gold, such as jewellery or gold bars/coins. The lender weighs the gold and calculates the amount offered based on several checks of purity and other factors. The money can be used for any purpose.
- The loan must be repaid in monthly instalments so that it can be cleared by the end of the tenure and the gold can be taken back to the borrower's custody. If the borrower fails to repay on time, the lender reserves the right to take over the gold to recover the losses.
Loan Against Assets
- Like pledging gold, individuals and businesses pledge property, insurance policies, FD certificates, mutual funds, shares, bonds, and other assets to borrow money. Based on the value of the pledged assets, the lender will offer a loan with some margin.
- The borrower needs to make repayments on time so that they can get custody of the pledged assets at the end of the tenure. Failing to do so, the lender can sell the assets to recover the defaulted money.
Loan Against Property
This type of loan is taken by pledging residential or commercial property. The loan amount sanctioned is usually a percentage of the property's market value. These loans are ideal for long-term needs such as higher education, business expansion or significant medical expenses.

What is the Loan Process?

The loan process is the step-by-step journey from applying for a loan to receiving the funds and repayment. The lender evaluates the borrower’s eligibility, verifies the documents, assesses risk, and then disburses the approved loan amount. Each stage ensures a fair and secure lending experience for both parties. These steps will explain the process in detail.

Application:
The borrower fills out a loan application and submits the required documents.
Processing:
The lender will then review the application and check the borrower’s credit history, income, and repayment capacity.
Verification:
A background check and documentation validation are conducted for accuracy and authenticity.
Approval:
If the borrower qualifies, the loan is approved, and terms are finalised.
Disbursement:
The sanctioned amount is credited to the borrower’s account.
Repayment:
The borrower will then have to repay the loan through EMIs or as per the agreed repayment schedule.

Important Factors Lenders Look at to Approve Your Application

Credit Score

Your credit score plays an important role in deciding whether the lender will proceed with your application or reject it at the initial stage. This is especially true for unsecured loans.

Since a credit score represents the borrower's credit history, the lender analyses the borrower's repayment history and concludes whether the borrower can repay on time or will default on payments. The loan approval is based on the lender’s judgment after the necessary analysis.

Income and Employment History

Your monthly or annual income and employment history play a crucial role in loan approval as well. Based on if your income is stable or not, the lender may or may not be convinced that you can repay the loan. This applies

Even if you are self-employed, the lender assumes that your business has been running well for the past few years and that your turnover is satisfactory.

Debt-to-Income Ratio

Your debt-to-income ratio is also essential. You must have a low debt-to-income ratio so the lenders can think that you have enough cash at hand every month to make the repayments and handle the family expenses. If you have an income of Rs 1 lakh per month and your debt repayment commitments already exceed Rs.75,000 already, a new loan will not be provided to you as you will need the remaining income to take care of your domestic expenses.

Collateral

The lender may decide on the interest rate applicable to your loan based on the collateral you provide and its current market value. From the lender's perspective, giving collateral will make the deal more secure, which may result in more trust and a lower interest rate. An unsecured loan is infamous as it includes a higher interest rate than other loans.

Down Payment

The money you have saved and the effective execution of your savings plan for a down payment will increase the lender’s trust in you. The higher the down payment, the lower the loan amount requirement.

Features and Benefits of Loans

There are several types of loans categorised based on various factors.
You can choose the type of loan you wish to take based on your requirements and eligibility.
The lender has the ultimate power to decide the loan amount they wish to offer you based on several factors, such as repayment capacity, income, and others.
A repayment tenure and interest rate will be associated with every loan.
The bank may apply several fees to every loan.
Many lenders provide instant loans that take a few minutes to few hours to get disbursed.
The interest rate is determined by the lender based on the Reserve Bank of India’s guidance.
The lender determines the requirement for security.
A third-party guarantee can be used instead of security in some cases.
The loan repayments must be made in equated monthly instalments over the pre-determined loan tenure.
There may or may not be the option for full/part prepayment.
Some loan types and lenders may levy a penalty for prepayment of loans.

Eligibility for Loan

The eligibility criteria to get a loan varies based on the type of loan you are looking for. Generally speaking, you may consider the following simple criteria to check your eligibility.

A decent credit score
Constant income flow
Age between 23 years and 60 years at the time of entry
A few assets such as FDs, investments, immovable property, etc.
A good relationship with your bank
A timely debt repayment history

Documents Required

Salaried Applicants

Application form with photograph
Identity and address proof
Last 6 months’ bank account statement
Latest Salary Slip
Form 16

Self-Employed Applicants

Application form with photograph
Identity and address proof
Last 6 months’ bank account statement
Proof of business
Business profile
Income Tax returns (self and business) for the last three years
Profit/loss statements and balance sheets of the last three years

Loan EMI Calculator

A Loan EMI Calculator is a handy tool to calculate the monthly amount payable to the lender as well as the total interest. To calculate the EMI applicable to your loan amount, all you need to do is enter the values for principal Amount (P), Time duration (N), and Rate of interest (R).

How to Apply for a Loan?

Applying for a bank loan is simpler than one would think. But before you apply for one, you should be aware of your financial situation, given you will have to pay back the loan amount later. You must analyze your needs and decide think it’s an ideal way out for you. Given below are the steps on how you can proceed with applying for a loan.

Step 1: Choose the lender you would like to borrow from based on your research and check for your eligibility.

Step 2: Visit the bank branch or their official website to apply for the loan.

Step 3: Submit or upload all the necessary documents and proofs.

Step 4: The bank will process your application and get in touch with you to inform their stand within the stipulated time frame.

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Frequently Asked Questions

What is loan payment?

Loan payment is the process of repaying borrowed money, along with interest, over a predetermined period of time.

What is loan amortisation schedule?

A loan amortization schedule shows the repayment of a loan over time, showing how each payment is split between principal and interest, helping borrowers track their outstanding balance and total interest paid.

What is loan's full term?

A loan's full term is the total duration over which the loan has to be repaid. It can range from a few months to several years.

What is the loan formula?

EMI = [P x R x (1+R)^N] / [(1+R)^N

P is the principal loan amount
R is the monthly interest rate (annual rate divided by 12),
N is the loan tenure in months.

About the Author

Jinta Jacob

Content Writer - Personal Finance

I’m a personal finance content writer with significant experience in financial analysis and data science. I write about digital payments, banking, fintech tools, and government schemes, breaking down complex concepts and making the idea of personal finances feel less like a burden and more like something you can feel in control of. When not decoding money matters, I'm behind the lens, capturing emotions and moments that often go unnoticed.. Read more

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