ABCs of Business Loan: Understanding Commonly Used Terminologies

Ever dreamt of expanding your business to reach new heights of success? A Business Loan in India is the most commonly used financial tool to help entrepreneurs achieve their business goals. With a business loan, an entrepreneur can acquire cutting-edge equipment, simply smooth out cash flow fluctuations, and expand operations, among others.

A business loan can be the key to unlocking many possibilities. But navigating the world of loan applications amid difficult-to-understand financial terminology can feel like decoding a complex language.

This comprehensive glossary serves as your cheat sheet to understanding business loan terminology. We'll break down key terms into clear, concise definitions, empowering you to confidently discuss loan options with lenders. Consider it your guide to securing the right financing option for your venture and propelling your business forward.

Commonly Used Terms and Their Meanings

1. Principal: The core amount of money borrowed, excluding interest and fees.
2. Interest: The cost of borrowing money, expressed separately from the principal amount. The interest amount plus the principal amount constitutes the EMI payment.
3. Interest Rate: The cost of borrowing money, expressed as a percentage of the loan principal. Interest rates can be fixed (remain constant throughout the loan term) or variable (fluctuate based on market conditions), or semi-fixed, that is remain fixed for a specified period and then fluctuate as per the market conditions. A low-interest rate means lower monthly payments and vice versa.

Also Read: Understanding Interest Rates: Fixed vs. Semi-Fixed vs. Floating

1. EMI: EMI stands for Equated Monthly Installment. It's the fixed amount of money you pay each month to repay a loan, like a home loan or a car loan. This amount includes both the principal amount you borrowed, and the interest charged by the lender. EMI helps you spread out the repayment of your loan over a set period, making it easier to manage your finances.
2. Loan Tenure: This refers to the loan duration, typically ranging from a few months to several years. A shorter loan term translates to higher monthly payments but allows you to be debt-free sooner. Conversely, a longer term offers lower monthly payments but spreads out the repayment over a longer period.
3. Maturity Date: This is the critical deadline by which the entire loan amount (principal + interest) must be repaid in full.

Example: You need an INR 5 lakh loan to purchase new inventory for your business. The lender offers you the loan at a 10% interest rate per annum and you choose to repay the loan in 60 months or 5 years. The total interest amount will be INR 1,37,440. The total EMI payment (interest + principal) = 1,37,440 + 5,00,000 = INR 6,37,440. This can be easily calculated using the EMI calculator here.

In this example,
Principal = INR 5,00,000
Interest = 1,37,440
Interest rate = 10%
Loan tenure = 5 years

Different Types of Business Loans:

Term Loan: A term loan is a type of business loan that is borrowed for a specific amount of money, with a fixed repayment schedule and a predetermined maturity date. The borrower receives the entire loan amount upfront and then repays the loan over a set period, typically in regular installments. Term loans are commonly used by businesses to finance long-term investments, such as purchasing equipment, expanding operations, or acquiring another business.

Term loans are often secured by collateral, such as equipment or real estate, to provide reassurance to the lender and potentially lower the interest rate. However, term loans can also be unsecured, meaning they do not require collateral but may have higher interest rates and stricter eligibility criteria.

Line of Credit or Overdraft Facility: A line of credit or an Overdraft Facility is a type of revolving credit that allows a borrower to access funds up to a predetermined maximum amount, known as the sanctioned limit. Unlike a term loan where the borrower receives a lump sum upfront, with a line of credit, the borrower can draw funds as needed, up to the sanctioned limit. The borrower only pays interest on the amount of funds that are actually borrowed and used.

Lines of credit are often used by businesses to address short-term cash flow needs, manage seasonal fluctuations in revenue, or fund ongoing operating expenses. They can also be used for larger expenses such as business expansion, inventory purchases, or equipment upgrades.

Also Read: Understanding Overdraft Facility: A Simple Explanation

Secured Loan: A secured business loan is a type of loan that requires the borrower to provide collateral, such as assets or property, to secure the loan. The collateral acts as a form of security for the lender in case the borrower defaults on the loan. If the borrower fails to repay the loan, the lender retains the right to seize and sell the collateral to recoup their losses. Secured business loans are often used by businesses that may not qualify for unsecured loans due to a lack of credit history, lower credit scores, or higher risk factors. By offering collateral, the borrower can reduce the lender's risk and potentially secure a lower interest rate or higher loan amount.

Unsecured Loan: An unsecured business loan is a type of loan that does not require the borrower to provide collateral or security in order to qualify for the loan. Instead, the loan is approved based on the creditworthiness and financial stability of the borrower. Unsecured business loans are typically used by small and medium-sized businesses to finance short-term expenses, such as working capital, inventory purchases, equipment upgrades, or marketing campaigns.

Also Read: Confused Between Secured and Unsecured Loans? Let us simplify this for you!

Other Terminologies – Costs, Repayments, and more:

1. Amortization Schedule: This detailed breakdown shows how each loan payment is allocated between principal and interest over the loan term.

2. Loan-to-Value Ratio (LTV): This ratio compares the loan amount to the value of the collateral (for secured loans). A lower LTV indicates a less risky loan for the lender and may lead to better terms for you.

3. Basis Point: A unit used to express interest rates, equal to 1/100th of one percent. It is used to describe interest rates and origination fees.

4. Closing Costs: Fees associated with finalizing a loan, including origination fees, title searches, and attorney fees.

5. Debt Service: Regular payments made towards the principal and interest of a loan.

6. Delinquent: A loan payment that is missed or past due.

7. Demand Loan: A loan with no set repayment term, where the lender can request repayment at any time.

8. Guarantor: An individual or entity who promises to repay the loan if the borrower defaults.

9. Loan-to-Cost Ratio (LTC): The Loan-to-Cost (LTC) ratio is a financial metric commonly used by lenders to evaluate the risk of providing a business loan for a specific project or investment. The LTC ratio compares the amount of the loan being requested to the total cost of the project. It helps lenders determine how much of the project will be funded by debt (the loan) versus equity (the borrower's own funds).

The formula for calculating the Loan-to-Cost ratio is:

LTC ratio = Loan amount / Total project cost

For example, if a borrower is requesting a loan of INR 50,00,000 to fund a project that has a total cost of INR 1,00,00,000, the Loan-to-Cost ratio would be:

LTC ratio = INR 50,00,000 / INR 1,00,00,000 = 0.5 or 50%

10. Origination Date: The date a loan is funded and becomes active.

11. Prime Rate: The interest rate offered by lenders to their most creditworthy customers. This benchmark rate can influence other loan rates.

12. Underwriting: The process lenders use to assess a loan applicant's creditworthiness and risk before approving a loan.

13. Variable Interest Rate: An interest rate that can fluctuate over time based on an underlying benchmark rate set by Reserve Bank of India (RBI). This means your monthly loan payments may also adjust periodically. Variable rates can be attractive when they are initially lower than fixed rates but be sure to understand the potential impact of rising interest rates on your future payments.

Ready to take the next step?

Don't wait! Godrej Capital Business Loans offers a variety of financing options to suit your specific needs. Use your newfound knowledge of loan terminology to explore business loan offerings and find the perfect fit for your business.

Godrej Capital also offers specialized Business Loans for Women and Business loans for MSMEs. Our expert loan specialists are also happy to answer any questions you may have. Contact us today to unlock the potential of your business! Apply now

Also Read: Everything you need to know about Business Loans – A definitive guide

Get expert financial advise, visit our Knowledge Center.

Related FAQs

1. How to calculate Business Loan EMI?

You can easily calculate your Business Loan EMI using an online EMI calculator. It’s quick, simple, and accurate. Click here to access.

2. Can I get a Business Loan without collateral?

Absolutely! Many lenders offer collateral-free business loans. Your eligibility depends on factors like business revenue, credit score, and repayment capacity. Godrej Capital offers unsecured Business Loan, Business Loan for Women, Business Loan for MSMEs.

3. Is a Business Loan risky?

Like any loan, a Business Loan involves risk. However, with careful planning and responsible borrowing, it can be a powerful tool for business growth.

4. What is a credit score?

A credit score is a numerical representation of your creditworthiness. It reflects your ability to manage credit responsibly. A good credit score can improve your chances of loan approval.

5. Can I get a Business Loan with a bad credit score?

While a good credit score increases your chances, it's not always a deal-breaker. Some lenders offer loans for borrowers with less-than-perfect credit.

Disclaimer:

The contents of this article are for information purposes only and not a financial advisory. The information is subject to update, revision, and amendment and may change materially.
The information is not intended for distribution or use by any person in any jurisdiction where such distribution or use would be contrary to law or regulation or would subject Godrej Capital or its Affiliates to any requirements.
Godrej Capital or its Affiliates shall not be responsible for any direct/indirect loss or liability incurred by the reader for making any decisions, financial or otherwise based on the contents and information mentioned. For more information, please visit www.godrejcapital.com