Loans are an important aspect of banking functionality that helps to build the economy of the nation. Financial institutions help the individual or an enterprise financially to acquire a property or use it for personal reasons.
In return, the banks charge an interest that has to be paid by the individual or an enterprise along with the principle in a certain period. This transaction helps the banks to offer cumulative interest to the customers who have a savings or a checking account.
The bank is an institution uses money as the commodity for sale. The money accrues interest while saving and money also accrues interest while lent.
This balance is struck every year and this also helps the bank be profitable in their respective businesses. The loan that is offered to the people is under certain norms that the banks lay. The norms are used to ascertain a person’s creditworthiness to offer a loan. This also helps the banks to ascertain the maximum amount that can be borrowed by an individual or an organization.
The maximum amount a person can borrow from a bank or use it from a credit card is called the limit. This limit is fixed based on the applicant’s debt to income ratio. These two terminologies work hand in hand in the banking sector. There are a few major differences between them to understand their functionality in the banking system.
Loan vs Limit
The main difference between Loan and Limit is that a loan is the amount of money a person or an organization borrows from the bank while the limit is the maximum loan amount that can be offered by the bank to an individual or an organization. The limit is fixed by the bank and any amount below the limit can be borrowed by the customer.
Comparison Table Between Loan and Limit (in Tabular Form)
| Parameter of Comparison | Loan | Limit |
|---|---|---|
| Meaning/Definition | A loan is the amount of money borrowed by the customer to pay back with the interest amount in a certain period. | The limit is the maximum loan amount a customer can borrow from the bank. |
| Calculation Base | The loan amount is calculated as per the margin set by the lending bank. | The limit is calculated by analyzing the income to debt ratio. |
| Change in Amount | The loan amount can vary anywhere between the limit offered by the credit. | The limit can vary or change when the income to debt ratio changes to a better score. |
| Frequency of Change | The loan amount can change depending on the requirement of the customer and it can be frequent but must be within the limit. | The frequency of change in the limit is so less |
| Deciding Authority | The loan is sanctioned by the lending bank. | The limit is fixed by the credit committee. |
What is Loan?
A loan is the amount of money borrowed from the bank by a customer. This money that is offered in advance by the bank, expects the customer to payback along with the interest that is pre-defined before the disbursal of the loan.
The loan is a financial transaction where a customer applies for it. The bank shall check the customer’s creditworthiness and check with the limits that can be offered.
Once the loan amount is approved, the bank and the customer shall come under an agreement of repayment. This includes the period and the interest percentage for the amount of money borrowed.
The loan is of various types; personal loans, mortgage loans, business loans, home loans, and so on. Whatever the category of the loan it may be, one aspect remains constant is, the customer shall pay back the loan with interest in Equated Monthly Installments.
The variety of loans have a variety of interest percentages. The loans are also categorized as secured and unsecured loans.
It is ideal to understand that the unsecured loans have higher interest percentage when compared to the secured loans. The unsecured loans can be through credit card, personal loan, and any loan which does not require any security.
A mortgage is the most secured loan for both the parties; bank and the customer. The customer is required to submit a lot of documents and also must offer the property as collateral.
The collateral must be higher in value when compared to the loan availed. There is no risk for the bank and the amount offered is also very high when compared to the unsecured loans.
What is Limit?
A Limit is the maximum loan amount an individual or an organization can borrow from the bank. This is determined by the bank utilizing the debt to income ratio of the customer and it stands fixed.
The customer can avail of the loan in the limit offered and can never go beyond the limit. The maximum amount of loan is fixed to the credit card, overdraft amount, personal loans, and any type of loan which is under the umbrella of borrowing.
Also, fixing the limit does not mean that the loan is approved. The process of ascertaining the limit is different from offering the loan.
Usually, the debt to income ratio of 36% is considered worthwhile for the loan underwriters to establish the limit. Other factors come into the picture while fixing the limit, the credit score, and credit history.
In the case of setting the limit for the credit card, the major aspect considered is credit history. The lenders may also check for the creditworthiness of the customer by checking the history of non-payment, bankruptcies if any.
The work history of the customer is also noted for ascertaining the limit to borrow. These are all a part of offering unsecured loans.
In the case of secured loans, the expense ratio of the property is ascertained to fix the limit. The house expense ratio must never go more than 28%.
Main Differences Between Loan and Limit
- The main difference between Loan and Limit is, the loan is a transaction where the bank offers the customer money for which the customer pays back with interest in a certain period while the limit is the maximum loan amount a customer can borrow from any financial institutions.
- The base for calculation also differs, the loan amount is calculated based on the margin set by the bank while the limit is set by the calculation of income to debt ratio.
- The loan amount can vary or change anywhere between the limit offered and the frequency depends on the customer’s requirement while the limit changes depending on the credit committee.
- The frequency of change in the amount is more in the case of the loan however it is very less in the case of a change in limits.
- Bank decides the loan amount while the credit committee decides the limit.
Conclusion
The fixing of the limit plays a major role in borrowing the funds. The documents and banking procedures are more when compared to loan approval documents. These strict norms of setting the maximum loan amount are to have the bank in a secured zone.
The money is after all the other people. The functionality of the bank to offer interests to the customers who have a bank account must not be hampered by futile checking and actions while offering a loan to anyone. The complete credit history is noted before setting the limit.
The limit can never go high unless the debt to income ratio improves. It majorly relies on the customer’s payback diligence too.
References
- https://www.aeaweb.org/articles?id=10.1257/pol.20140108
- https://escholarship.org/content/qt0m60s01q/qt0m60s01q.pdf