Loans vs. Advances - Difference Between Loans and Advances

Organisations across the world cannot function without funds. It is an essential part of a business that ensures all the material required for production, administrative and operating expenses of the entity are met in a timely manner. However, that’s not all that the funds are used for. Companies need money to constantly invest to make their product or service better in comparison to their competition. 

Individuals need funds to take care of a variety of requirements and carry on with their affairs without any hurdles. Having said that, neither a company nor an individual has access to unlimited funds. Loans and advances can fulfil this deficit in funds. 

Let’s deep dive into the definitions to understand the concepts with more clarity. 

What is a Loan?

When a financial institution offers a sum of money in the form of a debt to another enterprise or individual that is meant to be paid back with interest within a specified period of time is referred to as a loan.

For example, let’s say a personal loan has been sanctioned by a financial institution. Then, an agreement is drawn up that outlines all the terms and conditions, the repayment amount and time period, the interest, fees and any other applicable charges, etc. But before the loan is approved, the financial institution will run a personal loan eligibility check to ensure that the applicant meets the required criteria as per their policy.

 What is an Advance?

The common concept of an advance hovers around a type of loan that is offered to a  business entity or an individual may also seek an advance from a financial institution to meet short-term requirements Thus, an advance is rather like a credit facility extended to a borrower, which he may use to fulfill any short term requirements.

The advance is generally provided for a shorter duration of time, for instance, a year. The bank will sanction this as a short-term loan, an overdraft, cash credit or a bill purchase. That said, the advance will be facilitated only if the borrower meets specific conditions as outlined by the Reserve Bank of India.

Difference Between Loans and Advances

Take a look at the common differences between loans and advances.

1. The Formality of Loans and Advances:

The first point of differentiation between loans and advances is in the fulfilment of formalities that goes into getting the funds. Usually, the process of getting a loan sanctioned from a financial institution is very formal in nature.

There are a lot of administrative procedures involved before the application of a loan is accepted. The individual or enterprise has to undergo a strict screening process that checks if the loan, along with interest can be repaid back to the institution on time.

The process is not quite the same for advances. Since the loan is being approved only if the borrower meets pre-defined conditions such as enlisting primary security, guarantees or even a collateral. Usually, the level of screening or procedures may not be as exhaustive or stringent as it is offered by a lender to an existing customer.

2. Amounts Involved in Loans and Advances:

When a business or an individual makes a loan application, it is usually for a significant sum of money (except for unsecured business loans, which are usually below INR 50 lakhs). This can be availed to kickstart business operations, purchase inventory or spend it on research and development. When individuals avail a loan, in most cases it is used for high-end expenditures (except for personal loans which are usually below INR 25 lakhs) such as buying a home, purchasing a car, fund higher education or organise a wedding.  

On the other hand, advances made out to individuals or business entities are in much smaller amounts that are extended to meet immediate and short-term financial objectives. 

 

3. Payment Duration in Loans and Advances:

The period of repayment between loans and advances is another point of differentiation. Loan products such as personal loan, car loan, education loan or a home loan have a longer repayment tenure. It can range anywhere from up to 5 years for a personal loan till up to 30 years for a home loan. The mode of repayment is via EMIs or Equal Monthly Installments as the outlined tenure of the loan agreement.

Advances have a much smaller repayment period generally between 3 months to a year at the most. Repayment terms may vary and depend on the agreement between the lender and the borrower. 

4. Interests in Loans and Advances:

Loans from financial institutions attract an interest component which is added on to the principal at the time of repayment. The interest component is proportionately spread across the repayment tenure and is calculated based on the principal amount borrowed. The objective of charging the is to cover the risk associated with sanctioning the funds and the time value or money. 

The interest component on advances is usually very low since the repayment tenure does not exceed 12 months. Hence, the risk involved is much less as well as the monetary value. 

5. Securities in Loans and Advances:

At the time of loan approval, financial institutions may require a collateral deposit if the amount of loan required is high. This acts as a form of security which can be seized by the bank or NBFC if the borrower defaults on loan repayments for a said period of time. Acceptable types of collateral include land, property, gold, fixed deposits, certain types of shareholdings, etc.

In the case of advances, there is no requirement of offering security usually. Sometimes, lenders may ask for primary security such as a fixed deposit or a guarantee.