Loans are an essential aspect of banking functionality that helps build the nation’s economy. Financial institutions help the individual or an enterprise financially acquire or use a property for personal reasons.
In return, the banks charge an interest that the individual or an enterprise has to be paid along with the principal in a certain period. This transaction helps the banks offer cumulative interest to customers with savings or a checking account.
The bank is an institution that uses money as a commodity for sale. 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 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 demonstrate the maximum amount an individual or an organization can borrow.
The limit is the maximum amount a person can borrow from a bank or use from a credit card. 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 significant differences between them to understand their functionality in the banking system.
Key Takeaways
- A loan is a sum of money borrowed from a lender that is usually paid back with interest over time, while a limit is the maximum amount of credit that a borrower can access from a lender.
- Loans are typically used for specific purposes like buying a house or car, while limits can be used for various purposes like making purchases or paying bills.
- Loans and limits involve borrowing money from a lender, but loans require repayment of the borrowed amount plus interest, while limits only require repayment of the borrowed amount.
Loan vs Limit
The difference between Loan and a Limit is that a loan is the amount of money a person or an organization borrows from the bank. In contrast, the limit is the maximum loan amount the bank can offer to an individual or an organization. The bank fixes the limit, and the customer can borrow any amount below the limit.
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Comparison Table
| Parameter of Comparison | Loan | Limit |
|---|---|---|
| Meaning/Definition | A loan is money the customer borrows to repay with interest 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 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 when the income-to-debt ratio changes to a better score. |
| Frequency of Change | The loan amount can change depending on the customer’s requirement, and it can be frequent but must be within the limit. | The frequency of change in the limit is so less |
| Deciding Authority | The lending bank sanctions the loan. | The credit committee fixes the limit. |
What is Loan?
A loan is the amount of money borrowed from the bank by a customer. This money is offered in advance by the bank, which expects the customer to pay back along with the pre-defined interest before the loan’s disbursal.
The loan is a financial transaction which a customer applies for it. The bank shall check the customer’s creditworthiness and the limits that can be offered.
Once the loan amount is approved, the bank and the customer agree on repayment. This includes the period and the interest percentage for the money borrowed.
Loan is of various types; personal loans, mortgage loans, business loans, home loans, and so on.
Whatever the loan category may be, one aspect that remains constant is the customer shall pay back the loan with interest in Equated Monthly Installments.
The variety of loans has a variety of interest percentages. The loans are also categorized as secured and unsecured loans.
It is ideal to understand that unsecured loans have a higher interest percentage when compared to secured loans. Unsecured loans can be through credit cards, personal loans, and any loan that does not require security.
A mortgage is the most secured loan for both parties; the 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 compared to 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 customer’s debt-to-income ratio, and it stands fixed.
The customer can avail of the loan within the limit and can never go beyond the limit. The maximum loan amount is fixed on the credit card, overdraft amount, personal loans, and any loan 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 significant aspect considered is credit history. The lenders may also check for the customer’s creditworthiness by studying the history of non-payment and bankruptcies.
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 a Limit is a loan is a transaction where the bank offers the customer money for which the customer pays back with interest in a certain period. In contrast, the limit is the maximum loan amount a customer can borrow from any financial institution.
- 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 calculating the income-to-debt ratio.
- The loan amount can vary or change anywhere between the limit offered and the frequency depending 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 significantly less in the case of a limit change.
- Bank decides the loan amount, while the credit committee decides the limit.
- https://www.aeaweb.org/articles?id=10.1257/pol.20140108
- https://escholarship.org/content/qt0m60s01q/qt0m60s01q.pdf
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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.
