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Loans and advances are common banking and financial terminologies that relate to the borrowing of funds. However, there are differences between them, right from eligibility to how to borrow, interest rate payable, repayment terms, tenure and more. As a business owner, if you are looking for funds for meeting business needs, it’s recommended to understand the meaning and differences between loans vs advances and borrow accordingly.
What is a loan?
A loan is a sum of money that is borrowed by an individual or business from a bank or similar lending institution. Loans come with specific eligibility criteria for borrowing and documentation requirements and is lent to the borrower for a specific duration (number of months/years) at a specific loan interest rate. The borrower is obligated to repay the loan amount in EMIs as per the terms and conditions stated in the loan agreement.
What is an advance?
An advance on the other hand is a short-term credit facility offered by financial institutions and banks to meet daily business expenses. Advances are usually given for a period of a year (or similar) as per RBI guidelines and interest rates. They are usually provided to meet working capital needs that businesses may have from time to time.
Top 5 differences between Advance and Loan
Now that we understand how these credit facilities work, let us look at the main differences between loans and advances.
Loan vs Advance – Key differences
|Loans (i.e., business loans) can be borrowed as short-term (i.e., 1-3 years) or long-term (i.e., 3-15 years) business loans||Advances are usually on short term (i.e., repayment within 1 year)|
|Loans can be availed for different purposes – personal loans, business loans, car loans, commercial vehicle loans, home loans, working capital loans, loans against property for business, medical equipment loans, loans for traders, etc.||Advances are usually disbursed to meet immediate cash crunch and working capital requirements – secured or unsecured advances, term advances with specific repayment schedule, revolving advances like line of credit that can be used repeatedly, or demand advances|
|Loan approvals/disbursals have specific eligibility criteria and documentation requirements to reduce risks of default i.e., more formal procedures and guidelines to follow||Approvals for advances are less time consuming, require minimal paperwork, and have lenient/flexible criteria as the sum applied for and tenure is short and based on the borrower’s creditworthiness/banking records|
|Interest rates on loans vary between lenders, type of loans and security offered – for business loans, the interest rates range between 10-22% p.a.||Interest rates are usually higher as these are borrowed for a short duration and usually without collateral|
|Repayment amount and duration is usually fixed – i.e., EMIs to be paid as per T&C (Learn how to calculate interest on business loans for EMI)||Repayment terms are more flexible as sum borrowed is smaller, though some advance credit facilities come with fixed repayment dates|
Types of loans vs advances – How they differ
As mentioned previously, there are different types of loans and advances. In this section, we take a look at some of the popular types of loans and advances and how they differ from each other.
What is a cash advance?
A cash advance is the act of withdrawing a sum of money from an ATM machine or bank by using a credit card. The sum withdrawn is against a pre-determined credit limit. It usually comes with a cash advance fee and high APR.
It is advisable to take cash advances only when required as taking a cash advance too frequently, or not repaying cash advance loans in time can indirectly impact credit scores.
Cash advance vs Personal loan:
While both personal loans and cash advance refer to borrowing money, they have some differences.
- Personal loans can be for short or long duration, have lower interest rates, and are usually borrowed for personal reasons (e.g., home renovation)
- Cash advances are for shorter duration (usually 12 months), and comes with higher interest rates and cash advance fees
Credit card cash advance vs personal loan:
A credit card cash advance is one that is availed against a credit card. For example, if your credit card limit is ₹1 lakh, your credit card cash advance limit can be ₹20,000. This means that you can visit the bank or a bank ATM and withdraw up to ₹20,000. This facility should ideally be used sparingly as it comes with high fees and can lead to a dip in your credit scores if over utilised.
A personal loan as mentioned, refers to borrowing funds from banks/NBFC for personal use. The EMI amount, repayment terms and duration are as per the loan agreement.
|Credit card cash advance||Personal loan|
|Availed against an existing credit card as per mentioned credit limit to meet WC needs||Can be borrowed to meet personal expenses e.g., home interiors/repairs|
|Can be withdrawn from an ATM machine or bank||Can be availed from any bank or lending institution based on required eligibility|
|Comes with higher cash advance fees and interest rates to be repaid as per borrowing terms||Comes with fixed interest rates, tenure, repayment terms|
Merchant cash advance vs business loan:
Business owners can avail a merchant cash advance if they are using credit cards for receiving payments from customers. There is no fixed date to repay and repayment is done based on sales. This is beneficial for businesses as they do not have to repay a fixed EMI but pay back based on sales and revenue generated.
Business loans on the other hand are short and long term loans borrowed for business activities. It usually involves a detailed procedure, with businesses having to meet the eligibility criteria, submit documents, and repay the EMI as per the interest rates. Lenders ask questions before approving a business loan to reduce risks and also check the creditworthiness of the borrower.
Note: There are also professional loans offered by banks such as business loans for chartered accountants, business loans for traders, business loans for doctors etc.
Small business loan vs cash advance:
A small business loan is usually a short-term loan finance offered to an SME to meet their business expenses and operational needs. A credit card cash advance is a small amount of money that can be availed with a credit card against the approved credit limit. It involves high interest rates and a fee.
House building advance vs home loan:
House Building Advance (HBA) is offered to central government employees to help them build/construct a house or acquire one. These advances are offered to temporary and permanent employees provided they have completed 10 continuous years of service. The interest rate on HBA is usually low (7.1% till March 2023 as per 7th Pay recommendations and increased to 7.5% for FY23-24). The total amount one can borrow is 34 months of basic pay or ₹24 lakh or the cost of the house or the amount as per repaying capabilities.
A home loan on the other hand is offered by banks and financial institutions to individuals to build or buy a house (old and resale). These are loans with collaterals, in that the home is considered as collateral until the amount and interest is paid back. You can claim tax benefits if you avail a home loan.
House building advance interest vs normal home loan interest rate:
Home loans can come with fixed, floating or hybrid interest rates. In general, banks offer home loans with interest rates starting from 8.5% p.a.
House building advance interest rate as mentioned currently stands at 7.5% p.a.
|House Building Advance||Home loans|
|Offered to central government employees to construct a house||Offered by banks/financial institutions to individuals to build/buy a house|
|Employee must have been in service for at least 10 years||Home loans can be offered to any individual provided they meet the bank’s eligibility criteria and have the documents in place|
|The amount one can borrow is usually 34 months of basic pay or ₹24 lakh or the cost of the house or the amount as per the ability to pay back||The amount offered depends on the value of the property, the borrower’s creditworthiness and financials, and other requirements|
|HBA interest rates currently stands at 7.5% p.a.||Fixed, floating or hybrid interest rates usually starting from 8.5% p.a.|
Example of loan vs advance
Consider yourself the owner of furniture business. You have some daily operational payments pending and access to funds would be helpful. There are also expected increase in sales in the next 3-6 months based on previous year’s data and trends. Moreover, buying new equipment will fast track the furniture making process which will in turn help you to have shorter production cycles and quick deliveries. Access to funds will be helpful to:
- Meet everyday operational expenses (Approximately ₹50,000)
- Buy new machinery/equipment (Approximately ₹7,00,000)
When you approach your regular bank, it provides you with the following options:
- Machinery loan of up to ₹6,00,000 for purchasing the machinery. This comes with a specific rate of interest and may or may not require additional collateral security (i.e., the machine is the collateral) based on the lender and amount being borrowed. The repayment terms are clearly articulated in the loan agreement with pre-payment options. Since this is a high value loan amount, the tenure is also longer (usually 3-5 years).
- Overdraft (i.e., advance facility) for meeting operating expenses. Here, you need to be an existing account holder at the bank and can borrow a small sum of money against your account even when it is zero or nearing it. Based on your creditworthiness and banking history, the bank may offer a small overdraft credit facility (in this case, a sum of ₹50,000) to enable you to meet challenges of immediate cash shortage.
Loan vs Advance – Which is better for you and how to get them?
We come to the final question – Loans vs Advances – which one is the better option for you?
By now you should be familiar with the differences between a loan and an advance. You should also be able to understand when to avail which and why.
- Whether you take an advance or a loan, there’s an interest payable and you will have to return the principal plus interest in time.
- Your choice of credit facility should depend on your business needs, forecast and future goals.
- For instance, if you are a logistics company owner, and want to expand your fleet, availing a commercial vehicle loan is the best option.
- Again, if you are a new business and want to borrow a small amount for business operations, consider availing a Aadhaar loan for business.
Remember, a loan in the end is a debt – you can refinance a business loan and continue growing your business, but you will have to repay it in time. You can approach any recognised banks or NBFCs for a business loan (or any other). They will evaluate your need and perform due diligence before sanctioning the loan.
An advance on the other hand can be availed when you need instant funds. The disbursement is quick (usually 24-48 hours) though you can only avail small sums. These will also have to be repaid in time. There is however greater flexibility and usually for a short duration.
FAQs on loans vs advances
What are the types of loans for businesses?
Is collateral required for an advance?
What are the types of advances?
- Bills purchased
- Cash credit