Introduction
When seeking financing or investing your cash, it is crucial to know the differences between bonds and loans. Bonds and loans are both forms of financing, but they are fundamentally different in composition, design, characteristics and the inherent value. This article aims to define the differences between bonds and loans in ways that align with what meets your financial goals in India.
What is a Bond?
Think of a bond as a loan made to a company or the government, for which they promise to make periodic interest payments. When you buy a bond, you buy debt security from an entity: the Government of India, PSUs or Corporations. The actual bond is a certificate (today, they are issued and held in electronic (demat) form, via authorised exchanges or agents). The bond generates periodic interest (commonly known as coupons), and when the bond matures, you will receive your original principal back. For example, if you buy a 10-year government bond, you will receive interest income every year, and then after 10 years, you will receive your original investment back.
Open Demat Account and Start Trading!
Most bonds (especially government and corporate) are traded on exchanges like NSE or BSE, meaning they are tradable and relatively liquid. Bondholders can sell them before maturity, but you will have to see the market price first, as it may have changed depending on the current interest rate and changes to credit ratings. Bonds would be the best option if you want new, predictable income with limited risk. Generally, government bonds are the safest, since the government backs those bonds, i.e. sovereign.
What are Loans?
Now, think of borrowing money from, let's say, a bank to purchase a residential property or expand your business. This is a loan. A loan is a private contract between you, as the borrower, and the lender, which can be a bank or a non-banking financial company (NBFC), for instance. The lender is lending you the money in the form of a lump sum amount, and you will pay back the lender over time, generally in equated monthly instalments (EMIs), which include both the principal and interest. Loans can be structured in many ways to meet your needs, particularly in the form of home loans, personal loans, or business loans, and they can be charged with fixed or floating interest.
Unlike bonds, loans are not traded. Loans are typically used to meet specific financial needs, such as purchasing a vehicle, funding education, or managing working capital. In India, loans can be obtained on specific terms from lenders (such as the State Bank of India, HDFC Bank, etc.), with qualifying criteria determined by credit scores, income of the borrower, and repayment ability.
Bonds vs Loans: The Essential Difference
The following is a comparison of the bond and loan differences:
If you purchase a PSU bond worth ₹1 lakh and expect to earn a coupon rate of 7%, you expect to earn ₹7,000 yearly. A personal loan worth ₹1 lakh at 12% may yield expectations of monthly EMIs in the ballpark of ₹3,300/month for 3 years, including principal and interest.
Which Should You Choose?
Choosing bonds or loans depends on what you're trying to accomplish. If you're an investor and want passive income with minimal risk, bonds (especially government or high-rated corporate bonds) could work well for you. Bonds provide stability, are tradable, and are great for long-term wealth creation. A loan suits your requirements if you want to obtain capital for a specific purpose, like recently purchasing a home in Mumbai or starting a business in Delhi. However, with a loan, you need to share your plans with your lender about paying it back.
Always weigh your risk tolerance, liquidity needs, and discipline before investing in a bond or loan. For bonds, you need to assess the issuer's credit ratings and the conditions in the market. For loans, you need to assess the interest rate and the various terms and conditions lenders apply, given your local markets (for example, the State Banks of India, local NBFCs, etc.).
Conclusion
Understanding the differences between bonds and loans can inform your financial decisions. Bonds provide an opportunity to grow wealth, or rather, bonds have expected returns. Loans provide you with available funds to pay for personal or business goals. In India's fluctuating financial markets, both have a valid place. Whether buying a 10-year G-Sec or a home loan from any bank, your choice should reflect your goals and appetite for risk. You can explore places like NSE or consult a SEBI-registered financial advisor for more precise advice.
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