Meaning of Loan
When you need money and you borrow it from someone then it is called loan. You can borrow money from anyone like your friend or your relatives or from a bank or anyone else. When you borrow money then you have to repay it back after certain time. You also need to pay interest on the amount borrowed.
In simple words:
A loan is borrowed money that must be returned back with interest.
When someone gives you loan then it is also known as lending money. Loans are also known as borrowings.
The size of amount borrowed and the period for which amount borrowed does not matter. Even if you borrow Rs 100 from your friend for one day, still it is known as loan.
Meaning of Interest
Suppose you need money and you want to borrow it from someone else. Why would anyone else give you money? What if you did not repaid his money back? So there is a risk when someone gives you money and hence they might not be interested to take this risk.
So to make people interested in lending you money, you need to give them some extra benefit. Like, you can say that if you give me one lakh rupees now, then I will give you one lakh five thousand rupees back. So the person giving you money gets rupees five thousand rupees extra. Since he is getting extra money so he will become interested in lending you money. Rs 5000 extra which you pay him is known as interest. The amount that you borrowed which is rupees one lakh in our example is known as Principal amount.
In simple words:
The extra amount paid to make someone interested in lending you money is known as interest.
Please note that sometimes when amount is borrowed from close relatives or friends then the lender may not take any interest due to cordial relations with the borrower.
Purpose of taking loans
- People take loans for many reasons, such as :
- Buy a house or car
- Start or grow a business
- Pay for education
- Handle emergencies
- Other reasons
Meaning of Capital
It is the money or any other asset that a person invests in their own business. The money invested comes from the person’s own savings.
In simple words:
Capital is your own money used to start or run a business.
Loan vs Capital
| Point of Difference | Loan | Capital |
| Meaning | Borrowed money from others (like banks) | Money invested by the person in own business |
| Repayment | Must be repaid | No need to make repayment |
| Interest | Interest is paid | No Interest is paid |
| Sources | Friends, relatives, banks, others | Own money |
Example case study to understand difference between loan and capital
Mr Ramesh, wants to open a bakery in his town. He needs Rs 5 Lakhs for this purpose. He has two options
Option 1 : Using Own Money
Mr Ramesh has saved Rs 5 Lakhs from his salary from his past job. He can use this money to buy a shop, buy baking equipment, and start his bakery.
This Rs 5 Lakhs is his capital because it is his own money. He need not return this money to anyone else
Option 2 : Take Loan
Instead of using his own savings, Mr Ramesh goes to a bank and borrows Rs 5 Lakhs. He promises to pay it back in 3 years with 8% interest per year.
Now, this money is a loan, not capital. Mr Ramesh has to repay this money to the bank.
Process of taking and repayment of loan with Interest
Here you will find a simple workflow of taking and repaying loan from a bank. In case you take a loan from some friend or relative then instead of applying you will request for a loan.
Conclusion
A loan is borrowed money that you have to return, while capital is your own money which need not be repaid to anyone.