What is a loan?
A term loan refers to a type of line of credit where a sum of money is lent to another party in exchange for future repayment of the principal amount or value. In many cases, the lender also charges interest or a financing fee on the principal, which the borrower must repay on top of the principal balance.
Loans can be for a single fixed amount or available as an open line of credit up to a fixed limit. Loans come in many different forms, including secured, unsecured, business, and personal loans.
KEY TAKEAWAYS
- A loan is when money is given to another party in exchange for repayment of the loan principal amount plus interest.
- Lenders will consider a prospective borrower’s income, credit score, and debt levels before deciding to offer them a loan.
- A loan may be secured by collateral, such as a mortgage, or it may be unsecured, such as a credit card.
- Revolving loans or lines can be spent, repaid, and spent again, while term loans are fixed-rate, fixed-payment loans.
- Lenders may charge higher interest rates to risky borrowers.
Understanding Loans
A loan is a form of debt incurred by an individual or entity. A lender, usually a corporation, financial institution, or government, pays the borrower an amount of money. In return, the borrower agrees to a number of specific terms, including financing costs, interest, repayment period, and other terms.
In some cases, the lender may require a bond to secure the loan and guarantee repayment. Loans can also come in the form of bonds and certificates of deposit (CDs).It is also possible to take out a loan through a 401(k) account.
The Lending Process
This is how the lending process works: When a person needs money, they apply for a loan from a bank, corporation, government or other entity. The borrower may be asked to provide details such as the reason for the loan, financial history, social security number (SSN), and other information. The lender reviews this information along with the person’s debt-to-equity (DTI) ratio to determine if the loan can be repaid.
The creditor either rejects or approves the application based on the applicant’s creditworthiness.The lender must provide a reason for rejecting the loan application. If the application is granted, both parties sign a contract with the details of the contract. The lender transfers the loan amount, after which the borrower has to repay the amount including any additional costs such as interest.
The terms of the loan are agreed upon by each party before the money or property changes hands or is paid off. If the lender requires collateral, make a note of this on the loan documents.Most loans also contain provisions on a maximum interest rate and other conditions such as the term until repayment.
Why are loans used?
Loans are granted for a variety of reasons including major purchases, investments, renovations, debt consolidation, and business ventures. Loans also help existing businesses to grow their businesses. Credit allows for an increase in the total money supply in the economy and opens up competition by lending to new businesses.
Loan interest and fees are an important source of income for many banks and some retailers through the use of loans and credit cards.
Loan Components
There are several important conditions that determine the loan amount and how quickly the borrower can repay it:
- Principal: This is the initial loan amount that is borrowed.
- Loan Term: The period in which the borrower expects to repay the loan.
- Interest Rate: Rate of increase in money owed, usually expressed as an annual percentage rate (APR).
- Loan Repayment: The amount of money that must be paid monthly or weekly to meet the loan terms.The repayment plan can be used to determine this based on the capital sum, the loan term and the interest rate.
In addition, the lender may also charge additional fees, such as upfront fees, service fees or late payment interest. Collateral, such as real estate or a vehicle, may also be required for larger loans. If the borrower defaults on the loan, these assets can be confiscated to pay off the outstanding debt.
