A. Definition of Loan
In finance, a loan is the lending of money by one or more individuals, organizations, and other entities to other individuals, organizations etc. The recipient (i.e. the borrower) incurs a debt, and is usually liable to pay the debt until it is repaid, and also to repay the principal amount borrowed. The document evidencing the debt, e.g. a promissory note, will normally specify, among other things, the principal amount of money borrowed, the interest rate of the lender is charging, and date of repayment. A loan entailed for the period of time, between the lender and the borrower.
The interest provides an incentive for lenders to engage in the loan. In a legal loan, each of these obligations and restrictions is enforced by contract, which can also place the borrower under known as loan covenants. Although this article focuses on monetary loans, in practice any material object might be lent.
Acting as a provider of loans is one of the main activities of financial institutions such as credit cards and companies. For other institutions, such bonds are a typical source of funding.
B. Types of Loans
A secured loan is a loan in which the borrower pledges some assets (e.g. a car or house) as collateral.bA mortgage loan is a very common type of loan, used by many individuals to purchase residential property. The lenders, usually a financial institution, are given security – a lien on the title to the property – until the mortgage is paid off in full. If the borrower defaults on the loan, the bank would have the legal right to repossess the house and sell it, to recover sums owing to it. Similarly, a loan is taken out to buy a car may be secured by the car. The duration of the loan is often shorter. There are two types of auto loans, direct and indirect. In a direct auto loan, a bank lends the money directly to a consumer. This is an indirect auto loan, a car dealership (or connected company) acts as an intermediary between the bank or the financial institution and the consumer.
Unsecured loans are monetary loans that are secured against the borrower’s assets. These may be available from financial institutions under many different guises or marketing packages:
- credit card debt
- personal loans
- bank overdrafts
- credit facilities or lines of credit
- corporate bonds (may be secured or unsecured)
- peer-to-peer lending
Interest rates on unsecured loans are often expensive for secured loans because they are severely limited, subject to higher risk compared to secured loans. An unsecured lender must borrow the loan, obtain a money judgment for a contract, and then pursue an execution against the borrower’s unencumbered assets (that is, those already pledged to secured lenders). In insolvency proceedings, secured lenders traditionally have priority over unsecured lenders when a court divides up the borrower’s assets. Thus, a higher interest rate reflects the additional risk that in the event of insolvency, the debt may be uncollectible.
Demand loans are short-term loans that typically do not have fixed dates for repayment. Instead, carry a floating interest rate which varies according to the prime lending rate or other defined loan terms. Demand loans can be called for repayment by the lending institution at any time. Demand loans may be unsecured or secured.
A subsidized loan is a loan on which the interest is reduced by an explicit or hidden subsidy. In the context of college loans in the United States, it refers to a loan on which no interest is accrued while a student remains enrolled in education.
A concessional loan, sometimes called a “soft loan”, is granted on terms of substantially more generous loans, either through below-market interest rates, by grace, the period of the combination of both. Such loans may be made by foreign governments to develop countries or may be offered to employees of lending institutions as well as employee benefits (sometimes called a case).
C. Loan Payment
The most typical loan payment type is the fully amortizing payment. The monthly rate has the same value over time
D. Abuses in Lending
Predatory lending is one form of abuse in the granting of loans. It usually involves granting a loan in order to put the borrower in a position that one can gain an advantage over him or her; subprime mortgage-lending and payday-lending are two examples, where the moneylender is not authorized or regulated, the lender could be considered a loan shark. Usury is a different form of abuse, where the lender charges excessive interest. In different time periods, the acceptable interest rate has varied, from no interest at all to unlimited interest rates. Credit cards companies in some countries have been accused by consumers of lending at usurious interest rates and making money out of volatile “extra charges”. Abuses can also take place in the form of the customer, using the lender by not repaying the loan or by intent to defraud the lender.
E. How Do Interest Rates Affect Loans?
Interest rates have a huge effect on loans. In short, loans with high interest rates have higher monthly payments or take longer to pay off loans with low interest rates. For example, if a person borrows $ 5,000 on an install or term loan with a 4.5% interest rate, he faces a monthly payment of $ 93.22 for the next five years. In contrast, if the interest rate is 9%, the payments climb to $ 103.79.
Similarly, if a person owes $ 10,000 on a credit card with a 6% interest rate and pays $ 200 each month, it will take him 58 months or nearly five years to pay off the balance. With a 20% interest rate, the same balance and the same $ 200 monthly payments, it will take 108 months or nine years to pay off the card.
The interest rate on loans can be set at a simple interest or a compound interest. Simple interest is interest on the principal loan, which banks almost never charge borrowers. For example, if an individual takes out a $ 300,000 mortgage from the bank and loan agreement stipulates that the interest rate on the loan is 15%, this means that the borrower will have to pay the bank the original loan amount of $ 300,000 x 1.15 = $ 345,000.
Compound interest is interest on interest and means more money in interest to be paid by the borrower. The interest is not only applied on the principal, but also on an accumulated interest of previous periods. The bank assumes that at the end of the first year, the borrower owes the principal plus interest for that year. At the end of the second year, the borrower owes the principal and the interest for the first year plus the interest on interest for the first year. The interest owed when compounding is taken into consideration is the simple interest method because of the accrued interest from the previous months. For shorter time frames, the calculation of interest will be similar to both methods. As the lending time increases, though, the disparity between the two types of interest calculations grows.