What is a Loan?
A loan is a term that we are all familiar with. The processing of loans is one of the most important functions of a bank. It keeps our economy stable and facilitates the implementation of monetary policies. Let's take a look at the different forms of loans and get some answers to some common questions.
A loan is a financial transaction in which one or more individuals, organizations, or other entities lend money to other individuals, organizations, or entities. The recipient (i.e., the borrower) incurs a debt and is generally responsible for paying both interest and the principal sum lent before the debt is repaid.
The document evidencing the debt (for example, a promissory note) will usually include information such as the principal amount borrowed, the interest rate charged by the lender, and the due date. A loan involves the lender and the borrower reallocating the subject asset(s) for a period of time.
The lender is encouraged to participate in the loan because of the interest. Each of these obligations and restrictions is enforced by contract in a legal loan, which can also impose additional restrictions known as loan agreements on the borrower.
Secured and Unsecured Loans
A loan is when you borrow money from a friend, bank, or other financial institution in exchange for repayment of the principal plus interest in the future. The principal is the amount you borrowed, while the interest is the fee you paid to get the loan. Because lenders are taking a chance that you will default on the loan, they must compensate for this risk by charging a fee known as interest. Secured and unsecured loans are the most common types of loans. A secured loan is one in which the borrower pledges an asset (such as a car, boat, or house) as collateral. The lender takes possession of the asset if the borrower defaults or fails to repay the loan. Unsecured loans are preferred, but they are less common. If the borrower doesn't pay back the unsecured loan, the lender doesn't have the right to take anything in return.
Any financial institution can approve and disburse a term loan, which can be short-term or long-term. Over a set period of time, the offered loan amount will be repaid in regular payments, such as equated monthly instalments (EMIs). Term loans are available with both fixed and floating interest rates. A term loan for business purposes typically has a repayment period of 12 to 84 months. Term loans are available in a variety of forms, including business loans, personal loans, home loans, education loans, auto loans, and gold loans.
The total amount financed in a loan is known as the base loan amount. The base loan amount can include the purchase price minus the down payment, as well as any fees or closing costs.
Personal Loans - These loans are available from almost any bank. The good news is that you usually have complete freedom over how you spend your money. You could take a vacation, purchase a jet ski, or purchase a new television. Personal loans are typically unsecured and relatively simple to obtain if you have a good credit history. The disadvantage is that they are usually for small amounts, usually not exceeding $5,000, and the interest rates are higher than those offered by secured loans.
Personal loans are used for a variety of purposes, including wedding expenses and debt consolidation. Personal loans can be unsecured, which means you won't have to put up any collateral, such as your house or car if you default on your loan.
For debt consolidation and major purchases, this is the best option.
If you owe money on a credit card with a high interest rate, a personal loan could help you pay it off faster. To use a personal loan to consolidate your debt, you'd apply for a loan equal to the amount you owe on your credit cards. If you're approved for the full amount, you'll pay off your credit cards with the loan funds instead of making monthly payments on your personal loan.
A personal loan may offer a lower interest rate than a credit card, depending on your credit score — and a lower interest rate could mean significant savings. It might be useful to get a sense of the average debt consolidation loan rate.
If you need to finance a large purchase, such as a home improvement project, or if you have other large expenses, such as medical bills or moving expenses, a personal loan may be a good option.
Cash Advances - Cash advances from your credit card company or other payday loan institutions are an option if you are in a pinch and need money quickly. These loans are simple to obtain, but the interest rates can be extremely high. They are usually only for small sums of money, such as $1,000 or less. These loans should only be considered if there are no other options for obtaining funds.
Student Loans - These are excellent options for funding a college education. The Stafford and Perkins loans are the most common types of student loans. The interest rates are low, and you usually don't have to pay back the loans while enrolled full-time in college. The disadvantage is that these loans can easily exceed $100,000 over the course of four, six, or eight years, leaving new graduates with significant debts as they begin their new careers.
When you opt for an education loan against property, it covers:
- Tuition fees
- Course material cost
- Study tour charges
- Medical costs, etc.
Mortgage Loans - This is almost certainly the largest loan you'll ever receive! This is probably the best option if you're looking to buy your first home or some other type of real estate. The house or property you are purchasing serves as collateral for these loans. That means if you don't pay your bills on time, the bank or lender may repossess your home or property. Mortgages enable people to purchase homes that would otherwise require years of saving. They're usually structured in 10, 15, or 30-year terms, and the interest you pay is tax-deductible and relatively low when compared to other types of loans.
Home Equity Loans and Lines of Credit - These loans allow homeowners to borrow against the equity in their homes. The difference between the appraised value of your home and the amount you still owe on your mortgage is the equity or loan amount. These loans can be used for home improvements, home additions, or debt consolidation. The interest rate is frequently tax-deductible, and it is also relatively low when compared to other types of loans.
Small Business Loans - People who want to start a business usually get these loans from their local banks. They do necessitate a little more effort than usual, and they frequently necessitate the creation of a business plan to demonstrate the viability of your endeavor. Because these are frequently secured loans, you will be required to put up some personal assets as collateral if the business fails.
Factors to be Considered Before Applying for a Loan
There are a few things that people who want to apply for loans should look into first. They include the following:
1. Credit Score and Credit History
If a person has a good credit score and history, it demonstrates to the lender that he can make timely payments. As a result, the higher the credit score, the more likely the person will be approved for a loan. An individual with a good credit score has a better chance of obtaining favourable terms.
Another factor to consider before applying for any type of loan is an individual's income. Pay stubs, W-2 forms, and a salary letter from their employer must be submitted by an employee. If the applicant is self-employed, all he needs to submit is his tax return from the previous two years and, if applicable, invoices.
3. Monthly Obligations
A loan applicant must also consider their monthly obligations in addition to their income. For example, a person may earn Rs.60,000 per month but owe Rs. 55,000 in monthly obligations. Lenders may be hesitant to lend to such individuals. It's for this reason that most lenders require applicants to list all of their monthly expenses, including rent and utility bills.
- Overestimating loan repayment capacity
- Applying to multiple lenders simultaneously
- Not disclosing previous debt details
- Availing loans with very long tenures
Context and Application
This topic is important for the students pursuing the below-mentioned disciplines.
- Master in Business Administration
- Masters in Commerce
- Bachelor of Economics
- Bachelor of Commerce
- Loan agreement
- Loan Guarantee
- Legal Financing
Want more help with your finance homework?
*Response times may vary by subject and question complexity. Median response time is 34 minutes for paid subscribers and may be longer for promotional offers.
Loans Homework Questions from Fellow Students
Browse our recently answered Loans homework questions.