What Exactly Is a Loan?
Generally speaking, a loan is a type of credit instrument in which a sum of money is loaned to another party in exchange for future repayment of the loan’s value or principal amount. Most of the time, the lender will also charge interest and/or finance charges on top of the principal amount, which the borrower will be required to repay in addition to the principal amount owed. Depending on the loan type, it may be possible to obtain a one-time loan for a specific amount, or it may be possible to obtain an open-ended line of credit up to a specified limit. Loans are available in a variety of shapes and sizes, including secured, unsecured, commercial, and personal loans.
Loans: What You Need to Know
A loan is a type of debt that can be incurred by an individual or by a business. A sum of money is advanced to the borrower by the lender, which is typically a corporation, financial institution, or government. In exchange, the borrower agrees to a specific set of terms, which may include finance charges, interest, a repayment date, and other terms and conditions, among other things. When a lender requires collateral to secure a loan and ensure repayment, this is known as a โcollateral requirement.โ Besides loans, bonds and certificates of deposit can also be used as collateral (CDs). Additionally, it is possible to borrow money from one’s 401(k) account.
Here’s how the loan application and approval process works. The process of applying for a loan from a bank, corporation, government or other entity begins when someone is in need of money. The borrower may be required to provide specific information, such as the reason for the loan, their financial history, their Social Security Number (SSN), and other information, before the loan can be approved. The lender examines the information, including the borrower’s debt-to-income (DTI) ratio, to determine whether or not the loan can be repaid. The lender makes a decision on whether or not to approve the application based on the applicant’s creditworthiness. If the loan application is denied, the lender is required to provide a reason for the denial. Upon approval of the application, both parties will be required to sign a contract outlining the terms of the agreement. The lender advances the loan proceeds to the borrower, who then has 30 days to repay the loan amount plus any additional fees or charges, such as interest, that were incurred.
A loan’s terms are agreed upon by both parties before any money or property changes hands or is disbursed to the other party. A lender’s requirement for collateral is specified in the loan documents if the lender requires it. Most loans also include provisions governing the maximum amount of interest that can be charged, as well as other covenants such as the amount of time that must elapse before repayment is due.
There are a variety of reasons for which loans are advanced, including large purchases and investments, renovations, debt consolidation, and business ventures. Loans can also be used to help existing businesses expand their operations. Loans allow for the expansion of the total money supply in an economy, as well as the opening of new markets to competition through lending to new businesses. A primary source of revenue for many financial institutions, as well as some retailers who use credit facilities and credit cards, is interest and fees collected on loans and credit cards.
Types of Loans
Loans are available in a variety of shapes and sizes. There are a variety of factors that can differentiate the costs associated with them, as well as the contractual terms under which they are offered.
Loans with collateral vs. loans with no collateral
Loans can be secured or unsecured, depending on the circumstances. Mortgages and auto loans are both classified as secured loans because they are backed or secured by collateral. In these instances, the collateral is the asset for which the loan is being obtained; for example, the collateral for a mortgage is the home, while the collateral for a car loan is the vehicle. Depending on the loan type, borrowers may be required to put up additional forms of collateral in order to qualify for the loan.
Unsecured loans, such as credit cards and signature loans, are common. As a result, they are not backed by any form of collateral. Unsecured loans typically have higher interest rates than secured loans because the risk of default on an unsecured loan is higher than the risk of default on an unsecured loan. This is due to the fact that if a borrower defaults on a secured loan, the lender has the right to repossess the collateral. Unsecured loan rates are notoriously volatile, fluctuating wildly depending on a variety of factors, including the borrower’s credit history.
Term Loan vs. Revolving Credit
Loans can also be classified as either revolving or term in nature. Revolving loans can be used over and over again, whereas term loans are loans that must be paid off in equal monthly installments over a specified period of time, such as five years. A credit card is a revolving loan that is unsecured, whereas a home equity line of credit (HELOC) is a secured revolving loan that is unsecured. A car loan, on the other hand, is a secured, long-term loan, whereas a signature loan is an unsecured, short-term loan.