The loan is simply referred to as a type of credit that involves a sum of money lent to another party in exchange for later repayment with interest or simply the principal amount. In some scenarios, the lender often gets repaid with interest or charges over the principal value. A loan can take the form of a one-time amount or they may be available as an open-end line of credit with an apportioned limit. Loans are offered in many forms such as secured, unsecured, commercial, and personal loans.
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WHAT YOU SHOULD KNOW
- A scenario whereby money is offered to another party in exchange for repayment of the loan principal with interest added is referred to as a loan.
- An agreement must be reached between two parties before the money is released for further repayment with interest.
- Loans call for collateral to secure the loan. E.g. mortgage or it could unsecure, e.g. credit card.
- Loans can be a revolving loan or fixed rate or payment loan.
Generally, loans can be best described as incurred debt which can be by an individual or corporate entity. The lenders could be a corporate financial institution or government in a position to lend funds to borrowers. The borrower should be able to concur with the requirements such as the interest charges, repayment date, and some other terms.
There are basically three reasons required from the borrower when applying for a loan.
They are financial history, social security number, and other information. The creditworthiness is what clears off the total reason a loan application should be denied or approved. When it is approved, the borrower and the lender get to sign a contract. Over the contract, it contains the repayment schedules and so on.
Before the loan is handed over to the second party, the terms must be agreed upon by both parties. The loan helps established companies to expand their business operations. The first intention of loans in the business world is growing. And over the financial lenders, loans serve as a way to make more money through interest rates as well as retailers for credit facilities and credit cards.
Now, loans having high-interest rates will attract higher monthly payments or take longer pay off other than a loan with lower interest.
Simple interest and compound interest
Interest rates can be simple interest or compound interest. Here is the reason for that – simple interest is interest on a principal loan. It is uncommon for banks to charge consumers with simple interest.
A compound interest as the name sounds means more interest needs to be paid by the borrower. It is assumed that the borrower owes the principal plus interest at the end of the first year, while in the second year, the borrower owes the principal and interest plus the first-year interest. This is because the interest charged monthly on the principal loan amount is high.
Types of Loans
There are couples of a number of loans depending on the cost involved and the terms of the contract.
A secured and unsecured loan
Loans can be secured or unsecured. In the likes of mortgage and car loans, there are secured loans because they are backed by collateral. The loan over here draws balance against default from the asset for which the loan is taken out. In a mortgage, a home as collateral and the vehicle secure a car loan.
Credit cards and signature loans are typically unsecured loans. Thus there is no need for backup (collateral). This makes it riskier and attracts more likes of high interest. This is riskier because the lender cannot lay hold of any asset unlike secured loans to recover the loss.
Revolving and Term Loans
Loans can also be in the form termed revolving or term loans. In revolving loans, it keeps on recycling the use from spending to repaying to spending it again. But in a term loan, the loans is paid off in equal monthly installments with respect to time. A typical example of revolving loans is an unsecured credit loans and home equity line of credit as secured revolving loans. Car loans are secured nature of term loan, while a signature loans is an unsecured term loans.