What do We Call Amounts of Money Borrowed from Lenders?
A lender is an individual, a group, government, or a company that offers to finance against security or after the client fulfill certain required conditions, which make it easy for them to gauge the probability of getting their money back. The money advanced to the client is called a loan, and the client is called the borrower or the debtor.
Generally, a loan can be defined as money, property goods of material products advanced to a needy party with a promise of repayment at a later date in full amount with additional costs incurred in terms of interests. The loan amount is inclusive of the value of the debt incurred and the interest in the value. This amount is known as the principal; the lender determines the interest on the other by use of some internal underwriting frameworks as well as simple and compound interest formulas. Loans can be a one-off piece of finance, or they can be open-ended and subject to regulation and capping.
Importance of loans
- Loans promote money supply in the economy by helping to bring to an equilibrium money demand and money supply.
- Loans are a primary source of income to the lenders.
- They enhance economic growth by extending financial aid to struggling companies or those that seek startup capital.
- By advancing loans to companies, better working environments can be instituted as well as masterminding the expansion and growth of these institutions.
- Loans help individuals to solve urgent financial problems.
How it works
For money or property to exchange hands between the borrower and the lender, loan terms must be agreed between these two parties. The terms of the loans usually consist of the expected loan term, the amount the borrower is advanced with, the amount of interest chargeable on loan, expected amount to be repaid, the channel of payment, payment plan, etc.
If the loan has a provision for the inclusion of collateral, then the contract shall stipulate it during negotiations. Those with higher rates of interest are characterized by excessive monthly installments, while those with low rates enjoy a more reduced installment plan.
Furthermore, a loan can either be identified as secured or unsecured. Secured loans are those that are secured using a valuable asset in the name of collateral. Contrarily, unsecured forms of financing involve those loan products that one can acquire without necessarily having to post collateral. Secured loans are usually characterized by lower rates of interest due to the presence of an appraisal. Unsecured loans have high-interest rates.
Another category of loans is revolving loans and term loans. From their names, term loans are fixed forms of financing with a fixed interest rate and a fixed repayment period. However, revolving loans are those that one can work’ they feature spending, repaying it, and spending again.
Types of loans
As discussed above, loans are differentiated majorly by the following factors:
- Security on the loan
- Repayment term
- Purpose of the loan
- Type of interest charged
- Security on the loan
Secured loans have a provision where the borrower must secure the financing with collateral. The collateral needs to be valuable to earn more from the loan and also to be charged lower interest rates on borrowing. Secured loans include; mortgages, auto loans, home equity lines of credit, business loans, bridging loans, etc. mortgages are house loans whereby the house is the collateral on loan. On the other hand, a home-equity line of credit is a loan taken against one’s house. In this case, the borrower must have sufficient equity in the home. This loan is also called a second mortgage.
An auto loan is a loan taken against a vehicle; bridging loans are secured using any form of tangible asset. As highlighted earlier, secured loans have a low-interest rate; however, whenever the borrower is unable to repay the amount of loan within the stipulated time, the loan is declared defaulted; hence the lender might move to claim ownership of the collateral. For instance, with mortgages, the lender may declare foreclosure; hence the borrower ends up losing the house.
On the other hand, unsecured loans are expensive due to their hefty rates of interest. The inability to repay may further damage the borrower’s credit rating hence preventing the borrower from future credit qualifications.
- Repayment term
With repayment terms, we have term and revolving loans. Term loans have a fixed repayment period with fixed and regular monthly installments. On the contrary, revolving loans are those kinds of loans that can be advanced, spent, repaid on time as spent again. To illustrate these loans, an auto loan is a secured term loan, while a signature loan is an example of an unsecured term loan. Also, a credit card debt is an example of an unsecured revolving loan, while a home-equity line of credit, on the other hand, is a secured revolving loan.
The type of lender also determines the type of financing. A lender can either be private or public. Private lending involves loans such as hard money loans, bridging loans, peer-to-peer loans, etc. Public lending, on the other hand, involves mortgages, business loans, asset financing, etc. Also, there are lenders who don’t pull a credit inquiry of the client and those that do so.
- Loan purpose
The purpose of the loan may significantly influence the kind of loan you apply for as well as the loan amount you may walk away with. However, circumstances under which you may be in will determine more the type of loan you take than the real purpose of the loan. For example, if you want a mortgage since it charges lower rates but your credit rating is weak, then you may decide to go for a bridging loan or a hard money loan instead.
- Type of interest
There are two main types of interest chargeable on a loan amount. They include simple interest and compound interest. Check Loan Advisor to compare loans online and you can get your ideal interest rates online.
The bottom line
A loan is an amount of money or any tangible asset advanced to a borrower with a promise of repayment of the full amount plus interest on an agreed-upon later date. Loans are issued by organizations, corporates, government, and its agencies, individuals, or groups of people.
Loans are crucial in an economy since they enable free flow of currency from one point to another hence creating the much-needed equilibrium in the money market. There are several types of loans based on the lender, repayment date, and security on loan, among others.