Loan
What Is a Loan?
The term loan refers to a type of credit vehicle in which a sum of money is lent to another party in exchange for future repayment of the value or principle amount. Loans can be given to individuals, corporations, and governments. The main idea behind taking out one is to get funds to grow one’s overall money supply. The interest and fees serve as sources of revenue for the lender. In many cases, the lender also adds interest or finance charges to the principal value, which the borrower must repay in addition to the principal balance.
Loans may be for a specific, one-time amount, or they may be available as an open ended line of credit up to a specified limit. Loans come in many different forms including secured, unsecured, commercial, and personal loans.
Types of loan
1. Secured loan
A secured loan is a type of debt in which the borrower pledges some asset as collateral like house, car, land etc.
A mortage loan is a always very common type of loan, used by many individuals to purchase residential or commercial property. The lender, usually a financial institution, is given security a lien on the title to the property until the mortgage is paid off in full. In the case of home loans, 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 taken out to buy a car may be secured by the car. The duration of the loan is much shorter often corresponding to the useful life of the car. There are two types of auto loans, direct and indirect. In a direct auto loan, a bank lends the money directly to a consumer. In an indirect auto loan, a car dealership acts as an intermediary between the bank or financial institution and the consumer.
Other forms of secured loans include loans against securities such as shares, mutual funds, bonds, etc. This particular instrument issues customers a line of credit based on the quality of the securities pledged. Gold loans are issued to customers after evaluating the quantity and quality of gold in the items pledged. Corporate entities can also take out secured lending by pledging the company's assets, including the company itself. The interest rates for secured loans are usually lower than those of unsecured loans. Usually, the lending institution employs people (on a roll or on a contract basis) to evaluate the quality of pledged collateral before sanctioning the loan.
2. Unsecured loan
Unsecured loan are monetary loans that are not secured against the borrower's assets. These may be available from financial institutions under many different guises or marketing packages:
- Credit cards
- Personal loans
- Bank overdrafts
- Credit facilities or lines of credit
- Corporate bonds
- Peer to peer lending
The interest rates applicable to these different forms may vary depending on the lender and the borrower. These may or may not be regulated by law.
Interest rates on unsecured loans are nearly always higher than for secured loans because an unsecured lender's options for recourse against the borrower in the event of default are severely limited, subjecting the lender to higher risk compared to that encountered for a secured loan. An unsecured lender must sue the borrower, obtain a money judgment for breach of contract, and then pursue execution of the judgment against the borrower's unencumbered assets (that is, the ones not 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.
Differences between a loan and a credit
A loan is a financial product that allows a user to access a fixed amount of money at the outset of the transaction, with the condition that this amount, plus the agreed interest, be returned within a specified period. The loan is repaid in regular instalments. The main characteristics of a financial loan include:
- The transaction has a pre-determined life span.
- 2.Once all the capital has been repaid through the payment of the instalments (monthly, quarterly, half-yearly…), the operation is concluded without the possibility of accessing more money, unless a new loan is arranged.
- 3.Interest is charged on the total amount of money borrowed.
- 4.Loans have a longer term, usually of years.
A credit is a more flexible form of finance that allows you to access the amount of money loaned, according to your needs at any given time. The credit sets a maximum limit of money, which the customer can use in part or in full. The customer may use all the money provided, part of it or none at all. We review the main characteristics of a credit that distinguish it from a loan:
- Interest on credits is usually higher than on a loan.
- Interest is only paid on the amount used, although there may be a minimum fee payable on the undrawn balance.
- As the money is returned, more will become available, provided that the limit is not exceeded.
- Unlike the loan, the credit is usually renewed each year in order to allow the customer to continue to use this credit facility whenever necessary.
The usual ways to obtain finance through a credit are credit cards and credit facilities or lines of credit, which are generally arranged through a current account in which deposits and withdrawals can be made up to the agreed limit.
Credits are usually used to cover delays between receipts and payments for companies, to deal with specific periods of lack of liquidity or for specific purchases. Loans, on the other hand, are often used to finance the purchase of goods or services.
1. Your Credit Score and History
Individual’s credit score and credit history can haunt them for years. This is because all potential lenders use these bits of information to gauge how much of a “safe bet” you are before handing you a loan. If your credit score is bad, then you may be locked out of lots of more affordable loans, so you will be charged high interest. While a five percent vs. eight percent interest rate on a different loan may not seem like a huge deal at first, it can end up costing you thousands of dollars more, depending on how much you borrow. So tread carefully.
2. Limitations
While you may be thinking of your income in relation to your debt, you need to take into account your monthly payments and how much you’ll be shelling over for a period of time. Also, you should look into different limitations a loan may set out from the get-go to better fit within your budget. Within this context, payday loans are helpful in that they are usually capped depending on your income, so you cannot borrow more than you are able to afford. The interest rates are also incredibly limited, so the likelihood of creating more debt for yourself is circumvented substantially. Loans that come with strings attached are pretty helpful, at the end of the day.
3. Hidden Fees
Before you take out a loan, be sure to read the fine prints. There are many hidden fees in most loans that may end up doubling your monthly payments and thus making it a less affordable option. Also, be sure that you know what the APR is, and how much late fees or penalties can cost you. These all add up tremendously and may cause you to dig an even deeper financial hole for yourself than previously imagined.
4. Consider All Your Options
There are many loan options out there, and it makes sense to take the time to review them. You don’t want to make a hasty decision out of desperation that rarely pays off. When taking out a loan, look through different banks or lenders who may be able to offer assistance without robbing you blind or overcharging you in terms of fees, and so on. Depending on the size of your debt, there may be other solutions on hand to help you out of a rut, such as a balance transfer card, etc.
Taking out a loan is a big decision, and should be treated as such. Knowing all the details and figuring out the fine print is crucial to the success of the process. When you’re finally ready to decide on borrowing money, you need to be absolutely sure you’re going with the most flexible and suitable lender for your case.