What is a loan?
Definition of loan can be described as a property, money, or other material goods that is given to another party in exchange for future repayment of the loan value plus interest and other finance charges. A loan can be for a specific, one-time amount, or it may be availed as an open-ended line of credit up to a specific limit. Loans come in different forms like personal, commercial, secured, and unsecured loans.
A loan is a debt incurred by an individual or some entity. The other party in the transaction is called a lender – it is usually a government, financial institution, or corporation. They lend the required sum of money to the borrower. In return, the borrowers agree to pay a certain set of terms, including any finance charges, interest, etc. with the initially borrowed money.
How does the loan process work?
When you need money, you apply for a loan from a corporation or a bank. You are required to provide specific details such as why you need the loan, you will have to disclose your financial history, Social Security Number (SSN), and other information which can vary from lender to lender.
The lender will review your application and check your debt-to-come ratio to evaluate if you can pay the loan back to them. Based on your application, the lender will either approve or deny the application. If your application is denied, the lender has to provide a reason for the same.
If your application is approved, a contract is signed between you and the lender. The lender transfers the loan amount to your account that you need to pay back along with the interest and other charges.
There are terms of a loan that must be agreed upon by both the parties before the contract is signed and money is disbursed. In some cases, the lender requires collateral, the details of which are covered in the loan document. Most loans also have provisions regarding the maximum amount of interest, and the length of time before repayment is required.
Why and when loans are given?
Loans are disbursed for many reasons. A borrower may need a loan for purchasing an item, debt consolidation, business ventures, renovations, or investing. Business loans can help companies expand their operation.
In short, loans allow for the growth in the overall money supply in an economy and open up competition by lending to new businesses. The interest and other fees that lenders (banks) take from borrowers are a source of revenue for them.
An important factor while taking a loan
For a borrower, one of the most important factors while taking a loan is interest rates. Loans with higher interest rates will cost more money to the borrower – he has to pay higher monthly payments or take longer to pay off the loan compared to the loan with a lower interest rate. For example, if you borrow $5000 on a 5-year installment for a term loan with a 4.5% interest rate, you will have to pay a monthly payment of $93.22 for the next five years. However, if your interest rate is 9%, you will have to pay $103.79 for the same period.
Let us understand it differently. If you have taken a loan of $10,000 and the interest rate is 6% and you decide to pay $200 per month, you need to pay for 58 months to clear off your loan or balance. With 20% interest, and the same balance and monthly payment, it will take 108 months to pay off the loan.
What questions should one ask while getting loan?
Few questions that one should ask while getting a loan are: How long will it take to get the money?, What is the interest rate on the loan?, What is the term of the loan? And Are there any fees?
What are the three common classifications of loans?
Loan can be classified into three main categories, namely, unsecured and secured, conventional, and open-end and closed-end loans.
What factors affect loan approval?
Factors such as credit score, debt-to-income ratio, down payment, work history & value and
condition of the home affect loan approval.
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