Loan
Definition
A loan is a sum of money that one or more individuals or companies borrow from banks or other financial institutions to be repaid over time with interest.
Detailed Explanation
In banking, a loan entails the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations, etc.
The recipient (i.e., the borrower) incurs a debt and is usually liable to pay interest on that debt until it is repaid, as well as to repay the principal amount borrowed.
The documents of the debt, such as a promissory note, will specify the principal amount of money borrowed, the interest rate the lender is charging, and the date of repayment. A loan may be for a specific, one-time amount or can be available as an open-ended line of credit up to a specified limit or ceiling amount (like a HELOC).
Loans come in many forms including secured, unsecured, commercial, and personal loans.
Secured loans are backed by collateral, meaning the lender can take possession of the borrower’s collateral if they default on the loan. Unsecured loans do not involve collateral, but usually have higher interest rates.
Common loan types include:
- Mortgage
- Auto
- Student
- Business
- Personal
Loans are essential for providing liquidity within the economy and allowing individuals and companies to make investments or purchases while spreading the payment over a period.
Example
John takes out a $300,000 mortgage with a 30-year term and a fixed interest rate of 4.5% to buy a house. This type of loan is secured by the house itself, which means the bank could foreclose on the house if John fails to make his mortgage payments.
Key Articles Related To Loans
Related Terms
Interest Rate: The percentage at which interest is paid by a borrower for the use of money that they borrow from a lender.
Mortgage: A loan specifically used to purchase real estate, secured by the property itself.
Principal Amount: The original sum of money borrowed in a loan or put into an investment.
Secured Loan: A loan backed by collateral, providing the lender an assurance that the loan will be repaid, or the assets can be taken.
FAQs
What factors determine the interest rate on a loan?
Interest rates on loans depend on several factors, including the creditworthiness of the borrower, the loan amount, term, and prevailing market conditions.
Can I pay off a loan early?
Yes, many loans can be paid off early, but some might have prepayment penalties that apply if the loan is repaid before the term ends.
What is the difference between a loan and a line of credit?
A loan provides a lump sum of money up front and involves regular payments until the total is repaid, whereas a line of credit offers access to funds up to a certain limit and is not advanced all at once.
Editor: Colin Graves