What Is a Loan?
A loan is money a lending entity gives to a borrowing entity that the borrower repays after a set period, usually with interest. Most loans are secured by collateral to minimize the risk of nonpayment and are governed by terms that the borrower agrees to.
There are many types of loans including closed-end, open-ended, unsecured and secured loans. A loan can be used for many purposes such as purchasing a home, making a large purchase, paying off debt or investing in an enterprise.
Loans are typically provided by banks, credit unions, private financial institutions and other financial providers. Some types of loans are revolving (you can continue to borrow funds up to your limit until you pay off the balance) while others are closed-ended, like mortgages and car loans.
In the business world, loans are often used to finance growth by funding expansion beyond a company’s cash flow. This can enable companies to grow more quickly than they would otherwise, enabling them to increase revenue and profits. The most common source of financing for new businesses is from lenders, but a company may also seek venture capital or other outside investors to help fund growth.
The term of a loan can vary from 1 to 15 years and may depend on the purpose for which it was borrowed, the amount borrowed and other factors. Typically, the longer the term of a loan, the more interest will be paid on it. Some loans are structured with payments that shift from principal to interest over the course of the loan, while others have a fixed payment each month.
Unsecured loans, such as credit card balances, are not backed by any assets and come with higher interest rates than secured loans. Generally, the lender can’t seize the borrower’s property in the event of default but will report it to the credit bureaus, which could impact a person’s ability to get another loan in the future.
Secured loans are backed by an asset such as a home or automobile and therefore can offer lower interest rates than unsecured loans. To obtain a secured loan, borrowers must complete an application and often submit documentation such as tax returns and credit reports. The loan contract typically outlines the specifics of the loan and will spell out the required collateral and any other terms the borrower must agree to.