What Is a Loan?
A loan is a financial instrument in which a sum of money is given to the borrower by a lender in exchange for future repayment of the principal plus interest. A loan can be disbursed for a variety of reasons including investment, debt consolidation and business ventures. Loans serve to grow the overall money supply in an economy and also help open up competition by allowing companies to expand their operations. There are different types of loans based on the amount and purpose of the loan, the length of the term and the type of payment mechanism. The most common loan is a mortgage, followed by a credit card and personal loan.
A common misconception is that a loan is the same as a credit, however, there are several differences between them. The main difference is that a loan is disbursed for a specific amount of money and is only available to the borrower once the debt is paid in full, while a credit is a facility which allows the borrower to access capital at any time as long as they pay off their outstanding balance. A credit also has a pre-determined life span which means that the facility becomes inactive after the final disbursement of the borrowed capital.
Personal loans are often used to make large, one-off purchases such as a car or home and may require a security mechanism such as a lien against the property being purchased. Revolving loans can be helpful for small businesses that want to manage cash flow and bridge short-term funding gaps, but these facilities are not as flexible as a line of credit.
There are many types of lenders that can offer a loan to individuals, including banks, alternative (non-bank) lenders and online loan providers. The underwriting and approval process for these types of loans varies from lender to lender but usually requires a credit score, income information and existing debts to be reviewed before funds are disbursed. Some lenders also evaluate a borrower’s assets to determine their level of risk and creditworthiness.
The terms of a loan are agreed between the borrower and the lender prior to funds being disbursed, and the details are typically outlined in a document that is signed by both parties. If collateral is required, it will be clearly outlined in the documents, as well as any provisions for maximum amounts of interest.
Getting a loan is a big decision, and it’s important to understand the differences between the various types of loans before you decide to take on this type of debt. By taking the time to research and understand the various options, you can be more confident in your decision and ensure that you are not paying unnecessary fees or interest charges. The right loan can help you achieve your goals and improve your financial wellbeing.