What is a loan

In finance, a loan is the lending of money by one or more persons, entities, or other entities to another person, entity, etc. The beneficiary (ie the borrower) incurs a debt and is generally required to pay interest on this debt until it is repaid and the principal amount borrowed is repaid.

The document evidencing the debt (such as a promissory note) generally indicates, among other things, the principal amount borrowed, the interest rate applied by the lender and the date of repayment. A loan involves the redistribution of the assets in question between the lender and the borrower over a period of time.

The interest is an incentive for the lender to participate in the loan. With a legal loan, each of these obligations and restrictions are contractually enforced, which may also subject the borrower to additional restrictions called loan covenants. Although this article focuses on monetary loans, in practice any tangible object can be loaned.

Acting as a lender is one of the main activities of financial institutions such as banks and credit card companies. For other institutions, issuing debt contracts such as bonds is a typical source of funding.

Personal loan

Secured

A secured loan is a form of debt in which the borrower pledges an asset (eg car, house) as collateral.

A mortgage loan is a very common type of loan used by many people to purchase residential or commercial property. The lender, usually a financial institution, receives security - a lien on 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 has the legal right to repossess the home and sell it to collect monies owed.

Similarly, a loan taken out to buy a car can be secured by the car. The term of the loan is significantly shorter - often in line with the useful life of the car. There are two types of auto credit, direct and indirect. With a direct auto loan, a bank lends money directly to a consumer. In an indirect auto loan, a car dealership (or related company) acts as an intermediary between the bank or financial institution and the consumer.

Other forms of secured loans are securities loans - such as stocks, mutual funds, bonds, etc. This particular instrument grants customers a line of credit based on the quality of the pledged securities. Gold loans are granted to customers after an assessment of the quantity and quality of the gold of the pledged items. Businesses can also take out secured loans by pledging business assets, including the business itself. Interest rates on secured loans are generally lower than unsecured loans. Typically, the lending institution employs staff (on a role or contract basis) to assess the quality of the pledged collateral before approving the loan.

Unsecured Loans

Unsecured loans are loans of money that are not secured by the property of the borrower. These may be available from financial institutions in many different forms or marketing packages:

credit card
Personal loans
discovered
Credit facilities or lines of credit
Corporate bonds (can be secured or unsecured)
loan between individuals
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. In the UK these may fall under the Consumer Credit Act 1974 when they apply to individuals.

Interest rates on unsecured loans are almost always higher than on secured loans because an unsecured lender's recourse against the borrower in the event of default is severely limited, exposing the lender to greater risk. compared to a secured loan. An unsecured lender must sue the borrower, obtain a money judgment for breach of contract, and then seek enforcement of the judgment against the borrower's unencumbered assets (i.e. those that have not yet been pledged to secured lenders). In bankruptcy proceedings, secured lenders traditionally take precedence over unsecured lenders when a court divides a borrower's assets. Thus, a higher interest rate therefore reflects the additional risk that the debt will become uncollectible in the event of bankruptcy.