Loan definition and type.
What is a Loan?
A loan is a sum of money that one or more individuals or businesses borrow from banks or other financial institutions so as to financially organize intended or accidental events. In doing so, the borrower incurs a debt, which he has to pay back with interest and within a given duration of time.
The recipient and the lender must decide on the terms of the loan before any money differences hands. In some issues, the lender expects the borrower to offer an asset up for collateral, which will be defined in the loan document. A common loan for American households is a mortgage, which is carried for the purchase of a property.
Loans can be provided to individuals, corporations, and governments. The major idea behind taking out one is to get funds to grow one’s overall money supply. The interest and fees operate as sources of revenue for the lender.
Types of Loans
Loans can be categorized further into secured and unsecured, open-end and closed-end, and conventional types.
1. Secured and Unsecured Loans
A secured loan is one that is supported by some form of collateral. For instance, most financial institutions expect borrowers to present their title deeds or other documents that show ownership of an asset, until they reimburse the loans in full. Other assets that can be put up as collateral are stocks, bonds, and personal property. Most people apply for secured loans when they want to borrow huge sums of money. Since lenders are not typically ready to lend large amounts of money without collateral, they hold the recipients’ assets as a form of assurance.
Some common features of secured loans include lower interest rates, strict borrowing limits, and long repayment periods. Examples of secured borrowings are a mortgage, boat loan, and auto loan.
Conversely, an unsecured loan implies that the borrower does not have to offer any asset as collateral. With unsecured loans, the lenders are very thorough when evaluating the borrower’s financial status. This way, they will be able to calculate the recipient’s capacity for repayment and determine whether to award the loan or not. Unsecured loans include commodities such as credit card purchases, education loans, and personal loans.
2. Open-End and Closed-End Loans
A loan can also be defined as closed-end or open-end. With an open-ended loan, an individual has the liberty to borrow over and over. Credit cards and lines of credits are real examples of open-ended loans, although they both have credit regulations. A credit limit is the biggest sum of money that one can borrow at any point.
Relying on an individual’s financial wants, he may prefer to use all or just a quantity of his credit limit. Every time this person pays for an item with his credit card, the remaining available credit declines.
With closed-end loans, individuals are not permitted to borrow again until they have paid back them. As one makes payments of the closed-end loan, the loan balance reduces. However, if the borrower expects more money, he needs to apply for another loan from scratch. The procedure involves presenting documents to prove that they are credit-worthy and waiting for authorization. Examples of closed-end loans are a mortgage, auto loans, and student loans.
3. Conventional Loans
The term is frequently used when applying for a mortgage. It implies to a loan that is not guaranteed by government agencies such as the Rural Housing Service (RHS).