Chapter-One: Introduction

LOAN In finance, a loan is a debt evidenced by a note which specifies, among other things, the principal amount, interest rate, and date of repayment. A loan entails the reallocation of the subject asset(s) for a period of time, between the lender and the borrower. In a loan, the borrower initially receives or borrows an amount of money, called the principal, from the lender, and is obligated to pay back or repay an equal amount of money to the lender at a later time. Typically, the money is paid back in regular installments, or partial repayments; in an annuity, each installment is the same amount. The loan is generally provided at a cost, referred to as interest on the debt, which provides an incentive for the lender to engage in the loan. In a legal loan, each of these obligations and restrictions is enforced by contract, which can also place the borrower under additional restrictions known as loan covenants. Although this article focuses on monetary loans, in practice any material object might be lent. Acting as a provider of loans is one of the principal tasks for financial institutions. For other institutions, issuing of debt contracts such as bonds is a typical source of funding. Types of loans [edit]Secured See also: Loan guarantee A secured loan is a loan in which the borrower pledges some asset (e.g. a car or property) as collateral. A mortgage loan is a very common type of debt instrument, used by many individuals to purchase housing. In this arrangement, the money is used to purchase the property. The financial institution, however, is given security — a lien on the title to the house — until the mortgage is paid off in full. If the borrower defaults on the loan, the bank would have the legal right to repossess the house and sell it, to recover sums owing to it. In some instances, a loan taken out to purchase a new or used car may be secured by the car, in much the same way as a mortgage is secured by housing. The duration of the loan period is considerably shorter — often corresponding to the useful life of the car. There are two types of auto loans, direct and indirect. A direct auto loan is where a bank gives the loan directly to a consumer. An indirect auto loan is where a car dealership acts as an intermediary between the bank or financial institution and the consumer. [edit]Unsecured Unsecured loans are monetary loans that are not secured against the borrower's assets. These may be available from financial institutions under many different guises or marketing packages: • credit card debt • personal loans • bank overdrafts • credit facilities or lines of credit • corporate bonds (may be secured or unsecured) 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 United Kingdom, when applied to individuals, these may come under the Consumer Credit Act 1974. 1 Interest rates on unsecured loans are nearly always higher than for secured loans, because an unsecured lender's options for recourse against the borrower in the event of default are severely limited. An unsecured lender must sue the borrower, obtain a money judgment for breach of contract, and then pursue execution of the judgment against the borrower's unencumbered assets (that is, the ones not already pledged to secured lenders). In insolvency proceedings, secured lenders traditionally have priority over unsecured lenders when a court divides up the borrower's assets. Thus, a higher interest rate reflects the additional risk that in the event of insolvency, the debt may be uncollectible. [edit]Demand Demand loans are short term loans [1] that are atypical in that they do not have fixed dates for repayment and carry a floating interest rate which varies according to the prime rate. They can be "called" for repayment by the lending institution at any time. Demand loans may be unsecured or secured. [edit]Subsidized A subsidized loan is a loan on which the interest is reduced by an explicit or hidden subsidy. In the context of college loans in the United States, it refers to a loan on which no interest is accrued while a student remains enrolled in education.[2] Otherwise, it may refer to a loan on which an artificially low rate of interest (or none at all) is charged to the borrower. An unsubsidized loan is a loan that gains interest at a market rate from the date of disbursement 1. Personal Loans These loans are offered by most banks, and the proceeds may be used for virtually any expense (from buying a new stereo system to paying off a common bill). Typically, personal loans are unsecured, and range anywhere from a few hundred to a few thousand dollars. As a general rule, lenders will typically require some form of income verification, and/or proof of other assets worth at least as much as the individual is borrowing. The application for this type of loan is typically only one or two pages in length. Approvals (or denials) are generally granted within a few days. The downside is that the interest rates on these loans can be quite high. According to the Federal Reserve, they range from about 10-12%. The other negative is that these loans sometimes must be repaid within two years, making it impractical for individuals looking to finance large projects. In short, personal loans (in spite of their high interest rates) are probably the best way to go for individuals looking to borrow relatively small amounts of money, and who are able to repay the loan within a couple of years. 2. Credit Cards When consumers use credit cards, they are essentially taking out a loan with the understanding that it will be repaid at some later date. Credit cards are a particularly attractive source of funds for individuals (and companies) because they are accepted by many - if not most - merchants as a form of payment. In addition, to obtain a card (and, by extension, $5,000 or $10,000 worth of credit), all that's required is a one-page application. The credit review process is also rather quick. Written applications are typically approved (or denied) within a week or two. Online / telephone applications are often reviewed within minutes. Also in terms of their use, credit cards are extremely flexible. The money can be used for virtually anything these days from paying college tuition to buying a drink at the local watering hole. (To find out more about this process, see The Importance of Your Credit Rating and How Credit Cards Affect Your Credit Rating.) There are definitely pitfalls, however. The interest rates that most credit-card companies charge range as high as 20% per year. In addition, a consumer is more likely to rack up debt using a 2 credit card (as opposed to other loans) because they are widely accepted as currency and because it's psycho logically easier to hand someone a credit card than to fork over the same amount of cash. (To read more on this type of loan, see Take Control Of Your Credit Cards, Credit, Debit And Charge: Sizing Up The Cards In Your Wallet and Understanding Credit Card Interest.) 3. Home-Equity Loans Homeowners may borrow against the equity they've built up in their house using a home-equity loan. In other words, the homeowner is taking a loan out against the value of his or her home. A good method of determining the amount of home equity available for a loan would be to take the difference between the home's market value and the amount still owing on the mortgage. The loan proceeds may be used for any number of reasons, but are typically used to build home additions, or for debt consolidation. The interest rates on home-equity loans are very reasonable as well. In addition, the terms of these loans typically range from 15 to 20 years, making them particularly attractive for those looking to borrow large amounts of money. But, perhaps the most attractive feature of the home-equity loan is that the interest is usually tax deductible. The downside to these loans is that consumers can easily get in over their heads by mortgaging their homes to the hilt. Furthermore, home-equity loans are particularly dangerous in situations where only one family member is the breadwinner, and the family's ability to repay the loan might be hindered by that person's death or disability. Even a 1% increase in interest rates could mean the difference between losing and keeping your home if you rely too heavily on this style of loan. Note: In situations like these, life/disability insurance is frequently used to help protect against the possibility of default. (To keep reading on this subject, see Home-Equity Loans: The Costs and The Home-Equity Loan: What It Is And How It Works.) 4. Home-Equity Line of Credit This line of credit acts as a loan and is similar to home-equity loans in that the consumer is borrowing against his or her home's equity. However, unlike traditional home-equity loans, these lines of credit are revolving, meaning that the consumer may borrow a lump sum, repay a portion of the loan, and then borrow again. It's kind of like a credit card that has a credit limit based on your home's equity! These loans may be tax deductible and are typically repayable over a period of 10 to 20 years, making them attractive for larger projects.

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