A loan is essentially when money is loaned to another party with the payment of interest and principal amount over an extended period of time. Each party involved in a loan transaction enters into a contract by promising to repay the loan on specific terms. Loan terms are generally agreed upon before any funds are advanced. However, a loan can also be secured by a security such as a home or it can be unsecured like a credit card.
The amount of the loan can be repaid over a specified period of time with or without making extra payments. The repayment schedule depends on various factors such as the loan term, the interest rate charged on the loan, the amount of borrowed money and the cost of the loan. The repayment terms are determined at the time of borrowing. For example, a loan taken for remodeling a home will have a different repayment structure from that taken for a vacation to Maine. Likewise, the cost of a loan will vary from one company to another.
The type of loan also differs depending on the reason for borrowing. For example, a personal loan is taken to expand a household income so that more family members can get employed. Personal loans are usually short term in nature with low interest rates. Businesses may use loans for purchasing new equipment or expanding existing facilities. In all cases, the interest rates will be determined by prevailing interest rates at the time of application.
Business and home loans can be used to satisfy diverse purposes. Businesses usually need to meet short-term cash requirements such as to meet inventory shortfalls or for acquisition of land or property. Home owners normally take a loan to satisfy major expenses like home improvement, paying off big debts like a house loan or repaying education costs. A major advantage of taking a business or home loan is that the borrowers can often get rid of debts faster than the usual repayment period because they are able to defer payment until a later period. In addition, credit cards carry a comparatively low interest rate compared to home-equity loans, which can help save money for the borrowers.
Another loan type that allows longer repayment period is revolving loans. Repayment can be spread over several years or can be done in small installments. Therefore, if the period of payment is long, interest rates are lower. This type of loan allows people to spread out payments and also helps them to increase their capacity to repay. Small monthly installments allow borrowers to manage their budget and debts.
The terms and conditions of a loan agreement are decided by both the borrower and lender based on various factors like credit history, income, repaying ability, collateral, value of the property used as collateral, and so on. The borrower agrees to pay back a certain part of the loan amount every month while the lender keeps increasing the loan amount according to the agreed repayment plan. There are different types of loan agreements available and they include personal loan agreement, home equity loan agreement, car loan agreement, merchant cash advance agreement and so on. While choosing a particular type of agreement, the borrower must ensure that it suits his needs and the requirements of his financial institution.