Understanding what a loan is and how loans work are the first steps in borrowing responsibly…
What is a loan?
A loan is a type of debt and is defined as the temporary provision of money usually at interest. That is, it is a sum of money which is given to an individual/s with the intent that it is to be repaid at a future date along with any agreed upon interest.
The party who agrees to give another party a certain amount of money with the expectation of total repayment is referred to as the lender and the receiving party is referred to as the borrower.
The largest form of debt financing today is the loan, however, debt financing can come in many forms such as, credit cards, hire-purchase and retail store cards as some examples.
The specific terms of a loan are often spelled out in the form of a contract or a promissory note.
Today, most loan applications are handled by banks or other professional lending institutions and they use a number of criteria to determine if a potential borrower is eligible for a loan. These may include:
- Past credit history
- Current income
- Current assets
- Income to debt ratio – can the borrower afford to pay the loan back with interest?