What is a Loan?
A loan is a legal agreement between a borrower and a lender whereby the borrower takes an amount of money (the principal) that they must later repay.
Loans may be made for a predetermined, one-time amount or as an open-ended line of credit with a limit up to a certain amount. In addition to secured and unsecured loans, there are also commercial and personal lending options.
A secured loan is one where the borrower has pledged a valuable item as security before being approved for funding. A lien, or the right to possess another person's property while a debt is unpaid, is given to the lender. In other words, if a secured loan is not repaid, the loan issuer will have the legal right to confiscate the item pledged as collateral. Mortgages and auto loans are the two most often used secured loans. In these instances, up until the secured loan is entirely repaid, the lender retains the deed or title, which is a representation of ownership.
In general, lenders are reluctant to make big unprotected loans. Secured loans lessen the likelihood that the borrower will default because they run the risk of losing the collateralized asset. The borrower may still be responsible for the balance of the debt even if the collateral is worth less than the total amount owed.
Secured loans typically have a greater acceptance rate than unsecured loans, making them a better choice for borrowers who wouldn't otherwise be eligible.
A loan that doesn't require any sort of collateral is known as an unsecured loan. Lenders approve unsecured loans based on a borrower's creditworthiness rather than their assets as collateral. Personal loans, school loans, and credit cards are a few examples of unsecured loans.
Character—may include a borrower's job history, income level, credit history and records that demonstrate their history of meeting debt responsibilities, as well as any pending legal matters.
Using a ratio to compare a borrower's debt to income, capacity assesses their capacity to repay a loan.
Any assets that borrowers may own besides income and that can be used to repay debt, such as down payments, savings, and investments, are referred to as capital.
Loans that are secured only allow for collateral. Something provided as security for loan repayment in the event that the borrower defaults is referred to as collateral.
Conditions—the state of the lending environment at the time, market trends, and the purpose of the loan
Term Loan vs. Revolving Loan
Loans can also be classified as term or revolving. A term loan is one that is repaid in equal monthly amounts over a predetermined period of time, as opposed to a revolving loan, which can be used, repaid, and used again. A home equity line of credit (HELOC) is a secured, revolving loan, as opposed to a credit card, which is an unsecured, revolving loan. A signature loan is an unsecured, short-term loan, while a car loan is a secured, long-term loan.
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