What is a Loan?

A loan is a sum of money that one or more individuals or companies borrow from banks or other financial institutions so as to financially manage planned or unplanned events. In doing so, the borrower incurs a debt, which he has to pay back with interest and within a given period of time.



In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations etc. The recipient (i.e., the borrower) incurs a debt and is usually liable to pay interest on that debt until it is repaid as well as to repay the principal amount borrowed



Personal loan
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Secured
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See also: Loan guarantee

A secured loan is a form of debt in which the borrower pledges some asset (i.e., a car, a house) as collateral.



A mortgage loan is a very common type of loan, used by many individuals to purchase residential or commercial property. The lender, usually a financial institution, is given security – a lien on the title to the property – until the mortgage is paid off in full. In the case of home loans, 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.


Similarly, a loan taken out to buy a car may be secured by the car. The duration of the loan is much shorter – often corresponding to the useful life of the car. There are two types of auto loans, direct and indirect. In a direct auto loan, a bank lends the money directly to a consumer. In an indirect auto loan, a car dealership (or a connected company) acts as an intermediary between the bank or financial institution and the consumer.


Other forms of secured loans include loans against securities – such as shares, mutual funds, bonds, etc. This particular instrument issues customers a line of credit based on the quality of the securities pledged. Gold loans are issued to customers after evaluating the quantity and quality of gold in the items pledged. Corporate entities can also take out secured lending by pledging the company's assets, including the company itself. The interest rates for secured loans are usually lower than those of unsecured loans. Usually, the lending institution employs people (on a roll or on a contract basis) to evaluate the quality of pledged collateral before sanctioning the loan

Things to Consider Before Applying for a Loan

For individuals planning to apply for loans, there are a few things they should first look into. They include:


1. Credit Score and Credit History

If a person has a good credit score and history, it shows the lender that he’s capable of making repayments on time. So, the higher the credit score, the higher the likelihood of the individual getting approved for a loan. With a good credit score, an individual is also has a better chance of getting favorable terms.


2. Income

Before applying for any kind of loan, another aspect that an individual should evaluate is his income. For an employee, they will have to submit pay stubs, W-2 forms, and a salary letter from their employer. However, if the applicant is self-employed, all he needs to submit is his tax return for the past two or more years and invoices where applicable.


3. Monthly Obligations

In addition to their income, it’s also crucial that a loan applicant evaluates their monthly obligations. For instance, an individual may be receiving a monthly income of $6,000 but with monthly obligations amounting to $5,500. Lenders may not be willing to give loans to such people. It explains why most lenders ask applicants to list all their monthly expenses such as rent and utility bills.


Final Word

A loan is a sum of money that an individual or company borrows from a lender. It can be classified into three main categories, namely, unsecured and secured, conventional, and open-end and closed-end loans. However, regardless of the loan that one chooses to apply for, there are a few things that he should first assess, such as his monthly income, expenses, and credit history.