What is a Loan?

Summary

Before taking any loan it’s very important to understand the different aspects of the loan. You should know about different types of loans, hidden costs of loan and different formalities involved in getting a loan.

What is Loan?

A certain amount of money that is given by one party to the other party with the expectation of it being fully repaid is called a Loan. The nature of this transaction is financial. All the specific terms and conditions that are a part of the transaction from either side are formally laid out in a promissory note.

The Lender always has the right to ask for an interest amount apart from the original amount that he had lent. The party that has borrowed the money has to specify the due dates. These days it is more common for the lender to specify the amount of the interest and due dates for repayment of the loan. At times the lenders also charge a late fee from those people who do not return the money on the due date.

Interest and other Hidden Costs

When you are considering a loan, repaying the loan is not all that you have to think about. There is the interest and many a time there are also other hidden costs like finance charges that you need to accommodate into your repayment plan. Most people with a traditional mindset avoid going for a loan unless it is absolutely necessary. Buying a new vehicle and a home are the two most common purposes for which people take loans. Another emerging trend is need for financing higher education. Banks and private financiers are the usual sources for loans. The interest rates for such loans can be either fixed at the time the loans are taken or may vary according to the prime federal rate.

Difference between Loan and Gift

Make no mistake- there is a wide difference between a gift and a loan. Imagine that a relative or a friend gives you some money say $3000 to buy yourself a new car. This is a gift and not a loan because there are no terms and conditions of repayment. The giver cannot sue you in a civil lawsuit. But if the giver specifies that it is a loan, or if he expects even a dollar of it to be repaid, then it will be formally considered a loan.

Loan Formalities

Institutions like banks and private financiers always make sure to do the necessary paperwork before sanctioning loans to applicants. Even if loans are given to friends or relatives, it is always advisable to go for a formal agreement of the terms and conditions. In the absence of clear records in the case of friends and family, courts often have to spend ages in determining if the money was a gift or a loan. And this is all the more important when large amounts are involved.

When you apply for a loan to private institutions or banks, they employ certain criteria to determine your eligibility. The current income and assets along with the credit history of the person in the past are the standard criteria.

Know Your Purpose and Capacity

Another factor is the purpose for which the loan is sought. A loan to expand an already started project is given more priority over something which has not begun yet. The amount of the loan sought is evaluated against the income of the person, to determine the capacity for repayment. Therefore the borrower needs to consider the total cost of the loan, including the amount, interest and other extra costs before applying for a loan.