Many people use a loan to fund purchases they would not otherwise be able to obtain, such as a home or a car. While loans can be great financial tool when used properly, they can be great adversary as well. To keep from taking on too much debt, you should understand how loans work and how money is made for the lenders before you begin borrowing money from eager lenders.
They are used to make money for the lenders—with that in mind, no lender wants to lend someone money without the promise of something in return. Keep this in mind as you research loans for yourself or a business—the way loans are structured can be confusing and cause large amounts of debt. It’s important to know how loans work before you borrow. With a better understanding of them, you can save money and make better decisions about debt—including when to avoid acquiring more or how to use it to your advantage.
Before you take out a loan, it’s wise to become familiar with some key terms that are associated with all types of loans. Before you borrow, take your time to find out more what your signing up for and what to keep in mind. For more info, you can also visit this site.
Term
This is the amount of time that the loan is lasting. You must pay back the money within this specific timeframe. Different types of loans have different terms. Credit cards are considered revolving loans, meaning you can borrow and repay as many times as you want without applying for a new loan.
Interest Rate
This is the amount the lender is charging you for borrowing money. It’s usually a percentage of the amount of the loan, and is based on the rate the Federal Reserve charges banks to borrow money overnight from each other. This is called the federal funds rate, and is the rate banks base their own interest rates off.
Several rates are based upon the federal funds rate—such as the prime rate, which is a lower rate reserved for the most creditworthy borrowers, like corporations. Medium and high rates are then given to those with more risk to the lender, such as smaller businesses and consumers with varying credit scores.
Costs Associated With Loans
Understanding any costs associated with a loan can help you figure out which one to choose. Costs are not always advertised upfront when signing for a loan and are usually in financial and legal terminology that can be confusing.
Interest Costs
When you borrow, you have to pay back the amount you borrowed plus interest, which is usually spread over the term of the loan. You can get a loan for the same principal amount from different lenders, but if either or both the interest rate or term vary then you’ll be paying a different amount of total interest.
The costs to a borrower can be very deceiving when rates are taken into account. The annual percentage rate (APR) of a loan is the most popularly advertised by creditors because it doesn’t account for compounding interest that is paid over a number of periods.
A simple way to calculate your loan interest is to multiply the principal by the interest rate and periods per year for the loan. However, not all loans are designed this way, and you may need to use a calculator for loan amortization or an annual percentage rates to determine how much you will end up paying over the term of the loan. Usually you can choose on how to pay off your interest and that should be mentioned in your loan contract.
Amortization is the term used for how money is applied to your loan principal and interest balance. You pay a fixed amount every period, but the amount is split differently between principal and interest for each payment, depending on the loan terms. With each payment, your interest costs per payment go down over time.The amortization table shows an example of how a monthly payment is applied to principal and interest.
Applying for a Loan
When you want to borrow money, you visit with a lender—either online or in person—and apply for a loan. Your bank or credit union is a good place to start. You can also work with specialized lenders such as mortgage brokers and peer-to-peer lending services.
After you provide information about yourself, the lender will evaluate your application and decide whether or not to give you the loan. If you’re approved, the lender will send funds to you or the entity you’re paying—if you’re buying a house or a car, for example, the money might be sent to you or directly to the seller.
Shortly after receiving the funding, you’ll start to repay the loan on an agreed-upon recurring date (usually once a month), with a pre-determined rate of interest. Be sure to read the terms carefully before signing up for a loan.
Differences Between Consumer Lending and Business Lending
From a borrower’s perspective, there are some legal protections with personal loans that aren’t extended to borrowers with business loans.
Depending on the country you take the loan in, usually there are multiple institututions looking after that the loans given out are safe for the consumer. The general protections from discrimination extend to all forms of credit, whether it’s a personal loan or a business loan.
However, the specific regulations of the Equal Credit Opportunity Act become more relaxed for business loans—the bigger the business entity, the fewer restrictions on their loans. The restrictions that get relaxed have less to do with discrimination and more to do with what kind of notifications the lender must give the borrower, and how long the lender must retain certain records on the borrower. The Fair Housing Act, on the other hand, doesn’t explicitly distinguish between consumer loans and business loans.