Loan

In the world of finance, a loan is a formal agreement between two parties. One party, known as the lender, provides money or assets to another party, called the borrower. This arrangement involves the reallocation of assets for a specific period of time. The borrower incurs a debt that must be repaid according to a set schedule. To encourage lending, the borrower usually pays interest. Interest is an extra amount paid for the privilege of using the lender's money.

Most loans are governed by a legal contract. This document is often called a promissory note. It specifies the principal amount, which is the original sum borrowed. It also lists the interest rate and the specific date for repayment. Contracts may also include loan covenants. These are additional restrictions placed on the borrower to protect the lender. In a legal setting, these obligations and restrictions are strictly enforced.

Loans are often categorized as either secured or unsecured. A secured loan requires the borrower to pledge an asset as collateral. Collateral is an item of value, such as a house or a car, that the lender can claim if the debt is not repaid. A mortgage is a common type of secured loan used for property. If a borrower defaults on a mortgage, the lender has a lien on the title. This gives the bank the legal right to repossess and sell the property to recover the money.

Other secured loans include those backed by securities or gold. A loan against securities uses items like shares or bonds to create a line of credit. Gold loans are issued after experts evaluate the quality and quantity of pledged gold. In contrast, unsecured loans do not require any collateral. Common examples include credit cards, personal loans, and bank overdrafts. Because unsecured lenders face higher risk, they usually charge higher interest rates. If an unsecured borrower fails to pay, the lender must often sue to obtain a money judgment.

There are also specialized types of lending designed for specific situations. A demand loan is a short-term loan without a fixed repayment date. These loans often have floating interest rates that change based on market terms. A lender can "call" a demand loan, requiring immediate repayment at any time. A bridge loan is used to "bridge the gap" between buying a new asset and selling an old one. This is common when someone wants to buy a new home before selling their current one. Bridge loans often require collateral to protect the bank.

Some loans receive special assistance through subsidies or concessions. A subsidized loan has reduced interest due to an explicit or hidden subsidy. In the United States, college students may receive subsidized loans where no interest accrues during enrollment. Concessional loans, or "soft loans," offer terms much more generous than standard market loans. These might include very low interest rates or grace periods. Foreign governments sometimes grant these to developing countries.

Lending can also involve different target markets and complex math. Loans are categorized by whether the debtor is a consumer or a business. For personal loans, lenders look at a borrower's credit score to determine interest rates. For commercial loans to businesses, lenders use credit ratings instead. Many loans use fully amortizing payments. This means each monthly payment has the same value over time. This process ensures the loan is paid off by the end of the term.

Finally, loans have important implications for taxes and legal ethics. In the United States, a loan is not considered gross income to the borrower. This is because the borrower has a legal obligation to repay the debt. However, interest paid is considered income for the lender. If a debt is discharged, meaning the lender forgives the debt, it becomes income for the borrower. It is also important to recognize lending abuses. Predatory lending involves taking advantage of borrowers, sometimes acting like a "loan shark." Usury is the practice of charging excessive or illegal interest rates.