In financial terms a loan is a specific sum of money lent by an individual, a group of individuals or a financial institution to a specific person or organization. The borrower is said to be in a debt of the amount that he or she has borrowed. The borrower has a liability which means that it is his or her obligation to pay the principal amount back along with the interest. Interest rate that is to be paid is pre decided by the borrower and the lender, if the loans are taken from a formal financial institution they will essentially be in line with the monetary policy of a specific economy. The interest is the sole purpose for which a lender would lend money, it is the only incentive for them engage in this activity
There shall be legal proof of any sort of loan that is taken from one party to another, they are typically in the form of a legal promissory note which includes the agreement of both the parties along with the amount of money that is lent and on the rate of interest it is lent on. Also a very essential part of this note would be the date of repayment, which is the date by which the borrower would return the principal amount along with the interest.
The loans may be secured or unsecured. Secured loans consist of collaterals. Collateral refers to an asset which shall crucially have a value equal to or more than what a borrower is supposed to pay back that is equal to or more than the amount of the debt on the borrower. The system of collateral is majorly to protect the lender if, under any circumstances, the borrower is unable to pay back the money he or she has borrowed. In such cases the lender would sell the asset to gain the amount of money he lent to the borrower. Unsecured loans are the ones without any sort of collateral involved which implies that these loans are given without any sort of security for the lender.
Unsecured loans can be many different forms in a financial institution such as banks. They may be in the form of a credit card debt, a bank overdraft, corporate bonds or loans – such loans may come under the short-term loans that we will further discuss in detail.
As the public welfare department in every country is developing loans may even be subsidized by the government of a specific economy which implies that that the interest rates charged on the loan would be much lower than what it shall be essentially. These loans will only be given for specific purposes, for instance education, healthcare, investment by a firm in an eco friendly machinery etc.
Loans are also classified on the basis of time period they are taken for, however when the phrases “Long-term” and “Short-term” are used they connote more than just the time period for which the loan is obtained by the borrower. For instance a long-term loan would refer to the kind of loan that is taken for more than a tenure of 5 years and which is secured sort of loan that means it requires a collateral by the lender to the borrower. These loans have a fixed amount of interest charged on them; however a short term loan may have a reduced interest rate in certain scenarios. The amount that can be borrowed in a long-term loan is not limited.
Short term loans refer to the money that is being lent for a short period of time, to be more specific the minimum time period can be 12 months that 1 year, however it can go up to 60 months that it 5 years. These loans are useful when a person requires a small amount of capital for a smaller period of time, the amount of money may not be more than 25 lakh rupees. In majority of scenarios these loans are unsecured kind of loans which essentially implies that no collateral is needed for such loans, hence they are very convenient and safe for a potential borrower.
There are very crucial conditions that a potential borrower may need to fulfill to obtain such loans. A potential borrower shall possess a decent credit history moreover he or she shall have a source of income that caters to them regularly on monthly basis. The employment history of the potential borrower shall state that he or she has been in possession of a stable employment for past 2 to 3 years.
These loans may be taken for several purposes primarily to finance a short term investment in a financial institution, due to an arrival of a crucial medical emergency, for the higher education of a family member, for special and grand occasions like weddings or for travelling abroad for considerable period of time.