Loan Basics

Loan Basics

A loan is an amount of money that is temporarily given by one person to another. Since corporations are considered persons under the law, loans can be given by corporations to people as well. The way loans usually work is they are given by a bank or other financial institution to the person with the understanding that the person will pay the loan back plus interest. Therefore, the bank makes money by getting more money back than they loaned out.

Generally speaking, a loan will usually come with collateral. Collateral is something that the person taking the loan will put up that is roughly equivalent to the loan. That way, if the person fails to pay back the loan, the entity giving the loan will liquidate the collateral and then use that money to cover the losses they sustained by not getting the money loaned back.

If you think about it, a mortgage is actually the perfect example of the loan and collateral mechanism. If you want to buy a house, the bank will loan you up to 95% of the money required for you to buy the house. You then buy the house and put it up as collateral against the mortgage loan. If you fail to pay back the mortgage loan, the house reverts to ownership of the bank because they would take the collateral from you. The mortgage is in fact the most common conventional collateral loan in place today because more and more people are becoming property owners as time goes on.

Another thing that you need to understand regarding loan basics is that there is always an interest rate when it comes to these loans. Interest rates for loan are generally expressed in APR terms. This means that if you have an interest rate APR of 3%, you would be paying a monthly interest rate of 0.25%. Of course, the bank can choose to compound that interest at intervals of days, months or over the course of the entire year. That information will be in the loan contract which you should thoroughly examine before signing.