A loan is a financial transaction between two parties, in
which one party, namely the lender agrees to give another party, namely the
borrower a certain amount of money with the expectation of total repayment. The
specific terms of a loan are frequently spelled out in the form of a promissory
note or other contract.
In addition to the original amount of the loan, i.e. the principal
amount, the lender can ask for interest payments. The borrower must agree to
the repayment terms, including the amount owed, interest rate and due dates. Some
of the lenders may also collect financial penalties for missed or late
payments.
The Components of Loan
Any type of loan consists of the following three components:
- The
interest rate
- Security
component and
- Loan Term
The Interest Rate
Interest rate is the rate that lenders charge their
borrowers for the privilege of borrowing money. The interest rate is usually a
small percentage of the amount loaned. A higher interest rate results in a
higher monthly payment.
There are two different types of interest rates:
- Fixed:
Fixed rates are just that: fixed and unchanging. If your fixed interest
rate is 7 percent, it will be 7 percent for the life of the loan.
- Variable
interest rates: An interest rate that adjusts periodically to a predefined
margin above or below an index rate. A commonly used index is the bank
prime rate. It is also called "flexible interest rate."
For example,
you may take out a loan with a variable rate at prime +2. This means that
you'll pay two percent more than the prime rate, regardless of what it is.
Security Component
All loans are either secured loans or unsecured loans. This
refers to whether you are putting up assets, often referred to as collateral,
to guarantee your loan.
The Loan Term
The loan term is the total amount of time a borrowers is given
by a lender to pay off your loan. Most of the personal loans have a loan term of
1 to 5 years and many of the student loans have a loan term of 10-year.
In general, the longer the term, the higher will be the interest rate. The term is
the maximum length of time in which the borrower has to pay off their loan; but
loans can always be paid off before the term is up.
What should I do if I can pay off my monthly household expenses, but am having trouble paying off my loans?
- Pay off the loan with the highest interest rate first to save on interest payments.
- Talk to your creditor. Your creditor may be willing to reduce your payments or change the terms to accommodate your situation.
Some creditors might offer extensions, smaller payments over a longer period of time. Some creditors might accept partial payments.
- Get a debt consolidation loan. Be cautious of this option. If loan fees and interest rates are too high, it may not be the best option for you.
- Get professional advice. Reputable credit counselors can help you deal with your financial problems. Some organizations charge little or nothing for their services.
- Be cautious of companies that promise to fix your credit problems right away. Credit repair can be a long process that might take several years.
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