A loan is an amount of money required by a borrower from a lender wherein the borrower commits to pay back that required amount along with an interest over a specified period. The terms of the loan are mentioned in a contract ensuring that the lender has the confidence in the borrower clearing his dues.
Many people use loans to buy things for which they do not currently have the money but can pay over a period. These can be a house, car, studies, or any other personal loan for managing urgent situations such as hospitalization, medical expenses, etc.
However, it is not suggested by financial advisors that you take on too much loan as loans are big business for the financial organizations and lenders. However, it can also be a bit confusing to understand about loan and hence many people keep getting stuck with this system due to lack of knowledge.
Here are some of the important terms regarding the loan you must be aware of:
- Principal: It is the total amount of money you have agreed to borrow from a lender and need to pay back.
- Term: The time that the lender gives you to pay off your loan is the term. You must pay back your loan amount within that period. Different types of loans such as home loans, car loans, personal loans, student loans will have their own terms. In the case of credit cards, you will see that they have revolving loans and hence you can borrow as well as pay as many times you need and you don’t need to apply for a new loan each time.
- Interest Rates: When you borrow money from a lender, the amount they will charge you for borrowing money is called an interest rate. Usually, it will be a certain percentage of the principal amount and it will be based on the rate the Federal Reserve will charge the banks to borrow money from each other for a day. So, the bank bases their interest rates based on the federal funds rate. The rates for corporations which have higher credit rating get a lower rate of interest and those with smaller businesses or consumers, end up with higher interest rates as their risks are higher. When you borrow a loan, you must make your payments inclusive of interest rates and the principal.
There are also other costs that can be connected to taking a loan which in financial terms may be a bit confusing. Hence it is best you have a financial advisor to help you with these.