A loan is a debt instrument. One party lends assets, property, or money to another party in exchange for interest payments and the eventual return of the borrowed asset, property, or money. A loan agreement is usually drawn up in writing before any assets change hands between parties.
A loan agreement includes a creditor and a debtor. The creditor is the party that lends assets to the borrower. The debtor is the party that borrows assets from the lender. Often, individuals will borrow money from financial institutions such as banks. And frequently corporations will borrow money from investors by issuing bonds or other debt instruments.
A typical loan will have several standard features, including a principal amount, a maturity date, and an interest rate.
The principal amount is the amount that the borrower receives initially from the lender, and that the borrower must repay to the lender at the end of the loan contract. The maturity date is simply the date the loan contract expires. It is the date by which the borrower must repay all borrowed funds to the lender. The interest rate is essentially the cost of the loan. An interest rate states the amount of interest, as a percentage of the principal, that the borrower must pay the lender periodically over the life of the loan contract.
Secured debt refers to a loan backed by collateral. It is a loan contract with collateral. At initiation of the loan agreement, the borrower agrees to pledge certain assets to back the loan contract. If the borrower defaults on the loan, the creditor then has a claim on the collateral. The creditor, in event of default, can claim the collateral stated in the contract and liquidate it towards repaying the owed principal and interest.
An unsecured debt is a loan agreement that is not backed by collateral. The borrower does not pledge assets to back the loan contract. This type of loan is a more risky investment for the lender, as in the event of default there are no physical assets to claim and liquidate to collect unpaid debts.
Loan default occurs when the debtor becomes unable to make required payments to the creditor. Over the life of the loan, the debtor typically makes interest payments and then finally repays the principal amount. If at any time the debtor fails to make the required payments, the loan is considered in default.
Cathryn is a loan agent at a local commercial bank. Her job, mainly, is to evaluate and complete loan packages for customers that are suited to be taking a business loan. Cathryn loves her work because she can use her skills of analysis while also helping people create financial independence.
Today, Cathryn speaks with a customer who is needing a loan to start his industrial flooring business. Paul, the customer, believes he can create a successful business with a small amount of start up capital. Cathryn does her proper due diligence and confirms that Paul, a man with a solid standing in all of the 5 C’s of banking, is qualified for the loan.
Cathryn and Paul work out the specifics of the loan. Eventually, they establish the loan term. The two discuss the matter and decide that Paul, due to the small amount of money he needs beyond his savings, is looking for a short term loan. The two set one year as the period in which the loan must be repaid.
Paul appreciates Cathryn’s assistance. Cathryn appreciates the professional attitude Paul has brought to the table. The two appreciate the professional connection and agree to meet for lunch soon. Today has been a successful day for both parties.
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