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How Loans Work for You

A loan is an amount of money given by the lender to the borrower for a certain time period. After that time is over, the loan amount has to be returned with interest. The interest is the amount you have to pay for using the money.

Let us see how the bank mechanism works. Customers deposit money in the bank and the bank pays them an interest. The bank then hands out that money to borrowers at a higher interest rate. The bank thus makes a profit.

Loans can be secured or unsecured. Secured loans are backed by assets that a bank can take in case of non payment by the borrower. These assets are collateral. These can be a house or a car or financial instruments.

When a loan is handed out it is backed by proof of ownership of collateral. The loan contract specifies the following:
1. Date of the loan
2. Interest rate
3. Payments
4. Dates of payments

We must note that loans are handed out at Annual Percentage Rate i.e. APR. This is an equivalent annual interest rate that helps you compare loans.

Loans can be closed-end like car loans. One cannot change the terms and conditions without creating a new loan. Open-end loans can be used on a continuing basis without new contracts, for example credit cards.

Loans help you buy expensive things like a car, a house, education and vacations. Loans give you money when you need it, and you can pay back in installments.

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