What Is a Loan? Its Pros and Cons

Posted by Peter Bork on April 22nd, 2021

To understand the nuances and subtleties of loans, you first need to define its concept, forms and types. In most dictionaries, a loan is defined as an amount of money that is borrowed from a financial institution and has to be paid back, usually together with an extra amount of money that you have to pay as a charge for borrowing.

In the modern interpretation, a loan is considered to be social relations that arise between the subjects of economic relations on the basis of repayment and repayment. That is, you need to return both the loan itself and the interest for using it (even the minimum or commission).

Now we will tell you why there are no completely free (interest-free) loans. Well, first of all, it is unprofitable for lenders to distribute money “just like that”. Secondly, the real cost of any loan consists of the interest rate, various commissions, insurance and other bank charges. So even if your interest on the loan is zero, this does not mean that you just got it and you will not need to pay anything extra for it.

Types of loans

  1. Personal loan - used for the purchase of certain goods and services, which, as a rule, have a value that exceeds the actual financial capabilities of the borrower at a particular point in time. Such a loan is used by those who buy furniture, household appliances, and so on;
  2. Target loan - used for the implementation of any goal of the borrower (as a rule, vacation, expensive treatment, education). In this case, banks usually transfer funds not to the borrower's account but to the account of an organization that provides a particular service on the basis of a contractual relationship with the borrower;
  3. Payday loan - a short-term, small-dollar loan designed to help you cover immediate cash needs until you get your next paycheck. These loans usually charge high annual percentage rates (APRs), and payments are typically due within 2 weeks. therepostore.net helps consumers get the most affordable payday loans West Palm Beach;
  4. Car loan - used to purchase new or used cars. They are usually provided for a period of 1 to 5 years;
  5. Mortgage loan - used to purchase housing, which is pledged by the bank until the borrower fully repays the debt (in some cases, the debtors may even lose their home). The loan is given for a period of 10 to 30 years;
  6. Education loan - used to pay for higher education or any training courses, usually with reduced interest rates;
  7. Travel loan - a special loan for a travel trip provided by banks or travel agencies. This type of loan is very common nowadays;
  8. Loan for retirees - provided to retirees on special, usually with preferential terms;
  9. Commercial loan - a loan with a deferred payment, which the seller of the goods provides to the buyer;
  10. Bank loan - a borrowing received by a borrower on terms of repayment, payment, for a period and strictly specified purposes against collateral or other guarantees. The forms of this type of loan are leasing, factoring and forfeiting;
  11. State credit - loans from the state from the population of their country and foreign states for the purpose of financing public expenditures or covering the state budget deficit;
  12. International loan - provided by banks of one country to borrowers of another country;
  13. Lombard loan - a short-term financial loan secured by easily realizable movable property;
  14. Credit card - a registered payment plastic instrument issued by a bank and having a certain credit limit of funds available to the borrower to pay for goods and services or withdraw cash;
  15. Loan for small and medium-sized businesses - a financial loan issued by banks to open or expand a business. A well-designed business plan plays a decisive role in receiving a positive lending decision.

Loan forms

  • Commodity - a form that involves the transfer of a thing for temporary use. This form existed before the emergence of commodity-money relations between people. In the modern world, this form is implemented in installments, property lease, equipment leasing, commodity loans, and so on;
  • Cash - a form that involves the transfer of a certain amount of funds for temporary use. This form prevails in modern economic conditions;
  • Mixed - a form that involves the provision of a loan with a commodity, and the return of a loan with money, and vice versa (often used in international settlements).

Benefits of a loan

  • The opportunity to get a product or service right now, even if you do not have money to pay for it at the moment. In general, this is where the pros end.

Cons of a loan

  • Tedious paperwork and excessive fuss when applying for a loan (especially if lenders require a surety or collateral from you);
  • High interest rates and additional loan payments;
  • If you often use loans, then over time loans cause addiction, similar to alcohol or drugs;
  • It may happen that you lose your permanent source of income and will not be able to pay the loan;
  • The threat of meeting with collectors, which at least spoils your mood, at the most cripples your life. However, this won't happen if you do not repay the loan on time!

So, we have analyzed in detail the essence and types of loans, their pros and cons. But it should also be noted that, despite the significant disadvantages and risks that borrowers bear, loans should not be completely avoided at all. After all, there are situations when you cannot do without loans.

For example, you should not neglect a loan for urgent expensive treatment, education, purchase of housing.

How to choose a loan

If you do decide to take out a loan, first clearly define the purpose of the borrowed funds and, in accordance with this, choose the most optimal type of loan for yourself. For example, if you want to buy a new car, choose an auto loan. If you are planning to buy a home, then choose a mortgage. At the same time, remember that if you are offered an interest-free loan, think carefully before signing an agreement. Indeed, sometimes such loans, due to various additional commissions and fees, can reach sky-high overpayments that ordinary personal loans never dreamed of.

Things to consider before taking out a loan

  1. Consider the reality of the monthly loan payment. Tip: in order to make correct calculations, please note that monthly payments should not exceed 40% of your income;
  2. Stock up on a contingency fund, which is usually 3-6 monthly living wages. Keep this money at home or in a bank. This is necessary so that you can continue to make loan payments in the event of an unforeseen situation (job loss, disease, death of a loved one, etc.);
  3. Never take more than you need. That is, if you need 0, then take strictly 0, and not ,000 "just in case." Otherwise, you will overpay much more than you planned;
  4. Determine the optimal loan term. Principle: the longer you pay off the loan, the lower the monthly payment, but the greater the final overpayments. Therefore, in order to correctly calculate the most comfortable loan repayment period, follow the "20-30% rule". That is, use 20-30% of your income to repay a loan and calculate how long it will take you to finally pay off the debt;
  5. Take a loan in the currency in which you receive income;
  6. Do not neglect insurance, which will help you to provide confidence in the future and not be in debt in a difficult financial situation.

When comparing loan programs in different financial institutions, pay attention to the following parameters:

  • The amount of the down payment that you will have to pay in order to get a loan;
  • One-time origination fee charged for processing an application;
  • Monthly commission charged in addition to fixed interest;
  • Loan repayment scheme (equal monthly payments or monthly decrease in payments.

Any lender is obliged to inform the client of this very "total cost of the loan" before taking a loan.

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Peter Bork

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Peter Bork
Joined: April 22nd, 2021
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