Loan
Encyclopedia
A loan is a type of debt
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...

. Like all debt instruments, a loan entails the redistribution of financial asset
Asset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...

s over time, between the lender and the borrower.

In a loan, the borrower initially receives or borrows an amount of money
Money
Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past,...

, called the principal, from the lender, and is obligated to pay back or repay an equal amount of money to the lender at a later time. Typically, the money is paid back in regular installments, or partial repayments; in an annuity
Annuity (finance theory)
The term annuity is used in finance theory to refer to any terminating stream of fixed payments over a specified period of time. This usage is most commonly seen in discussions of finance, usually in connection with the valuation of the stream of payments, taking into account time value of money...

, each installment is the same amount.

The loan is generally provided at a cost, referred to as interest
Interest
Interest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds....

 on the debt
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...

, which provides an incentive for the lender to engage in the loan. In a legal loan, each of these obligations and restrictions is enforced by contract
Contract
A contract is an agreement entered into by two parties or more with the intention of creating a legal obligation, which may have elements in writing. Contracts can be made orally. The remedy for breach of contract can be "damages" or compensation of money. In equity, the remedy can be specific...

, which can also place the borrower under additional restrictions known as loan covenant
Loan covenant
A loan covenant is a condition in a commercial loan or bond issue that requires the borrower to fulfill certain conditions or which forbids the borrower from undertaking certain actions, or which possibly restricts certain activities to circumstances when other conditions are met.Typically,...

s. Although this article focuses on monetary loans, in practice any material object might be lent.

Acting as a provider of loans is one of the principal tasks for financial institution
Financial institution
In financial economics, a financial institution is an institution that provides financial services for its clients or members. Probably the most important financial service provided by financial institutions is acting as financial intermediaries...

s. For other institutions, issuing of debt
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...

 contracts such as bonds
Bond (finance)
In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...

 is a typical source of funding.

Secured

A secured loan
Secured loan
A secured loan is a loan in which the borrower pledges some asset as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan...

 is a loan in which the borrower pledges
Pledge (law)
A pledge is a bailment or deposit of personal property to a creditor to secure repayment for some debt or engagement, The term is also used to denote the property which constitutes the security....

 some asset (e.g. a car or property) as collateral
Collateral (finance)
In lending agreements, collateral is a borrower's pledge of specific property to a lender, to secure repayment of a loan.The collateral serves as protection for a lender against a borrower's default - that is, any borrower failing to pay the principal and interest under the terms of a loan obligation...



A subsidized loan is a loan that will not gain interest before you begin to pay it. It is known to be used at multiple colleges.

An unsubsidized loan is a loan that gains interest the day of disbursement.

A mortgage loan
Mortgage loan
A mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan...

 is a very common type of debt instrument, used by many individuals to purchase housing
House
A house is a building or structure that has the ability to be occupied for dwelling by human beings or other creatures. The term house includes many kinds of different dwellings ranging from rudimentary huts of nomadic tribes to free standing individual structures...

. In this arrangement, the money is used to purchase the property. The financial institution, however, is given security — a lien
Lien
In law, a lien is a form of security interest granted over an item of property to secure the payment of a debt or performance of some other obligation...

 on the title to the house — until the mortgage is paid off in full. If the borrower defaults
Default (finance)
In finance, default occurs when a debtor has not met his or her legal obligations according to the debt contract, e.g. has not made a scheduled payment, or has violated a loan covenant of the debt contract. A default is the failure to pay back a loan. Default may occur if the debtor is either...

 on the loan, the bank would have the legal right to repossess the house and sell it, to recover sums owing to it.

In some instances, a loan taken out to purchase a new or used car may be secured by the car, in much the same way as a mortgage is secured by housing. The duration of the loan period is considerably shorter — often corresponding to the useful life of the car. There are two types of auto loans, direct and indirect. A direct auto loan is where a bank gives the loan directly to a consumer. An indirect auto loan is where a car dealership acts as an intermediary between the bank or financial institution and the consumer.

A type of loan especially used in limited partnership agreements is the recourse note.

A stock hedge loan is a special type of securities lending
Securities lending
In finance, securities lending or stock lending refers to the lending of securities by one party to another. The terms of the loan will be governed by a "Securities Lending Agreement", which requires that the borrower provides the lender with collateral, in the form of cash, government securities,...

 whereby the stock of a borrower is hedged by the lender against loss, using options or other hedging
Hedge (finance)
A hedge is an investment position intended to offset potential losses that may be incurred by a companion investment.A hedge can be constructed from many types of financial instruments, including stocks, exchange-traded funds, insurance, forward contracts, swaps, options, many types of...

 strategies to reduce lender risk.

A pre-settlement loan is a non-recourse debt
Nonrecourse debt
Non-recourse debt or a non-recourse loan is a secured loan that is secured by a pledge of collateral, typically real property, but for which the borrower is not personally liable. If the borrower defaults, the lender/issuer can seize the collateral, but the lender's recovery is limited to the...

, this is when a monetary loan is given based on the merit and awardable amount in a lawsuit case. Only certain types of lawsuit cases are eligible for a pre-settlement loan. This is considered a secured non-recourse debt because if the case reaches a verdict in favor of the defendant the loan is forgiven.

Unsecured

Unsecured loans are monetary loans that are not secured against the borrower's assets. These may be available from financial institutions under many different guises or marketing packages:
  • credit card
    Credit card
    A credit card is a small plastic card issued to users as a system of payment. It allows its holder to buy goods and services based on the holder's promise to pay for these goods and services...

     debt
  • personal loans
  • bank
    Bank
    A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...

     overdraft
    Overdraft
    An overdraft occurs when money is withdrawn from a bank account and the available balance goes below zero. In this situation the account is said to be "overdrawn". If there is a prior agreement with the account provider for an overdraft, and the amount overdrawn is within the authorized overdraft...

    s
  • credit facilities or lines of credit
  • corporate bond
    Corporate bond
    A corporate bond is a bond issued by a corporation. It is a bond that a corporation issues to raise money in order to expand its business. The term is usually applied to longer-term debt instruments, generally with a maturity date falling at least a year after their issue date...

    s (may be secured or unsecured)


The interest rate
Interest rate
An interest rate is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender. For example, a small company borrows capital from a bank to buy new assets for their business, and in return the lender receives interest at a predetermined interest rate for...

s applicable to these different forms may vary depending on the lender and the borrower. These may or may not be regulated by law. In the United Kingdom, when applied to individuals, these may come under the Consumer Credit Act 1974
Consumer Credit Act 1974
The Consumer Credit Act 1974 is an Act of the Parliament of the United Kingdom that significantly reformed the law relating to consumer credit within the United Kingdom....

.

Interest rates on unsecured loans are nearly always higher than for secured loans, because an unsecured lender's options for recourse against the borrower in the event of default are severely limited. An unsecured lender must sue the borrower, obtain a money judgment for breach of contract, and then pursue execution of the judgment against the borrower's unencumbered assets (that is, the ones not already pledged to secured lenders). In insolvency proceedings, secured lenders traditionally have priority over unsecured lenders when a court divides up the borrower's assets. Thus, a higher interest rate reflects the additional risk that in the event of insolvency, the debt may be uncollectible.

Demand

Demand loans are short term loans (typically no more than 180 days) that are atypical in that they do not have fixed dates for repayment and carry a floating interest rate which varies according to the prime rate. They can be "called" for repayment by the lending institution at any time. Demand loans may be unsecured or secured.

Personal or commercial

Loans can also be subcategorized according to whether the debtor is an individual person (consumer) or a business. Common personal loans include mortgage loan
Mortgage loan
A mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan...

s, car loans, home equity lines of credit, credit card
Credit card
A credit card is a small plastic card issued to users as a system of payment. It allows its holder to buy goods and services based on the holder's promise to pay for these goods and services...

s, installment loan
Installment loan
An installment loan is a loan that is repaid over time with a set number of scheduled payments. The term of loan may be as little as a few months and as long as 30 years...

s and payday loans. The credit score
Credit score
A credit score is a numerical expression based on a statistical analysis of a person's credit files, to represent the creditworthiness of that person...

 of the borrower is a major component in and underwriting and interest rates (APR
APR
- In the context of organizations :*Agrarian Party of Russia, a left-wing political party in Russia*Alabama Public Radio*American Public Radio, now Public Radio International*Asia-Pacific Scout Region...

) of these loans. The monthly payments of personal loans can be decreased by selecting longer payment terms, but overall interest paid increases as well. For car loans in the U.S., the average term was about 60 months in 2009.

Loans to businesses are similar to the above, but also include commercial mortgage
Commercial mortgage
A commercial mortgage is a mortgage loan made using commercial real estate as collateral to secure repayment.A commercial mortgage is similar to a residential mortgage, except the collateral is a commercial building or other business real estate, not residential property. In addition, commercial...

s and corporate bond
Corporate bond
A corporate bond is a bond issued by a corporation. It is a bond that a corporation issues to raise money in order to expand its business. The term is usually applied to longer-term debt instruments, generally with a maturity date falling at least a year after their issue date...

s. Underwriting is not based upon credit score but rather credit rating
Credit rating
A credit rating evaluates the credit worthiness of an issuer of specific types of debt, specifically, debt issued by a business enterprise such as a corporation or a government. It is an evaluation made by a credit rating agency of the debt issuers likelihood of default. Credit ratings are...

.

Loan payment

The most typical loan payment type is the fully amortizing payment in which each monthly rate has the same value overtime.

The fixed monthly payment P for a loan of L for n months and a monthly interest rate c is:

Abuses in lending

Predatory lending
Predatory lending
Predatory lending describes unfair, deceptive, or fraudulent practices of some lenders during the loan origination process. While there are no legal definitions in the United States for predatory lending, an audit report on predatory lending from the office of inspector general of the FDIC broadly...

 is one form of abuse in the granting of loans. It usually involves granting a loan in order to put the borrower in a position that one can gain advantage over him or her. Where the moneylender is not authorized, they could be considered a loan shark
Loan shark
A loan shark is a person or body that offers unsecured loans at illegally high interest rates to individuals, often enforcing repayment by blackmail or threats of violence....

.

Usury
Usury
Usury Originally, when the charging of interest was still banned by Christian churches, usury simply meant the charging of interest at any rate . In countries where the charging of interest became acceptable, the term came to be used for interest above the rate allowed by law...

 is a different form of abuse, where the lender charges excessive interest. In different time periods and cultures the acceptable interest rate has varied, from no interest at all to unlimited interest rates. Credit card companies in some countries have been accused by consumer organisations of lending at usurious interest rates and making money out of frivolous "extra charges".

Abuses can also take place in the form of the customer abusing the lender by not repaying the loan or with an intent to defraud the lender.

United States taxes

Most of the basic rules governing how loans are handled for tax purposes in the United States are codified by both Congress (the Internal Revenue Code) and the Treasury Department (Treasury Regulations — another set of rules that interpret the Internal Revenue Code). Yet such rules are universally accepted.

1. A loan is not gross income to the borrower. Since the borrower has the obligation to repay the loan, the borrower has no accession to wealth.

2. The lender may not deduct (from own gross income) the amount of the loan. The rationale here is that one asset (the cash) has been converted into a different asset (a promise of repayment). Deductions are not typically available when an outlay serves to create a new or different asset.

3. The amount paid to satisfy the loan obligation is not deductible (from own gross income) by the borrower.

4. Repayment of the loan is not gross income to the lender. In effect, the promise of repayment is converted back to cash, with no accession to wealth by the lender.

5. Interest paid to the lender is included in the lender’s gross income. Interest paid represents compensation for the use of the lender’s money or property and thus represents profit or an accession to wealth to the lender. Interest income can be attributed to lenders even if the lender doesn’t charge a minimum amount of interest.

6. Interest paid to the lender may be deductible by the borrower. In general, interest paid in connection with the borrower’s business activity is deductible, while interest paid on personal loans are not deductible. The major exception here is interest paid on a home mortgage.

Income from discharge of indebtedness

Although a loan does not start out as income to the borrower, it becomes income to the borrower if the borrower is discharged of indebtedness. Thus, if a debt is discharged, then the borrower essentially has received income equal to the amount of the indebtedness. The Internal Revenue Code
Internal Revenue Code
The Internal Revenue Code is the domestic portion of Federal statutory tax law in the United States, published in various volumes of the United States Statutes at Large, and separately as Title 26 of the United States Code...

 lists “Income from Discharge of Indebtedness” in Section 61(a)(12) as a source of gross income
Gross income
Gross income in United States tax law is receipts and gains from all sources less cost of goods sold. Gross income is the starting point for determining Federal and state income tax of individuals, corporations, estates and trusts, whether resident or nonresident."Except as otherwise provided" by...

.

Example: X owes Y $50,000. If Y discharges the indebtedness, then X no longer owes Y $50,000. For purposes of calculating income, this should be treated the same way as if Y gave X $50,000.

For a more detailed description of the “discharge of indebtedness”, look at Section 108 (Cancellation of Debt (COD) Income
Cancellation of Debt (COD) Income
Taxpayers in the United States may have tax consequences when debt is cancelled. This is commonly known as COD Income. According to the Internal Revenue Code, the discharge of indebtedness must be included in a taxpayer's gross income...

) of the Internal Revenue Code
Internal Revenue Code
The Internal Revenue Code is the domestic portion of Federal statutory tax law in the United States, published in various volumes of the United States Statutes at Large, and separately as Title 26 of the United States Code...

.

See also

  • Finance
    Finance
    "Finance" is often defined simply as the management of money or “funds” management Modern finance, however, is a family of business activity that includes the origination, marketing, and management of cash and money surrogates through a variety of capital accounts, instruments, and markets created...

    , Personal finance
    Personal finance
    Personal finance is the application of the principles of finance to the monetary decisions of an individual or family unit. It addresses the ways in which individuals or families obtain, budget, save, and spend monetary resources over time, taking into account various financial risks and future...

    , Settlement (finance)
    Settlement (finance)
    Settlement of securities is a business process whereby securities or interests in securities are delivered, usually against payment of money, to fulfill contractual obligations, such as those arising under securities trades....

  • Debt
    Debt
    A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...

    , Consumer debt
    Consumer debt
    In economics, consumer debt is outstanding debt of consumers, as opposed to businesses or governments. In macroeconomic terms, it is debt which is used to fund consumption rather than investment...

    , Debt consolidation
    Debt consolidation
    Debt consolidation entails taking out one loan to pay off many others. This is often done to secure a lower interest rate, secure a fixed interest rate or for the convenience of servicing only one loan....

    , Government debt
    Government debt
    Government debt is money owed by a central government. In the US, "government debt" may also refer to the debt of a municipal or local government...

  • Bank
    Bank
    A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...

    , Fractional-reserve banking
    Fractional-reserve banking
    Fractional-reserve banking is a form of banking where banks maintain reserves that are only a fraction of the customer's deposits. Funds deposited into a bank are mostly lent out, and a bank keeps only a fraction of the quantity of deposits as reserves...

    , Building society
    Building society
    A building society is a financial institution owned by its members as a mutual organization. Building societies offer banking and related financial services, especially mortgage lending. These institutions are found in the United Kingdom and several other countries.The term "building society"...

  • Annual percentage rate
    Annual percentage rate
    The term annual percentage rate , also called nominal APR, and the term effective APR, also called EAR, describe the interest rate for a whole year , rather than just a monthly fee/rate, as applied on a loan, mortgage loan, credit card, etc. It is a finance charge expressed as an annual rate...

     (a.k.a. Effective annual rate)
  • Default (finance)
    Default (finance)
    In finance, default occurs when a debtor has not met his or her legal obligations according to the debt contract, e.g. has not made a scheduled payment, or has violated a loan covenant of the debt contract. A default is the failure to pay back a loan. Default may occur if the debtor is either...

  • Interest-only loan
    Interest-only loan
    An interest-only loan is a loan in which, for a set term, the borrower pays only the interest on the principal balance, with the principal balance unchanged...

    , Negative amortization
    Negative amortization
    In finance, negative amortization, also known as NegAm, deferred interest or graduated payment mortgage, occurs whenever the loan payment for any period is less than the interest charged over that period so that the outstanding balance of the loan increases...

    , PIK loan
    PIK loan
    A PIK loan is a type of loan which typically does not provide for any cash flows from borrower to lender between the drawdown date and the maturity or refinancing date, not even interest or parts thereof , thus making it an expensive, high-risk financing instrument...

  • Loan guarantee
  • Loan sale
    Loan sale
    A loan sale is a sale, often by a bank, under contract of all or part of the cash stream from a specific loan, thereby removing the loan from the bank's balance sheet....

  • Payday loan
    Payday loan
    A payday loan is a small, short-term loan that is intended to cover a borrower's expenses until his or her next payday. The loans are also sometimes referred to as cash advances, though that term can also refer to cash provided against a prearranged line of credit such as a credit card...

  • Refund Anticipation Loan
    Refund Anticipation Loan
    A refund anticipation loan is a short-term consumer loan secured by a taxpayer’s expected tax refund, and designed to offer customers quicker access to funds than waiting for their tax refund...

  • Student loan
    Student loan
    A student loan is designed to help students pay for university tuition, books, and living expenses. It may differ from other types of loans in that the interest rate may be substantially lower and the repayment schedule may be deferred while the student is still in education...

  • Syndicated loan
    Syndicated loan
    A syndicated loan is one that is provided by a group of lenders and is structured, arranged, and administered by one or several commercial banks or investment banks known as arrangers....

  • Title loan


US specific:
  • FAFSA
  • Federal student loan consolidation
    Federal student loan consolidation
    In the United States the Federal Direct Student Loan Program include consolidation loans that allow students to consolidate Stafford Loans, PLUS Loans, and Federal Perkins Loans into one single debt. This results in reduced monthly repayments and a longer term for the loan...

  • Federal Perkins Loan
    Federal Perkins Loan
    A Federal Perkins Loan, or Perkins Loan, is a need-based student loan offered by the U.S. Department of Education to assist American college students in funding their post-secondary education. The program is named after Carl D. Perkins, a former member of the U.S...

  • George D. Sax
    George D. Sax
    George D. Sax was the chairman of the board of Exchange International Corporation and Chicago's former Exchange National Bank...

     and the Exchange National Bank of Chicago - Innovation of instant loans
  • Stafford loan
    Stafford loan
    A Stafford Loan is a student loan offered to eligible students enrolled in accredited American institutions of higher education to help finance their education...

  • Student loan default
    Student loan default
    Defaulting on a student loan in the United States can have a number of negative consequences. To understand loan default, it is helpful to have a few common terms defined:Loan Deferment is a postponement of a loan's repayment...

The source of this article is wikipedia, the free encyclopedia.  The text of this article is licensed under the GFDL.
 
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