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What Is a Loan?

Chances are you have a general idea of what a loan is. You've probably had friends loan you money, for example. It's the same principle in a business sense, but your friends usually expect the exact amount of money back. Banks and loan offices, however, are not your friends.

What is a loan?

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A loan is simply an amount of money that is borrowed. The person who is getting the money is called the "borrower" and the person who is giving it is called the "lender".

Why would I need a loan?

Loans are used by people or business for many purposes. It's generally used for things that require a large amount of money from people who don't have that much money. Say you want to buy a phone for $200, but you only make $50 a week at your job. Instead of saving up for it you could loan the money from your parents to buy the phone right now. Then you would pay them back the $200 a little at a time, say $20 a week for 10 weeks. But now you're paying for the phone while enjoying the benefits of owning the phone.

Where can I get a loan?

Banks, loan offices, lending companies, several places.

Why are these places giving me money? Do they make money?

Absolutely they make money. Unlike your friends and parents, banks and other lending places expect more money returned than what you borrowed, a concept known as "interest". That's why you hear things like "Apply for a loan at 4% interest!" It can also be referred to as a "rate". The reason these places have this much money to lend is because they make enough money from interest. Think of interest in loan terms as the cost of borrowing money.

4% interest? How does it work?

Before you apply for a loan, you can view the loan's interest rate, APR (annual percentage rate), and term. I know it seems like we just kicked everything up a notch, but this stuff sounds more complicated than it is.

Interest rate: How "expensive" the loan is, so to speak. The higher the interest rate, the more you pay the lender for borrowing their money. It's in percentage terms because it depends on the amount of the loan. A $100,000 loan at 6% interest paid once a year means you have to pay $6,000 once a year just in interest . You would also have to pay back some of the $100,000 you borrowed which the interest doesn't count toward. This amount depends on how long you have to pay back the loan.

APR: Any place that lends money can come up with their own pay schedule. Loans wouldn't be much use if you had to pay back the money all at once, and then extra. Therefore, loan payments are usually once a month, but there's no set standard. The more frequent payments are, the more the "hidden" interest rate is. For this reason, the government requires banks and such to include an APR, which is the interest rate if they required you to pay them once a year. If you want to compare various loans, use the APR to compare how "expensive" the loans are.

Term: Simply the length of the loan. A 3 year loan, for example, requires you to make payments for three years, whether the payments are once a month, twice a year, or another frequency is up to the specific loan. The longer the loan, the more time you have to pay it back, and the more "expensive" it is.

Loans seem like a scam. Why does anyone get them?

To people who don't quite understand loans, they might seem shady. Loans can allow you to enjoy the benefits of an item or project that you wouldn't have been able to afford otherwise. It is important to research them carefully and understand exactly what you'll be paying, though. If you are ever unclear about what a loan entails, please consult someone who can walk you through it, preferably a professional.

So that's all there is to a loan?

Not exactly. If you understand what we've said here then you know enough to understand our articles. Further questions can be answered from websites like Investopedia and Wikipedia.

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Posted in Financial Services Post Date 04/10/2018


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