A Beginner’s Guide To Loans

Loans – a daunting word to hear in any day and age. But why exactly are loans considered such fearsome transactions to us? To quote noted author Dan Brown, “We all fear what we do not understand.” Many a time, we are scared simply because we are afraid of being on the losing end of financial jargon we know next to nothing about. In light of that, my aim in this article is to provide that basic insight into exactly what ‘loans’ are, the different forms they come in, their downsides and how to manage ‘loans-gone-wrong.’

To start off, let’s clearly define the term ‘loans.’ Loans are a debt made out from one individual, company or institution, to another, with an undoubted agreement that the original amount will be paid back in full. In this case, we’ll be dealing with monetary transactions (although objects and services can also be considered as loans).

Typically, loans consist of different elements that come together to ensure a successful transaction – the principle sum, an added interest rate, date of reimbursement, and more often than not, a contract, either verbal or written. How loans work would simply be that the borrower receives the stated principle sum from the lender, and is required to pay back the lender by a stipulated date, but with an added amount (a percentage of the principle sum).

Usually the borrower might face difficulties in returning the total sum (including interest rates!) to the lender at once, so repayment is done periodically, or in installments, and over an extended period of time until all of it is returned.

Borrowing money is always a tricky business but whether we like it or not, we live in an advancing world where loans are inescapable and embraced as part of our daily living. Loans now come in many various forms and are necessary in order to obtain commodities essential for our way of life.

Before exploring the different forms of loans, I will first break them down into two main types – secured and unsecured loans. Secured loans involves the pledging of an asset belonging to the borrower as a guarantee to the lender in case the principle sum loaned is unable to be returned. Unsecured loans are purely monetary transactions and do not involve pledging of other assets as collateral, but interest rates for such loans tend to be higher.

Under the ‘secured’ category, we have the following types of loans – housing loans, car loans, and commercial property loans.

As usual, the principle sum and interest rate have to be paid back to the lender (individuals, organizations or institutions such as banks) in annuity. In the cases of secured loans, borrowers are given the option of accepting either a fixed or “floating” interest rate, which depends on the changing interest rates over the period of time of the repayment. However as a precaution against situations where the borrower is unable to return the amount, usually the real estate or automobiles being bought with the borrowed money are used as a guarantee. In the event that the borrower is indeed unable to repay the loan or does not pay on time, the property or automobile purchased will be repossessed and resold to recoup losses. The cases of properties or real estate (whether for personal or commercial use) being used as collaterals are referred to as ‘mortgages.’ Thus, it is common to hear of most adults complaining about having to pay off their ‘mortgage’ or risk losing their property or ride.

Next, under the ‘unsecured’ category, there are personal loans, education loans, renovation loans and credit facilities. Personal, education and renovation loans are simply monetary loans made by the borrower from the lender, with no mortgage or collateral involved. The principle sum will have to be repaid along with interest, but for unsecured loans the interest is usually fixed and at a higher amount than secured loans. In the case of education loans, however, there tends to be the chance that the borrower (usually a student) is only required to start paying the interest when he or she graduates.

Credit facilities are provided by banks and would refer to the usage of credit cards for purchases. Unlike debit cards, credit cards allow for expenditure exceeding that of the actual amount possessed in bank accounts, with the excess paid off in monthly installments, with interest.

Although credit cards provide the ability to make higher priced purchases, people often lose track of the actual amount present in their accounts and run the risk of overspending. When this happens, the consumer will run into what is known as credit card debt, or consumer debt. When a consumer is late on repaying the sum owed to the bank, it is known as a “default” and the interest rates charged on the sum due increases and often, an extra ‘penalty’ sum is imposed. This cycle of increased rates and penalties will continue until payment is finally made, by which time the updated sum would have increased exponentially, and more repayment would have to be made.

Another risk consumers face with credit facilities would be a bank overdraft. There are many ways in which bank overdrafts occur, sometimes intentionally, through negligence, or through an ATM overdraft. Sometimes consumers would intentionally make a purchase that knowingly exceeds their savings amount, but ensure the purchase and penalty fee for over-expenditure by depositing sufficient funds. Negligent consumers encounter the same situation, with the difference being that the borrower is initially unaware that he or she has overspent. ATM overdrafts occur when a consumer, using a credit card as an ATM card ends up making withdrawals exceeding the maximum amount present in his or her account. When this happens, the consumer will again have to bear the penalty cost for exceeding the available funds and pay the deficit with interest.

The above mentioned are the most commonly faced problems when it comes to loans, which is why the notion of borrowing money is almost always synonymous with running debts. So, how does one go about getting out of debt?

First off, consumers can start by reviewing their debts. If possible, avoid multiple sources of credit as it is harder to keep track of the repayments that are to be made. With a large number of credit lines possessed, consumers often find that their income has to be split into numerous accounts, with most of their funds going into repaying the several deficits owed.

Secondly, draw up a monthly budget. Clearly list out monthly incomes against monthly expenses and try to figure out areas that can be reduced, or removed altogether. Having a proper documentation of how funds are allocated allows consumers to have a clearer understanding of the remaining funds they have on hand and not fall into the trap of overspending and repayments.

Lastly, as much as possible, consumers should aim to pay their installments on time and not run the risk of a default. This will ensure that interest and penalty charges are not incurred, so the amount owed to the lender does not keep building up. To make certain that this happens, consumers should try to stick strictly to their monthly budgets and be disciplined in depositing the proper amounts into their accounts for repayment.

With this basic introduction and tips for escaping debt, you need not be afraid of utilizing loans any longer! They are undoubtedly useful in times of need, and when undertaken wisely, can prove to be very rewarding.