The global credit system continues to evolve, gradually increasing its diversity. However, the components of loans remain stable. Therefore, it is worth taking a closer look at the main credit elements and their impact on the borrower’s profit.
Types of loans
The most common options are when a loan is granted for a specific lump sum or as an open-ended credit line up to a certain limit. The latter option implies that the loan can be spent, repaid, and spent again. In other words, it is a revolving credit line. Term loans usually have a fixed payment and interest rate. Credits are also differentiated by size. For large loans, a credit institution needs time to make a lending decision. If we are talking about small amounts, it is more profitable to use this loan app.
Interest rates and loans
Obviously, the higher the interest rate, the less profitable the credit is for the borrower. In addition, interest affects the amount of monthly payments and the total debt repayment period. At the same time, interest can be simple or compound.
The first option is interest on the principal amount of the debt, but it is quite rare, especially in the banking system. As for the compound percentage, it is essentially interest on interest, which means a larger payment amount for the borrower. That is, a percentage is charged both on the amount of the debt and on the accumulated interest for previous loan repayment periods.
If a loan is taken out for a short period, the difference between compound and simple interest is almost imperceptible. However, when it comes to large sums and maturities, the percentage will affect the size of the debt. That is why you should use a credit calculator before taking out a loan.
What does a loan consist of?
There are several components of credit that actually determine how useful and convenient a loan will be. Let’s take a closer look at them.
- The principal amount, i.e., the borrowed funds. Depending on the agreement with the lender and the client’s financial capabilities, it can be very different in size.
- Interest rate. This component of the loan varies significantly depending on the country, sector of the economy, type of credit, and, of course, the credit institution itself. Usually, interest is charged per year (annual percentage rate).
- Loan term. This is the period during which the credit must be repaid. Traditionally, mortgage loans are the longest in terms of time.
- Additional payments. The lender reserves the right to charge additional fees. This may be a service fee, a credit disbursement fee, or, in the case of late regular payments, a penalty.
- Collateral. This is used for large loans. It must be something owned by the borrower that is equivalent to the credit amount, such as a car, land, or real estate. In the event of default, this property is seized to repay the debt.
- Loan payments. These are funds that the borrower must pay during the period specified in the credit agreement. The frequency of payments may vary. Most often, it happens monthly, sometimes weekly, or every few months.
Lending results in an increase in the total money supply in the economy. Loans enable the creation of new businesses, which in turn increases competition in the market. And this is positive in any case, both for consumers and for the development of the economy as a whole.