What is a Loan?

Written by Wellington Ayugi

A loan is an arrangement where a Lender advances money, property or other material goods to a Borrower. The borrower then agrees to pay back what is owed to the lender with interest at a later date. A loan can either be a:

  1. Secured Loan: This involves the pledging of an asset (for instance a house, land or even car) as collateral to the lender, for the loan. In the event the borrower is unable to pay the loan, the lender takes ownership of the collateral.
  2. Unsecured Loan: This is a loan issued without a pledge of collateral, but based on the borrower’s ability to pay.

How Do Interest Rates Affect Loans?

The Interest is a fee exacted by the lender to offset the risk of the loan not being repaid. Interest rates have a huge effect on loans. Loans with high interest rates have higher monthly payments and generally take longer to pay off than loans with low interest rates. Most banks offer either:

  • Fixed-rate loans: Most loans offered by banks are fixed-rate loans. Fixed-rate loans mean that the bank keeps the interest rate constant throughout the life-cycle of the loan. 
  • Variable-rate loans: The interest rate on variable-rate (also called adjustable rate) loans moves up and down based on the changes of an underlying interest rate index that is set by the Central Bank.
Types of Loans

Personal Loans: This are loans issued for household, family and personal use. The loans can be used for different purposes and can either be unsecured or secured.

Student Loans: This is a loan offered to students by financial institutions or government agencies to pay for their higher education fees and living costs.  Usually, the loans advanced by government agencies have lower interest rates and customer friendly repayment terms compared to private lenders.

Mortgage Loans: These are loans offered by banks to help their customers purchase homes.

Cash Advances: These are easy-to-access short-term loans that are meant to shorten the gap from one paycheck to the next. However, they have high interest rates and are usually available for relatively limited amounts.

Home Equity Loans: A homeowner can be advanced a loan against the mortgage of their house. The loan is the difference between the appraised value of the house and the mortgage amount still owed.

How Can a Loan be Useful?
  • It has a flexible payment period: A loan cannot be repaid on demand unless the terms of the loan are breached. Therefore the borrower is guaranteed the funds for the entire loan period.
  • They can be available in a short period of time: In the event of an emergency you can obtain a personal loan in a short time. However, this is only possible if you have established a good credit relationship with the bank.

Loans are an effective option when it comes to short, medium and long term financing. The ultimate goal should always be to get the best rates and terms on the loan that best fits your needs. This requires going through a lot of information but it is worth the task. 

Learn more:

  1. Loans
  2. Common Loan Terminologies and Definitions
  3. Types of Consumer Credit and Loans

About the author

Wellington Ayugi

Wellington Ayugi handles Business Development at Covered and has a passion for personal finance, microfinance, and developments in financial technology