A Loan is generally defined as an arrangement, whereby a person or an organization lends money or asset to the borrower and the latter agrees to repay back the money or the asset along with the pre-determined interest charges after a stipulated time span. Generally, the lender has to bear the risk of loan default.
The principle function of the financial institutions is to provide loans. Loans take the form of debt when the financial institutions generate funds through issuing bonds or securities.
Categories of Loans
There are several kinds of loans differentiated on the basis of their payment structure, interest rates, collateral and associated risks. Different types of loans are:
Credit cards and lines of credit are the major examples of open-
ended loans. Under this particular category, a person can borrow money upto a credit limit. As the amount borrowed increases the credit limit falls while the latter goes up as the person repays the amount.
Contrary to open-ended loans, these do not allow people to borrow even after repayment. In this case, the concept of credit limit does not apply. So, the borrower won’t have any available credit for use. If the borrower needs to borrow more money, he will have to make fresh application for loan. Common types of close-ended loans are mortgage loans, auto loans, student loans.
In this type, the lender has to show an asset like house or car, which acts as collateral for the loan. In case of loan default, the lender is entitled to acquire rights of the property. Since, the loan is secured, the interest charges are comparatively low.
These loans do not have any asset as collateral. The loans are made on the basis of borrower’s credit history and income levels. Hence, the interest charged on such loans is very high. In situation of loan default, the lender has to resort to recovery mechanisms like debt collectors or filing lawsuit.
These loans are neither provided nor insured by government entities. Mortgage loans are often referred to as conventional loans. They generally follow the rules and guidelines of the Government Sponsored Enterprises (GSEs).
These loans are paid out with next paycheck as guarantee for the loan. They are short term loans with abnormally high Annual Percentage Rates (APR). Hence, it is generally advisable not to go for payday loans and look for alternatives.
Advance Fee Loans:
These are not loans in their real sense. The lenders usually convince the borrowers to obtain the loan by making initial payments. Once the money is sent, the lender usually disappears without even making the loan. There have been several instances of advance fee loan scams in history.
The Loan Process:
A customer generally has to undergo certain stages for acquiring loan. These stages are:
This is the first step towards obtaining loan. The lender collects information about borrower’s past debt records and present income and wealth status. In case of home loans or mortgage loans, the lender usually assesses the borrower’s affordability about how much the latter could spend. Different loan programs have different criteria for such evaluation.
This usually lasts for five days during which the borrower discusses the terms and conditions with the loan supplier and hands over the required documents for processing. At the end of this process, the borrower receives Good Faith Estimate (GFE) and Truth-In-Lending (TIL) statements with mentions of rates and associated costs of loan.
This stage lasts from day 5 to day 20. During this stage, the “processor” reviews the borrower’s past debt track to see whether there is any history of late payments, unacceptable behavior on borrower’s part or any property related issues.
It usually takes place between 21st and 30th day. The underwriter (borrower) checks if the loan package offered to him is adequate and acceptable. Moreover, further information must be furnished if either party demands so.
In situation of borrower’s failure to produce 20 % of the loan amount as down payment, the loan is submitted to a private mortgage insurer. Once the required information is furnished, the loan is returned to the mortgage company.
A closing time is assigned once the title insurance is ordered. This is done between day 25 and 30.
This occurs between days 25 and 45. During this period, the lender directs the loan to the borrower with a cashier’s cheque, draft or wire in exchange of the property title.
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Below are various types of loans, rates charged, and lenders of loans: