Learn About Loans


Learn About Loans


A loan is a sum of money advanced to a third party that must be repaid, with interest at some point in the future. The lender must bear the risk that the borrower may not repay the loan. The interest rate charged is the price for that risk. A loan is money, classified as debt, for temporary use.

A business has to apply for a loan through some lending organization. A lending organization might be a commercial bank, credit union, or other lending organization like a thrift institution or an alternative source of loans for businesses. Loans may also be guaranteed by the Small Business Administration which usually makes them easier to obtain.

Business Loan


Most small businesses will need to look for external funding at some stage, with loan (sometimes called debt) finance being one of the most common sources of funds for both start ups and existing businesses. There are many different types of loan finance, and your ability to raise external finance will depend on a number of factors, such as trading history, business type and security. Borrowing money often requires you to give personal guarantees, which risks your own finances.

Most loan or debt finance is provided as a loan to your business that ultimately has to be repaid to the lender. The cost to your business is the interest on the debt and any additional fees, such as arrangement and valuation fees.

Bank loans are one of the most common forms of loan finance as they are flexible and relatively accessible. Typically referred to as 'term loans', they are repaid over a specific period at an agreed rate. The loan is usually secured against a business asset so if you fail to make repayments the lender has some security, which they can seize to recover the sum owed.

You have to pay interest on the full amount of the outstanding loan so make sure you need all the money you borrow. So long as you adhere to the terms of the loan, it cannot be recalled early, though many lenders now insert a clause allowing them to foreclose.

An advantage of bank loans is that you can match the term of the loan to the expected life of the asset. For example, match a short-term asset (such as a computer) with a short-term loan, and a long-term asset (such as a piece of machinery) with a long-term loan.

When taking out a bank loan, shop around to see what deals are available. Interest rates and the term of the loan should be negotiated to ensure you can meet the repayments. It is also worth asking whether incentives such as an initial capital repayment holiday, reduced initial interest rate or reduced set-up fees are available.

When banks are assessing whether to offer you a loan, they will look at the 'gearing'. Gearing is the ratio of debt to equity in a business. The equity is the money that you (and maybe family, friends and others) have invested in the business. Gearing is usually calculated as debt divided by capital employed - and capital employed is the sum of the debt and equity - expressed as a percentage. Increasing the debt in your business will increase your gearing, which, in turn, will increase the perceived risks associated with your business. Banks aim to ensure that the gearing does not exceed 50%, though will sometimes be persuaded to go much higher.

The banks are also likely to look at the 'interest cover'. This is a ratio of the net profit to the interest. Banks look for interest cover of at least two and ideally higher.

Bank Loan

One of the most common types of financing is bank loans. In order to obtain a bank loan for a new business, you may need to present a business plan or a loan proposal, which are similar documents.

The advantage of seeking a bank loan may be that you or your family has a preexisting relationship or history with a bank that makes the process easier. In any event, a bank will focus on several things in reviewing your loan application.


First, they will want to know about your business (the business plan), how much money you need, and how you intend to spend it. Equally important is demonstrating to the bank how your business intends to pay the loan back and over what time period. Financial projections are most helpful at this time.

The advantages of using debt are:


  • the time to secure debt financing is usually shorter than equity;
  • the cost of the money (principal and interest) is readily measurable;
  • documentation costs for the transaction will probably be less than an equity transaction; and,
  • the equity of the company is not diluted by new ownership.

The disadvantages to debt are:


  • unlike equity, the company has to pay back debt;
  • the company must carry debt on its balance sheet as a liability, which may make it less attractive to some investors;
  • if the cash flow of the business is tight, debt service can put an undue strain on the finances;
  • in many small businesses, commercial lenders require the principals to personally guarantee the debt and possibly pledge personal collateral; and,
  • some lenders require rather onerous record keeping by the borrower, such as quarterly and annual financial statements—possibly audited and impose restrictions on certain business transactions without the lender’s consent.

Banks are in the business of loaning money—that is one of their main profit centers. Your task is to demonstrate to them that you are creditworthy and that the revenues from your company are likely to pay back the loan in a timely manner. You demonstrate your ability to pay back the loan through your financial projections. If you already have a history of running a profitable business, a historical financial statement coupled with a financial projection could win the day.

Unless you have substantial assets in your company and healthy annual revenues, banks are likely to look to the creditworthiness of the owners of the business. In other words, you and your partners’ credit histories will be checked and you may be required to submit a personal balance sheet.

Student Loan

There are several options available for student loan borrowers. But, before opting for one, it is necessary that you question yourself if you can hold down the expenses; if you can work more, either in the academic year or during vacations; or if there are scholarships available for you. It is often said that if you minimize spending or bring in more money, the amount you have to borrow for your education tends to go down.

Your options, in order of preference:


  • Federal Perkins Loans - The Federal Perkins Loan Program provides lowinterest loans to help needy students finance the costs of postsecondary education. Students attending any one of approximately 1,700 participating postsecondary institutions can obtain Perkins loans from the school.
  • Federal Subsidized Stafford or Direct Loans - The subsidized Federal Stafford Loan is a federal student loan available to students with financial need. Subsidized loans are among the least expensive loan options for students because the federal government pays the interest while the student is attending college on at least a half-time basis and during other periods of authorized deferment.
  • Federal Unsubsidized Stafford or Direct Loans - The unsubsidized Federal Stafford Loan is a federal student loan that is not based on financial need. Interest accrues on unsubsidized loans from the time the loan is disbursed by the school. If the borrower does not pay the interest as it accrues, it is capitalized (added to the loan balance).
  • Alternative or Private Loans

Many experts agree that you should borrow only as much as necessary. As mentioned earlier, it is often tempting to borrow whatever you are offered or are eligible to borrow. However, it is necessary to think first carefully about hoe much you really need, as well as to consider other possible options.

Always note that there is actually no need for you to borrow the entire amount shown in your award letter. And, even more important is that, never plan to borrow as much as you can up the yearly limits because if you do so, expect yourself to be deep down in debt.

Mortgage Loan

In the past decades, it was believed that a mortgage loan is a mortgage loan no matter whichever is chosen. But this theory is not workable anymore because of the many mortgage loan products available in the market. So, before choosing a mortgage loan, it is very important to decide which one is right for you. Finding the right mortgage loan means balancing your mortgage options with your housing requirements and financial picture, now and in the future. Also the right mortgage is not just having the lowest interest rate but much more than that. And this “much more” will be determined by your personal situation. Your personal situation and your limits to pay for monthly mortgage payments can be evaluated by answering the following questions:

  • What is your current financial situation (including income, savings, cash reserves and debt-to-cash ratio)?
  • How you expect your finances to changeover in the coming years?
  • Have you plan to return the mortgage loan before retirement?
  • How long you intend to keep your house?
  • How comfortable you are with your changing mortgage payment amount?

The answers to these questions will give you the idea of your financial position. Now the next step is to decide two key options:

  • mortgage length,
  • type of interest rate (fixed interest rate or adjustable interest rate).

The length of mortgage loan can be minimum 15 years; can be 20, or at maximum 30 years. While selecting a fixed or adjustable interest rate you should be aware of the facts that the adjustable interest rate mortgage is more risky because the interest rate will change, while a fixed-rate loan offers more stability because of the locked-in rate. You will be able to pay off a shorter-term loan more quickly, but your monthly payments will be substantially higher. Long-term fixed-rate loans are popular because they offer certainty, and many people find that they are easier to fit into their budget. Although, in long run they will cost you more, but you will have more available capital when you need it, and you will be less likely to default on the loan should an emergency arise.

In the light of above mentioned aspects, it is clear that the key to select the right mortgage loan for your needs should fit comfortably into your entire financial picture, that is having payments within your budget and comfortable level of risk connected to it.

Car Loan

The common thought is that getting a loan for your new car purchase is pretty easy and straightforward. However, it is not so. There are a few ostensibly minor variations which can be actually cost you a lot of money. Therefore, it is worthwhile checking various loan offers that may distinguish the desirability of one loan over another.

Finding a car loan with the right benefits and interest rate can be the difference between you buying the car of your dreams or simply a car that you can afford. So, it is important that you give yourself solid answers to these questions:

  • What is your current financial situation?
  • How you expect your finances to changeover in the coming years?
  • Which car you want?
  • Do you think it is likely that you will want to refinance at some time during the life of the car loan?

Before choosing a car loan, there are several things that should be kept in mind:

  • Credit History ---- there are several lenders that may lend you money even if you have bad credit, but they may penalize you to pay high interest rates.
  • Compare Rates ---- rates vary and there is no sense spending even a dollar more than you have to so get several quotes before you buy your car.
  • Transfer Balances ---- be sure to look for hidden fees and transfer balances that my not be apparent at first glance.
  • Required Information ---- lenders will require your financial information such as whether you own or rent a home, how much your payment is how much money you own on credit cards, etc.
  • Pre-Payment Penalties ---- if such a penalty is built into the loan contract, the lender will penalize you, by charging a fee, if you pay the loan off early, whether through refinancing or by any other means. So, if you think it is likely you will want to refinance at some time during the life of the car loan, this is clearly an important consideration.
  • Simple Interest Loan ---- never agree to a car loan that is not a simple interest loan.

  • Also, don’t forget to ask the following questions while looking for the right car loan:

  • What interest rate can you offer?
  • What is the allowed time of repayment?
  • What down payment will you make?

  • Remember to go through the car loan contract thoroughly and be sure you understand each and every word. If you don't, take your time and ask any expert. But don't let anyone rush you through the process. In this way, you could get the car loan that is right for you now and in future too.


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