Let’s start with the definition of a loan.
A loan is a type of credit vehicle in which a sum of money is lent by a party to another party in exchange for future repayment of the value. In most cases, the lender also adds interest and/or other finance charges to the principal value, which the borrower must repay in addition to the principal balance.
Sounds good? Now, along with the loan, there are a few more terms whose definition you might benefit from.*
Lender/Creditor: The party lending the sum of money.
Borrower/Debtor: The party borrowing the money to be repaid later.
Principal: The initial value of the sum of money being lent.
Interest: The amount charged by the lender as fees for the privilege of borrowing money, to be repaid in installments over a period of time.
Interest Rate: The amount of interest charged by the lender for the privilege of borrowing money, expressed as a percentage of the principal.
Finance Charges: A fee charged for the privilege of borrowing money to be repaid later. It can be a flat fee to be paid once (processing fees, late payment charges, etc.), or a percentage of the principal to be paid over the period of the loan (also called interest).
Loan Tenure: The duration of the loan repayment plan.
Loan Documentation: The document(s) that contain the details, and the terms and conditions, of the loan that is provided. It is a legally binding document that is signed by the lender and borrower.
Sanctioned Amount: This is the maximum amount of money the lender is willing to lend to the borrower.
Collateral: Any asset of fixed value which the lender accepts as security for a loan, such as real estate and property. The value of the collateral is typically more than the principal amount of the loan. It is a form of protection for the lender. If the borrower defaults on their payments and/or is unable to pay the amount, the lender can legally seize the collateral and sell it to recoup some or all of its losses.
Did you know that credit cards are also a type of loan?* Some loans, like a housing loan, are a one-time offering. On the other hand, credit cards are simply an open-ended line of credit that keeps revolving. Once you pay back the amount for a month, you can take it out again the next time.