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A loan is an amount of money that is borrowed from a lender with the agreement that it will be repaid over time, usually with interest. The borrower receives funds upfront and commits to paying back the principal plus an additional cost for using the money.
A loan creates a financial obligation between borrower and lender.
Loans can be issued by banks, financial institutions, or private lenders and may be used for purposes such as buying a home, starting a business, or financing education. The terms of a loan include the interest rate, repayment schedule, and maturity date. Interest compensates the lender for the risk of lending and the time value of money.
If the borrower fails to make payments, penalties may apply and the lender may take legal action. Loans can be secured, meaning backed by collateral, or unsecured, meaning based mainly on creditworthiness.
Short example:
Suppose a person borrows $20,000 from a bank at an annual interest rate of 5 percent to purchase a car.
The agreement states that the loan must be repaid over five years in monthly installments.
Each month, part of the payment reduces the original borrowed amount and part covers the interest. If the borrower misses payments, additional fees may be charged and the bank could repossess the car if it was used as collateral.
Disclaimer: Investing brings risks. Our analysts are not financial advisors. Always consult an advisor when making financial decisions. The information and tips provided on this website are based on our analysts' own insights and experiences. Therefore, they are for educational purposes only.
