A loan is a financial agreement between a borrower and a lender, where the borrower receives a specific amount of money (known as the principal) with the commitment to repay it over time. Loans generally fall into one of three main categories:-
- Amortized Loan
- Deferred Payment Loan
- Bond
Calculate : Amortized Loan / Deferred Payment Loan / Bond
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Amortized Loan: Fixed Payments Over Time
Many consumer loans fall into this category, where borrowers make regular payments covering both principal and interest until the loan is fully repaid. Common examples include mortgages, car loans, student loans, and personal loans. In everyday conversations, the term “loan” typically refers to this type. Instead of using a general loan calculator, borrowers may find it more useful to use specific calculators for each loan type.
Deferred Payment Loan: Lump Sum Due at Maturity
Often used for commercial or short-term financing, these loans require a single lump-sum payment at the end of the loan term. Unlike amortized loans, deferred payment loans do not involve periodic payments. Some variations, such as balloon loans, may have smaller interim payments, but the principal and remaining interest are due at maturity.
Bonds: Predefined Payout at Maturity
Bonds function differently from traditional loans. In this case, borrowers (issuers) commit to repaying a predetermined amount, known as the face or par value, when the bond matures. There are two primary types of bonds:
- Coupon Bonds – Pay periodic interest (annually or semi-annually) based on a percentage of the bond’s face value.
- Zero-Coupon Bonds – Sold at a discount and redeemed at full value upon maturity, with no periodic interest payments.
After issuance, a bond’s value fluctuates based on market conditions and interest rates, though its maturity value remains fixed.
Loan Basics for Borrowers
Interest Rate
Interest represents the cost of borrowing money, typically expressed as the Annual Percentage Rate (APR), which includes both interest and fees. In contrast, the Annual Percentage Yield (APY) reflects the interest earned on savings. Understanding the difference between APR and APY is crucial for financial planning.
Compounding Frequency
Loans accrue interest based on compounding frequency, meaning interest is calculated not just on the initial principal but also on previously accumulated interest. Most loans compound monthly, which can significantly impact the total repayment amount.
Loan Term
The loan term determines the repayment period. Longer terms generally result in lower monthly payments but lead to higher overall interest costs.
Types of Consumer Loans
Secured Loans (Backed by Collateral)
A secured loan requires borrowers to pledge an asset (e.g., a house or car) as collateral. If the borrower defaults, the lender has the legal right to seize the asset. Common secured loans include:
- Mortgages – The bank holds the property deed until the loan is repaid.
- Auto Loans – The lender retains ownership of the vehicle title until full repayment.
Since secured loans carry less risk for lenders, they often feature lower interest rates and higher borrowing limits.
Unsecured Loans (No Collateral Required)
Unsecured loans rely on the borrower’s creditworthiness rather than collateral. Lenders evaluate applicants using the Five C’s of Credit:
- Character – Credit history, income stability, and past debt obligations.
- Capacity – Debt-to-income ratio to assess repayment ability.
- Capital – Other assets, savings, or down payments.
- Collateral – Not applicable to unsecured loans.
- Conditions – Economic trends and loan purpose.
Unsecured loans typically have higher interest rates, lower borrowing limits, and shorter repayment terms. In some cases, lenders may require a co-signer—someone who agrees to repay the loan if the borrower defaults.
Common examples of unsecured loans include:
- Credit Cards
- Personal Loans
- Student Loans
If a borrower fails to repay an unsecured loan, lenders may involve a collection agency to recover outstanding payments.
For more details or to perform calculations related to these loans, refer to specific loan calculators such as the Credit Card Calculator, Personal Loan Calculator, or Student Loan Calculator.