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Terms of Credit Overview

Terms of Credit Overview When an individual obtains a loan from a lender, there are certain terms and conditions that come as part and parcel with the loan. For obtaining authorization to secure a loan, a borrower must adhere to the terms specified by the creditor. This includes complying with rules surrounding the payment of interest, making regular timely payments, and maintaining a positive credit history. If an individual fails to adhere to these terms, he/she may experience adverse consequences for his/her behavior.

Different types of loans have various conditions associated with their use. For example, some loans may require a borrower to supply the lender with collateral, while other loans will not. Unsecured loans will often charge a higher interest rate than secured loans. It is important for a consumer to fully understand the terms and conditions of a loan before entering into a legally binding financial agreement. 

Repayment

One of the most fundamental conditions attached to a loan or line of credit is repayment. When an individual obtains a loan from a bank or a credit union, he/she will be required to repay the creditor for the loan. Regulations surrounding repayment will vary based on the type of loan that an individual acquires.

When a consumer is granted a loan by a lender, they will specify the repayment plan to which a borrower must adhere. If the debtor fails to comply with the conditions of the financial agreement, he/she may face repossession or foreclosure.

Interest Rates 

Annual Percentage Rate

Before a consumer enters into a financial agreement with a lender, he/she should fully understand all of the terms and conditions included in that agreement. “Annual percentage rate” (APR) is a common financial term that is often used when explaining the terms of a loan.

When a creditor advertises the conditions of a loan, they often include the APR. If the annual interest rate is especially low, a lender will be sure to emphasize this in their advertisements. This is because the annual percentage rate has an important effect on the total sum of money that a borrower pays a lender.

The APR refers to the percentage of interest that a debtor will pay on a loan every year. The higher the annual percentage rate, the more money that the borrower will end up paying on a loan. The total value of repayment also depends on the length of a loan. The longer a loan is, the more in interest a borrower will be required to pay. 

Collateral 

When a creditor grants an applicant a loan, they are taking part in a risky investment. If the borrower fails to repay the loan, the lender will lose any money that was extended to the debtor. In order to avoid losing the entire value of a loan, it is common for a creditor to request collateral. An applicant may be granted a secured loan or an unsecured loan.

When an individual is extended a secure loan, he/she must provide the creditor with access to valuable personal property. This property will act as collateral for the loan. In the event that the borrower is unable to pay his/her debt, or if he/she files for bankruptcy, the creditor will seize the property as compensation for the loan.

Requiring collateral results in a less risky investment for the lender. However, many consumers fear obtaining secured loans because if they are unable to pay their debts, then they may lose valuable property, such as their home or their motor vehicle. 

Secured Bonds 

Secured bonds are similar in concept to secured loans. However, unlike a common loan, a bond is issued by a corporation to consumers with the intention of obtaining necessary funds. In many cases, banks and credit unions cannot address the financial needs of a large business. In instances such as this, a corporation will sell bonds to consumers.

The business will then be allowed to use the money it has been afforded and will repay the lenders at a future date. The lender will also receive interest on any money that he/she provides a company. Therefore, bonds are a way to make a long-term profit on a relatively small sum of money.

When a company issues a secured bond, it has assets to support the value of the bond. In the event that the company files for bankruptcy, these assets will be sold in order to compensate bondholders.

Therefore, secured bonds are often considered to be a safe investment because individuals who purchase a secured bond are guaranteed a return on their investment. Plus, if a company is required to file for bankruptcy, secured bondholders are the first creditors to be compensated. 

Debentures

Debentures are based on the same fundamental concept as secured bonds. When a company needs funds, it will sell debentures to consumers. However, unlike secured bonds, individuals who purchase a debenture are not offered collateral for their investments.

A debenture is a type of unsecured loan. A creditor is making an investment without any guarantee that he/she will be compensated for his/her loan. If a company files for bankruptcy, an individual who has purchased a debenture may not receive the payment that was owed.

Because of the increased risk associated with investing in a debenture, an individual who purchases an unsecured bond will often receive a greater profit than an individual who invests in a secured bond. Therefore, many individuals who are seeking a high profit and are unafraid of taking financial risks will purchase a debenture. There are many different types of unsecured bonds that an individual may obtain, ranging from government bonds to corporate bonds.

Government Bonds

Like a corporation, a government often needs to obtain financial resources in order to continue operating effectively. There are different levels of government, and therefore, there are numerous different types of government bonds that an individual may obtain.

When a consumer purchases a government bond, he/she is essentially loaning money to a government entity. As a result of issuing the government a loan, the buyer will receive interest payments throughout the duration of the bond.

A government bond is a method of investment that is often overlooked by investors. However, this type of investment may yield a substantial profit. Generally, purchasing government bonds is a much more stable investment than purchasing shares of stock.

Creditworthiness

When an individual applies for a loan or a line of credit, a lender will review his/her credit report in order to determine whether or not he/she is creditworthy. In order for an individual to be deemed creditworthy, he/she must have a solid credit history. If an applicant's credit report displays evidence of financial irresponsibility, it is likely he/she will be denied a loan.

In many instances, an individual who has a poor credit score will be granted a loan with a high interest rate attached to it. This helps to assure creditors that even if a borrower were to default on his/her loan, the lender would receive a larger portion of his/her expected payment than if the borrower were granted a low interest rate. 

Credit Risk

Banks and credit unions will perform a credit risk analysis on an individual that applies for a loan. If a credit risk analysis reveals that an applicant poses a high credit risk, the lender may refuse to grant a loan to him/her.

When performing a credit risk analysis, a lender will review an applicant's credit history, to determine if he/she has been financially responsible. An applicant is considered to be a safe investment if he/she has continuously made his/her monthly payments on time.

There are many different adverse behaviors that can cause an applicant to be viewed a credit risk. For example, if an individual has defaulted on a previous loan, he/she will be deemed a high-risk investment and many creditors will refuse him/her a loan.

There are loans that have been specifically designed for individuals who are considered to be a credit risk. It is important for an applicant to review all of the information about these types of loans, as they may often be even more harmful to individuals who have experienced financial trouble in the past. 

Financial Intermediation

Financial intermediation is essential to the credit system that has been developed in the United States. In theory, it is possible for an individual that saved a sum of money to loan this money to another consumer. The lender may charge interest on the loan and make a profit on his/her money. However, there are many problems with this scenario.

An individual does not have the experience that is necessary to determine to whom it would be acceptable to grant a loan and who would present a credit risk. If a lender is not cautious, then he/she may lose his/her funds in a unwise loan.

Financial intermediaries have the experience to determine which applicants are safe to be issued a loan. By utilizing the services of a financial intermediary, an individual that has saved a sum of money can more safely loan these assets and hopefully make a profit on his/her funds without the fear that he/she will lose this money.

Securitization

If a creditor's focus and resources are dedicated to previously-granted loans, then the lender may not have the ability to continue issuing new loans. In order to address this, a lender will have to discard of some of their previous financial agreements.

However, they are legally bound to adhere to the terms of the contract, and therefore, they are unable to dissolve a financial agreement before the duration of the agreement has ended.

Because of this, one of the primary ways that a lender frees up assets for new loans is by selling their previous financial agreements. The lender will gain a profit through the sale and have new resources available to continue issuing loans.

The process of securitization is also important when a corporation or a lender wishes to isolate its finances so that the credit history attached to one financial endeavor does not affect the prospects of a new economic venture.

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