Bank Loan

A loan is a type of debt. This article focuses exclusively on monetary loans, although, in practice, any material object might be lent. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower.

It is commonly believed that the borrower initially receives an amount of money from the lender, to be paid back, usually but not always in regular installments, to the lender. In fact, the lender, whether a bank or credit card company, does not provide any cash to the borrower, but simply extends “credit.” [1] The lender does this by making a credit entry into the financial account (e.g. savings or checking) of the borrower; the value of this credit is equal to the amount of the loan. At the same time, the bank, for example, marks the loan as a liability in one part of their accounting system, and an asset in another part. The amount of the asset is equal to the amount of money the borrower promises to pay back, known as the principal.

In this way, the bank or other lending institution creates money, which the borrower is now free to “spend.”

In addition to the principal, the lending institution generally charges the borrower a fee, referred to as interest on the debt, for the privilege of using this newly-created money. Note that the lender acts merely as an intermediary between the borrower and the party providing the goods or services that the borrower obtains with her loan money. The lender is not required to, and typically does not, furnish any tangible assets such as cash money.

In essence, the lending institution creates money out of thin air, by accounting entries, and makes a substantial profit in the process.[2] For example, if the interest on the loan is 6 percent, to be paid off in 30 years (a typical home mortgage contract), the borrower will end up paying more than double the amount of the loan. If the contract is for a loan of $100,000, the borrower at the end of the contract period will have paid back $ 215,838. The lender’s profit is greater than the original loan amount.

A loan is of the annuity type if the amount paid periodically (for paying off and interest together) is fixed.

A borrower may be subject to certain restrictions known as loan covenants under the terms of the loan.

Acting as a provider of loans is one of the principal tasks for financial institutions. For other institutions, issuing of debt contracts such as bonds is a typical source of funding.

Legally, a loan is a contractual promise between two parties where one party, the creditor, agrees to provide a sum of money to a debtor, who promises to return the money to the creditor either in one lump sum or in parts over a fixed period in time. This agreement may include providing additional payments of rental charges on the funds advanced to the debtor for the time the funds are in the hands of the debtor (interest).