Characteristic Of Loan Transactions

Lending and borrowing transactions are characterized by time factors, costs, and risk considerations; all three are closely related.

Time Factors. 

 

Term loans are classified by the length of time for which money is lent. Loans come in short-term, intermediate-, and long-term forms. Revolving credit and perpetual debt, however, have no fixed retirement dates. Revolving credit, better known as a "line of credit," provides a sum of money which the borrower draws down and then pays back, borrowing again when funds are needed again. Interest is paid only when funds are being used. Brokerage houses that extend margin credit for customers on certain securities work the same way. The holder of a perpetual loan, usually issued through a registered offering, only pays interest on the money and decides in his or her own time when to retire the principal.

Repayment Schedules match the type of loan obtained and also affect the costs of the borrowing. Payment terms available either call for combined payments of principal and interest at regular intervals or require interest payments only with the principal repaid as a single sum at the end of the contract. In the first case interest is charged only on the remaining balance of principal so that the interest portion declines over time. Under some types of leases, the lessor gradually acquires the real estate or the equipment being leased. In these cases the lease payment remains the same but the lessor's costs decline because he or she is able to claim a portion of the property as depreciation against taxes.

Cost.  

The cost of a loan is the interest charged. Interest may be fixed for the term of the loan or may be variable. If the rates are variable, they may be adjusted daily, annually, or at intervals of years (3, 5, and 10). Such rates (called floating rates) are tied to some index such as the prime federal lending rate. As a general rule interest costs are based on the current cost of money and the relative risk of the loan, so that collateralized debt costs less than unsecured debt.

Security. 

Assets pledged as security against the loss of the loan are known as collateral. Credit backed by collateral is secured. In many cases, the asset purchased by the loan often serves as the only collateral, but in other cases the borrower puts other assets, including cash, aside as collateral. Real estate or land collateralize mortgages. Unsecured debt relies on the earning power of the borrower.

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