A loan is when someone gives money to someone else in exchange for future repayment of that money, usually with interest.
When you need to borrow money to make a purchase you can’t otherwise afford on your own, the process looks something like this:
You apply for a loan from a lender
(such as a bank or other financial institution)
Lender reviews the application
Lender approves or denies the application
(if denied, the process ends here)
If approved, you and the lender
agree to the loan terms
Lender gives you the loan amount
You use the money to make the purchase
You make regular payments to the lender until the loan is repaid
But banks and other businesses aren’t the only ones that make loans—you could get a loan from a friend or family member. And not all loans involve money. If you check a book out from your library, the library is making you a loan.
Although there are many different kinds of loans, the ones you’ll most commonly encounter include:
|Type||What it is|
|Student loan||Offered to students and their families to help cover the cost of college or grad school|
|Mortgages||Loans to help people buy homes|
|Auto loans||Similar to mortgages, they help people pay for cars|
|Personal loans||May not have a designated purpose; can be used to cover various personal expenses, such as credit card debt|
|Business loans||Given to entrepreneurs or established companies to help them start or expand operations|
Loans can also be divided into two categories depending on whether the lender requires something of value to back the loan (known as “collateral”):
Secured loans are safer for lenders because they can always seize (and sell) your collateral if you don’t pay your loan. So, secured loans typically come with lower interest rates than unsecured loans.
While your parents might be willing to loan you some cash just because they love you, banks don’t feel the same. Instead, they’ll ask for specific information to figure out whether you’re likely to repay what you borrow.
Before making a loan, lenders typically look at your:
Some loans also require a down payment or collateral, which the lender also considers when making a decision.
Part of the loan process requires agreeing to a set of terms and conditions. The document you sign will include information on the:
Your agreement will likely also spell out when payments are due (and the amount of each payment) and any other fees or penalties you could face if you don’t follow the loan agreement.
Loans let people buy things they don’t have the money to cover up front in one lump sum. In return, the borrower agrees to pay back the loan amount, usually with interest, to the lender over a set period of time. People often turn to loans to help them buy a house or car, pay for college, or get a business off the ground.