Loans

A loan is a credit facility extended by a bank to the borrower, which is repaid in installments over a period of time.

Facts to consider when looking for a Loan type

When borrowing loans, you will often come across terms like:

 Secured loans.

 Unsecured loans.

 Revolving loans.

 Installment.

 Fixed rate loans.

 Adjustable rate loans.

While these terms are more or less self-explanatory, it is still useful to be clear on their exact meanings and what they imply before you finalize a loan contract.

Secured loans

A secured loan is one where you offer collateral of some kind against the loan. That means, if you default on the loan, the lender has the right (but not the obligation) to take possession of the asset you have pledged.

Unsecured loans

Loans are those where such collateral arrangements do not exist. These loans are granted based on your credit standing, ability to repay and other factors.

Revolving loans

A revolving loan is one where you have access to a continuous source of credit, up to a pre-determined credit limit. If the limit is say, $10,000, you can borrow any amount up to $10,000. And typically, you can repay all or part of the amount you borrowed at a time of your choosing, within the overall tenor of the loan.

Installment loans

Installment loans have a fixed repayment schedule. In most cases, the full amount of the loan is drawn down (i.e., borrowed) at once and both repayment schedule and amounts are fixed in advance. You do not have the option to re-borrow the amount that has been repaid.

Fixed rate loans

A fixed rate loan is one where the interest rate charged is fixed for the entire duration of the loan. The advantage is that you are immune to fluctuations in interest rates and can budget your cash outflows precisely. The disadvantage to you is that should interest rates fall, you lose in terms of opportunity costs. That is, you could have obtained a lower interest rate had you opted for an adjustable rate loan.

Adjustable rate loans

An adjustable rate loan is one where the interest charged fluctuates in line with a benchmark rate. This benchmark rate is usually the Prime Rate, which is what the US Treasury charges its prime borrowers. The advantage of an adjustable rate loan is that what you are paying is more or less in line with the market. If interest rates decline, so do your costs and vice versa. The disadvantage is that your cash outflows for interest are unpredictable.

Some things a bank will review when you seek for a loan

1. Balance sheet

The balance sheet is probably the first thing your loan officer will turn to. The balance sheet records your assets, liabilities and capital. Existing companies show a starting balance as a result of all past activities.

2. Credit history

The bank will determine when a person/business requests a loan is whether their personal and business credit is good.

3. Cash flow history and projections for the business

The cash flow from your business's operations — the cycle of cash flow, from the purchase of inventory through the collection of accounts receivable — is the most important factor for obtaining short-term debt financing.

4. Collateral

Financial institutions will look for a second source of repayment, which often is collateral. Collateral are those personal and business assets that can be sold to pay back the loan.

5. Ability to repay

Banks will want to see two sources of repayment - cash flow from your earnings/business, plus a secondary source such as collateral. In order to analyze the cash flow of your earnings, the lender will review the business's past financial statements.

6. Equity

Equity can be built up in a business through retained earnings or the injection of cash from either the owner or investors. Most banks want to see that the total liabilities or debt of a business is not more than four times the amount of equity.

7. Loan documentation

That includes business and personal financial statements, income tax returns, and frequently a business plan, and that essentially sums up and provides evidence for the all items listed.