Have you ever wondered how you can buy something that you cannot pay for just now? Wouldn’t it be great if you could pay for something bit by bit over a long period of time? Well then let me introduce you to loans.
Loans are a very common way of borrowing money from a person or an institution that lends you money at a nominal rate of interest.
It is a simple concept that has been there for ages and has been used by many to fund their projects. In fact, the concept of borrowing is so common that a basic understanding of it will lay the foundation of what loans are. It will be wise to remember that although loans are a very helpful tool in finance, ,they can be harmful too.
Failing to pay back the money one has borrowed can have serious consequences. So we should know what to do and what not to do when taking a loan. For that we need to understand loans in depth.
WHAT ARE LOANS?
A loan is a promise made by the borrower to the lender, to pay back the money they have borrowed, with some interest on it. Loans are usually paid back in small parts at regular intervals of time. These small parts are called installments. The lender usually charges a small fee for lending you the money, called interest.
The most common sources of lending are banks.
HOW IT WORKS
Imagine you see the latest edition of a toy that you want to buy and so you have been saving up some of your pocket money for it. The toy costs Rs 150 but when you open your piggy bank, you find that you have been able to save up only Rs 100. A very logical step now would be to ask your parents or grandparents for the extra 50 rupees that you promise to pay back from your pocket money later in small sums.
This is the very essence of borrowing. In a way, your parents or grandparents loaned the money to you.
Since they are your parents, or maybe your grandparents, they will probably not charge you anything for it, but a bank or any financial institution will charge some fee for lending you the money.
There are 2 major parties involved in a loan: The borrower and the lender. The borrower is the person who is borrowing the money and the lender is the person who is giving the money to the borrower under certain conditions and the promise of being returned the money.
There are 3 major elements of a loan : Principal, Interest and Time interval.
The Principal is the amount of money that you have borrowed.
The interest is the amount of extra money that you have to pay back to the lender along with your Principal.
The time interval is the interval in which the installments are to be paid.
Here’s an interesting fact:
Secured loans have a lower rate of interest typically as having collateral makes it less risky for banks to give loans.
Loans are an essential part of a person’s financial records as timely repayment of loans show that you are a trustworthy borrower. This is called a credit score. A good credit score makes it easier to get loans in the future.
DO’S AND DON’TS
Loans are actually encouraged by society as taking a loan shows the commitment to build something productive out of the borrowed money. People usually take loans to fund their college fees and get educated, or to buy a house and settle down, or maybe start up their own businesses. All these are commendable activities and loans are a very useful financial tool in such prospects.
With limited borrowing and timely repayment of the loans, you can build a better society that benefits all. In this way, loans form a cornerstone of society through which everyone can contribute even with some limitations.
However, there are some things that must not be done with loans. It is easy to fall into the trap of borrowing and get stuck with a lot of debt on your shoulders. One must control their desires and opt for what one needs, as opposed to what one person wants. Not being responsible with your repayments or borrowing excessively is the first step to trouble.
Be clear about your goals, know how much you can realistically repay and pay back the loans on time. That way you will get the best out of loans and build something better and innovative.