Understanding how loans work

Reviewing loan terms carefully is important for to understand your obligation when taking out a loan. There are different types of loans and each with its own requirements.

Understanding how loans work
Photo by Karolina Grabowska

Taking loans is not a comfortable topic in the world today; people are often worried that they may be unable to pay the accumulated interest and risk losing their precious assets. Unfortunately, many people are not familiar with how loans work. Many still have a lot of misconceptions about taking loans. Most people assume that a business or an individual is in a financial mess when they seek out for a bank loan. This notion might be widespread, but it is not always the case.

If you are looking to get a loan and are unsure how loans work, you are on the right page. This post will discuss how loans work, the various types of loans, and the requirements for multiple loans.

A loan is a fixed amount that is lent to an organisation or individual by a financial entity, an organisation, or an individual. This amount is to be repaid on a specific date. The loan recipient is the debtor, while the lender is the creditor. Also, loans come with interest. So, the amount to be repaid is usually more than the exact amount borrowed. Loans can be long-term; loans that are typically associated with high-interest rates or short-term loans that are linked to low-interest rates.

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Types of Loans

Several loans are offered in many countries across the globe. Therefore, knowing the various types of loans and their terms can help you choose the right loan for you at every point.

Some of the most common types of loans include the following:

Salary Advance Loan

This is a short-term loan that an individual could take while awaiting their pay-check. Although salary advance loans are easily accessible, they may come with high-interest rates. Most financial institutions that offer a salary account or services used by companies to manage their payroll offer this type of loan

Monthly Payment Loans

This is a type of loan in which the borrower has to make monthly payments to service the loan. It is a loan that can only be gotten by individuals that earn a steady monthly salary or have a thriving business with monthly recurring revenue.

Single Payment Loan

This loan type gives borrowers the freedom to get a loan of a fixed amount that will be paid in full at a particular time. The loan duration is often determined and agreed upon before the loan disbursement.

Unsecured Loan

As the name suggests, this type of loan can be obtained without collateral. However, it comes with high-interest rates, which is often a turn-off for many borrowers. You do not have to tender any assets with the unsecured loan before getting the amount you need.

Secured Loan

Unlike an unsecured loan, this loan type requires the prospective borrower to give up an asset as collateral to obtain the loan. The collateral must have an equivalent value to the amount of loan the applicant is requesting. If the borrower cannot pay up at the agreed time, the lender has the right to cease their asset. Once the asset is seized, the lender, usually a bank, can go on to sell the asset in an attempt to recover their money. Secured loans are not ideal for borrowing small amounts, as you might not want to risk an asset for an amount that is nowhere close to its value.

Additionally, secured loan comes with a low-interest rate and can be repaid over a long period of time. Secured loans might seem like an easy way to access colossal capital for starting a business or expanding an already existing one. However, they are generally considered riskier than other types of loans. If you cannot repay the loan, you may lose the asset. So, before settling for this type of loan, you should have a viable plan to pay it back. You might also want to consider other types of loans.


This is a personal loan that is often taken by people looking to purchase a house. It is not the best loan for business owners. However, if you are interested in owning a home or property long before you can actually afford one, you can take advantage of the existence of a mortgage.

Generally, mortgage loans involve three elements: principal, interest, and collateral. The principal is the actual amount lent to you for purchasing a home. You will not be paying back the exact amount you borrowed. There will always be a percentage increase, and this increase is known as interest.

The collateral involved in this type of loan differs from the collateral for a secured loan. Unlike a secured loan, where you need to submit an asset that you already own before getting a loan, with a mortgage loan, the property you purchase with the loan you get stands in as the collateral. Since the purchased property is the collateral, if you fail to service the loan according to the agreement, it is legal for the lender to take back the property.

Bank Loan Securities

Banks are businesses, and as such, they also operate to make profits. So, they would always require assurance that the money they lend will not be lost. This is why many major loan providers require a collateral. With collateral, a bank is sure that the borrower will not run off with their money. When a borrower cannot pay back a loan, the bank takes possession of the collateral, sells it, and offsets the loan. Common collaterals for obtaining loans include equipment, goods, personal property, and real estate.

To obtain a loan, you will be required to submit some essential documents, some of which can be:

  • Trust receipt
  • Joint memorandum
  • Negative pledge
  • Irrevocable standing debit order
  • Letter of Lien/Set-off
  • Debenture
  • Personal Guarantee
  • Legal Mortgage
  • Offer letter


We all need money to meet certain financial obligations. Loans come in handy when there is no alternative. There are various types of loans to choose from, and each of them has its basic terms and conditions. Generally, it is crucial to be careful when taking loans. You could lose a property you worked hard to acquire if you can not repay a loan.

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