The Basics Of Loans

A loan is a type of debt. Basically, a loan entails the redistribution of financial assets over time between the lender and the borrower. The borrower will initially receive an amount of money from the lender, which they will pay back to the lender, usually in regular installments.

Generally, Financial Institutions play the role of providing loans. But, for other institutions, issuing of debt contracts, such as bonds is a typical source of funding. Also, bank loans and credit are ways to increase the money supply.

Mortgages, credit card debt, bonds and lines of credit are other type of debts. A mortgage is a very common type of debt instrument generally used by people to purchase housing. In this arrangement, money is generally used to purchase property. However, the bank title's the house until the mortgage is fully paid off. If the borrower fails to pay it, the bank can repossess the house and sell it in order to get their money back.

Abuse in the granting of loans is known as predatory lending. This involves granting a loan in order to put the borrower in a position that one can gain advantage over him or her.

There are many types of loans. But here, in this article, I will explain the basic type of loan that is interest only loan. An interest only loan is a loan in which the borrower pays only the interest on the principle balance, for a fixed term; but in this, the principal balance remains unchanged. And then, at the end of this term, the borrower may renew the interest only mortgage, pay off the principal balance or convert the loan to a principal and interest payment loan at his/her option.

For example, in US, a five or ten year interest only period is typical. After this time, the principal balance is amortized for the remaining term.

Viewing it from an investor's perspective, these loans are sometimes artificially generated from structural securities, particularly CMOs. A pool of securities is created and then divided into tranches. Then, the cash-flows that are received from the underlying debts are spread through the tranches as per the predefined rules. An interest only loan is one type of tranche that can be created; it is generally created in tandem with a principal only tranche. These tranches will cater to two particular type of investors, depending upon whether the investor is trying to increase their current yield or just trying to reduce their exposure to prepayments of the loans.