LOAN FINANCING

Loan financing can be defined as an agreement between the lender and the borrower where the borrower borrows the money or property from the lender and agrees to return the property or repay the money, usually along with interest, at some future point(s) in time. The time to repay the loan is fixed in advance, and generally the lender has to bear the risk that the borrower may not repay a loan in future.

The borrower borrows an amount of money from the lender, which is called the principal amount. The interest is charged on the principal amount. The borrower is obliged to pay back the money or property at the decided time or can repay an  amount of money to the lender in installments. If the borrower repay in equal installments at regular interval of time , then it is known as an annuity. In such type of installments usually the amount paid is same and it contains both the principal amount and the interest amount.

Types of Loan

The loan can be classified as under:

Open ended and closed ended loans

Open ended loans can be borrowed again and again. Some examples of open ended loans are such as credit cards and lines of credit. In such kind of loans the borrower has a credit limit against his purchase. Each time the borrower purchases , his available credit limit decreases. As the borrower makes the payment , his available increases and he can borrow the same credit again and again.

Closed ended loans cannot be borrowed again and again. Once the borrower makes the payment the loan is ended. If the borrower needs to borrow more money , then he have to apply again for another loan. Mortgage loan, auto loans and student loans are some types of closed ended loans.

Secured and Unsecured Loans

Secured loans are the loans in which the collateral security of an asset is there. If the borrower fails to repay the loan amount then the lender can take the possession of the asset and use  it to cover the loan. Secured loans have less rate of interest than that of unsecured loans.

Unsecured loans are the loans in which there is no collateral security of an asset. It is more difficult to get such kind of loans had they have higher interest rates. An unsecured loan is issued and supported only by the borrower’s creditworthiness. Generally, a borrower must have a high credit rating to receive an unsecured loan. If the borrower fails to repay such loan then the lender has to exhaust collection options including debt collectors and lawsuit to recover the loan.

Working capital loan

A working capital loan can also be used to finance everyday operations of a company.

Bridge loan

A bridge loan, also known as "interim financing," "gap financing" or a "swing loan," is a short-term loan that is used until a company secures permanent financing or removes an existing obligation. This type of financing allows the user to meet current obligations by providing immediate cash flow. The loans are short term (up to one year) with relatively high interest rates and are backed by some form of collateral such as real estate or inventory. As the term implies, these loans "bridge the gap" between times when financing is needed.

Dr Himani Gupta

Associate Professor

Dept of Management