What is and how a loan works

A loan is one of the basic forms of financing that exists for individuals, companies, freelancers, entrepreneurs, etc. For centuries the loans exist and almost without changes, because after all a loan consists of giving a quantity of money, agreed in advance in a loan contract or credit policy, in exchange for some obligations. The most important to pay an interest plus the return of the entire borrowed money. The interests come to be the compensation that the lender receives for leaving his money, from two points of view:

  1. The risk assumed by the probability of default of the beneficiary of the loan.
  2. The opportunity cost, or what you lose by not using your money for other purposes.

Interest or interest rate, if we talk about the annual percentage that is used to calculate interest payments, there are several types. Basically two:

  • Fixed interest: the one that remains unchanged throughout the life of the loan. That is, it does not change since the loan is granted until it is completely canceled. It is usually used in loans not very long term, to avoid changes in interest rates that may be detrimental to any of the parties.
  • Variable interest: unlike the previous one, the interest rate changes during the life of the loan. In fact, it is calculated based on an index that serves as a reference to calculate the variations in the interest rate over time. In the case of the euro zone, the Euribor is used, or the average interest rate lending to banks in the euro zone. A differential is added to this index, that is, a percentage of profit margin for the lender. So the sum of both is what constitutes the variable interest rate that will be applied in each period.

Types and characteristics of the loans

Types and characteristics of the loans

As we said there are several types of loans in the market despite being something with hundreds of years of history. Basically a loan is classified according to the guarantee that it has, being able to distinguish between loans with real and personal collateral. The real guarantees are those that can be touched, such as real estate such as homes or premises. While the personal guarantees are those associated with a person, be it an individual or a limited company type company, and that are based on the patrimony of that person, such as a car, and the monthly income it has (payroll, pension, sales, etc). According to the above, the main types of loans that exist are:

  • Personal loans:

    Personal loans:

They are short-term loans of small amount, usually less than 50000 euros. But the normal thing is loans under 12,000 and 15,000 euros to be repaid in a period of between 3 and 5 years. But since they have no other guarantee than the individual, personal loans are usually associated with the purchase of life insurance, which covers the risk of death or incapacity of the owner for the insurance to pay the amount pending cancellation of the mortgage loan. An example of this type of insurance is the loan of immediate credit from La Caixa. These loans for individuals have different uses, at the discretion of the applicant, although they are normally used to buy cars, trips, or personal consumption. And sometimes if they grant even if the financial file of the applicant is not free of incidents for previous defaults, it is what is known as personal loans with asnef. But there are also personal loans for companies, not just private ones. In this case, its use is usually to finance current business expenses, although they are also called loans for working capital when liquidity and cash are not sufficient to make operating payments.

  • Mortgage loans:

    Mortgage loans:

They are long-term loans of a high amount, normally more than 100,000 euros. But they can reach millions of euros depending on the value of the mortgage guarantee. Given its high amount to return, the term usually reaches up to 40 years. Normally their destiny is to finance the purchase of a house or another property that serves as a guarantee, although they are also a way to obtain cheap financing, since the interest rate is lower than a loan with personal guarantee, normally when the property does not have other loads.