Loan Basics (2024)

Learn how to evaluate and get a loan, from the different loan types to how to protect yourself from predatory lenders.

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Frequently Asked Questions

What’s the difference between a bank guarantee and a letter of credit?

Both are promises from a financial institution that a borrower will be able to repay a debt. The bank guarantee is a more significant contractual obligation that protects both parties; letters of credit require certain criteria and are more commonly used internationally.
Learn MoreBank Guarantee vs. Letter of Credit: What’s the Difference?
How do I get my name off a cosigned loan?

The best option is to have the person using the money refinance the loan without your name on it. You can also try improving the main borrower’s credit rating, paying off the loan faster, or closing the account to stop being a loan cosigner.
Learn MoreGetting Your Name Off a Co-signed Loan
What’s the difference between a recourse and a non-recourse loan?

Both allow lenders to seize collateralized assets. If that doesn’t satisfy the debt, a recourse loan lets lenders go after the borrower’s other assets, while a non-recourse loan doesn’t permit that option.
Learn MoreRecourse vs. Non-Recourse Loan: What's the Difference?
Should you be careful about taking out a zero interest loan?

Yes, due to rigid monthly payment schedules, stiff penalties for not honoring zero-loan terms, and hard deadlines by which the entire balance must be repaid.
Learn MoreZero Interest Loans: Why You Should Beware
How does peer-to-peer lending work?

If it works out right, peer lenders get more interest than from many investments and peer borrowers pay lower interest than for many loans. These benefits come with greater risks and more work.
Learn MorePeer-to-Peer Lending Breaks Down Financial Borders
What are the legal protections against predatory lending?

Protective laws—both federal and state—can cap interest rates, ban discriminatory practices, and even outlaw some types of lending. But protection against predatory lending is a patchwork that differs depending on where you live.
Learn MorePredatory Lending Laws: What You Need To Know

Key Terms

Loan
A loan is when money is given to one party in exchange for repayment of the loan principal, plus interest. A loan may or may not be secured by collateral and loan options and interest rates depend on the prospective borrower’s income, credit score, and debt levels.
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Financing
Financing is the process of funding business activities and making purchases or investments. The two types are equity financing and debt financing.
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Line of Credit
This preset borrowing limit provides funding a borrower can draw on at any time. Its main advantage is flexibility, and potential risks include high-interest rates, penalties for late payments, and the risk of overspending.
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Collateral
Collateral minimizes risks to lenders by providing an asset to act as security for a loan. Mortgages and car loans are two common types.
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Unsecured Loan
These loans are not secured by collateral and usually come with higher interest rates. Most borrowers of unsecured loans need a higher credit score than for a collateralized loan.
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Bridge Loan
Used to “bridge” the gap until a person or company secures permanent financing or removes an obligation, these loans are often used in real estate. For example, a buyer can use one to purchase a new home while waiting for their current home to sell.
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Term Loan
Established small businesses with sound financials may use these loans to provide cash according to specific terms, with either a fixed or floating interest rate.
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Applicable Federal Rate (AFR)
This (there are 3 AFRs) is the minimum interest rate that the Internal Revenue Service allows for short-, mid-, and long-term personal loans. Charging rates lower than the appropriate AFR may have tax consequences.
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