What Is a Bank Loan?

A bank loan is a monetary loan received from a commercial lender. The loan may have a specific purpose, such as a car loan or a home loan. It will have a predetermined duration, and the loan will have an interest rate that is either fixed or adjustable. Generating loans and charging interest on those loans is the very purpose of a modern bank. Banks even loan money to one another occasionally through a facility known as the Fed funds rate.

Significance

The significance of bank lending cannot be overstated. Bank loans drive the United States economy. Bank loans provide the capital for businesses to start and expand. Bank loans also meet the payrolls that keep America working. Home ownership would be almost nonexistent if it weren't for bank loans. Credit cards are a type of unsecured bank loan, and they help to drive retail sales. In 2008, the collapse of the sub-prime mortgage industry caused a massive constriction in bank lending, leading to a 40+ percent drop in the stock market and the onset of a recession.

Function

The function of a bank loan is to provide the bank customer with the necessary funds to accomplish the purpose of the loan, and to provide the bank interest income. Most bank loans are made on collateral in one way or another, and therefore protect the bank from loss in the case of loan default. The majority of bank loans will be for a set duration at a fixed rate of interest.

The first step in attaining a bank loan is for a bank customer to fill out a loan application. The application will include personal information, financial information and questions about the purpose of the loan. Once submitted, the application will go into underwriting, where the bank will make a decision on whether or not to loan the money and at what rate of interest. The bank will investigate the customer's credit rating. If it is acceptable, the bank will issue the loan with an interest rate corresponding to the customer's credit score. The higher a customer's credit score, the lower the interest rate.

Some loans carry adjustable interest rates. These loans usually begin with a low, fixed rate of interest for a predetermined period of time. Once that period of time elapses, the adjustable rate interest provision of the loan is triggered. The rate of the loan adjusts up or down at predetermined intervals for the life of the loan, based upon the loan's underlying index. Adjustable rate loans almost always contain a maximum interest rate cap. Once that cap is reached, the interest rate cannot adjust any higher.

Types

There are many types of bank loans available. The most common types are car loans (both new and used), home loans (both fixed and adjustable rate), credit cards, student loans, business loans in several different forms, and personal loans.

Loans made on collateral--such as car loans and home mortgages--have a security attached to the loan. For example, if a customer stops paying on his car loan, the bank will repossess the car to protect their interest. The car is then sold to recover the outstanding balance of the loan. The same thing happens when a home goes into foreclosure.

Unsecured loans have no security attached to the loan, and therefore the bank is less protected. Unsecured loans include credit cards, signature loans and student loans. In the case of default on an unsecured debt, the bank may sue the customer to recover the funds. Yet, in reality, the only legal recourse the bank really has is to damage the defaulting customer's credit rating.

For a new business, any business loans attained will probably require a personal guarantee, known as a PG. Even though the loan is in the name and tax ID number of the business, the business owner or business officers must personally guarantee the repayment of the loan. In other words, if the business defaults on the loan, the business owner or officers become personally liable for the repayment of the loan.

Considerations

Before applying for a bank loan, a bank customer must consider how much the loan will ultimately cost by totaling the principal and interest payments over the term of the loan. He should decide whether it would be a better idea to just save the money and not take out the loan. In the case of a home loan, this is not realistic for most people, but saving money for a larger down payment can lower the interest rate on a home loan.

Warning

Do not take out a bank loan if you do not have the ability to repay the loan. In the case of home loans, delinquent payments can result in foreclosure. Likewise, in the case of car loans, delinquent payments can result in the repossession of the vehicle. Aside from the obvious embarrassment a situation like this causes, it also does lasting damage to your credit rating. A home foreclosure can stay on your credit report for up to ten years.

Resources

• Bankrate.com National Lending Rates