A loan is a sum of money borrowed from an entity with repayment of at least the principal after an agreed period of time. We say “at least the principal” because there are no-interest loans where the borrower is not required to pay any interest on the loan and if you do not have to pay back the principal (the amount borrowed), then, that is no longer a loan, it is a gift.
Even the cheapest loans have terms and conditions; if you need to get a loan, then here are some things you’ll need to watch out for 😉
- Maturity: Apart from credit cards which can be cancelled any time, so far there is no outstanding balance, most loans have a specified time by which the principal and all interests must be paid. The timeframe of a loan is important to help draw out a payment plan to avoid default.
While loans can be liquidated (repaid) before their maturity, having a specified time bound helps you plan towards the loan.
- Collateral: Collateral is an asset (usually a landed property) that is used to back a loan such that the creditor can seize that asset in case of default. Unsecured loans do not require collateral i.e. you do not have to provide an asset before getting the loan unlike a secured loan.
If you’re getting a secured loan it is necessary to know if you have an asset that matches the value of the loan and decide if you are willing to let it go in place of the loan. Instead of requesting for collaterals, unsecured loans require personal details such as Bank Verification Number (BVN), Contact details, Next of Kin, and so on to track the borrower.
- Interest Rates: This is a percentage that the creditor charges to cover the cost of lending out money. To give out a loan, the creditor faces an opportunity cost; the cost of the opportunities that he could have used the money for. Interest rates are usually monthly or annually so when the loan document says 10%, you need to confirm if that’s 10% monthly or annually.
For instance, a loan of N10000 at 10% interest monthly means that you’ll be paying N1000 every month and N12000 yearly as interest. Conversely, 10% annually means you pay N1000 yearly as interest. Because unsecured loans are not backed by collateral, the interest rates are usually higher than that of secured loans due to the high default risk. Default risk is the risk that you won’t pay back the loan.
- Inflation Rate: This is the rate at which prices are rising in an economy. There is an inverse relationship between prices and value of money i.e. as prices increase, value of money decreases. Creditors tend to charge a higher interest rate when the inflation rate is high because there is a risk that by the time you repay the loan, the value of the money will be lower. A loan will be favorable to the borrower if the inflation rate is higher than the interest rate.
- Ability to Repay: Considering the other factors you need to be able figure out if your income is sustainable enough to pay back the loans and any interest accruing. A loan can be borrowed for whatever reason but it makes more sense to borrow for business ventures. That way, part of the proceeds from the ventures can be used to settle the loan. Most banks require an account statement to show that you have a stable income to repay the loan.