Loan Working Agent
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A loan is a type of debt. This article focuses exclusively on monetary loans,
although, in practice, any material object might be lent. Like all debt
instruments, a loan entails the redistribution of financial assets over time,
between the lender and the borrower.
The borrower initially does receive an amount of money from the lender, which
they pay back, usually but not always in regular installments, to the lender.
This service is generally provided at a cost, referred to as interest on the
debt. A loan is of the annuity type if the amount paid periodically (for paying
off and interest together) is fixed.
A borrower may be subject to certain restrictions known as loan covenants under
the terms of the loan.
Acting as a provider of loans is one of the principal tasks for financial
institutions. For other institutions, issuing of debt contracts such as bonds is
a typical source of funding. Bank loans and credit are one way to increase the
money supply.
Legally, a loan is a contractual promise of a debtor to repay a sum of money in
exchange for the promise of a creditor to give another sum of money.
Types of loans
Secured
A secured loan is a loan in which the borrower pledges some asset (e.g. a car or
property) as collateral for the loan.
A mortgage loan is a very common type of debt instrument, used by many
individuals to purchase housing. In this arrangement, the money is used to
purchase the property. The financial institution, however, is given security — a
lien on the title to the house — until the mortgage is paid off in full. If the
borrower defaults on the loan, the bank would have the legal right to repossess
the house and sell it, to recover sums owing to it.
In some instances, a loan taken out to purchase a new or used car may be secured
by the car, in much the same way as a mortgage is secured by housing. The
duration of the loan period is considerably shorter — often corresponding to the
useful life of the car. There are two types of auto loans, direct and indirect.
A direct auto loan is where a bank gives the loan directly to a consumer. An
indirect auto loan is where a car dealership acts as an intermediary between the
bank or financial institution and the consumer.
A type of loan especially used in limited partnership agreements is the recourse
note.
A stock hedge loan is a special type of securities lending whereby the stock of
a borrower is hedged by the lender against loss, using options or other hedging
strategies to reduce lender risk.
Unsecured
Unsecured loans are monetary loans that are not secured against the borrowers
assets. These may be available from financial institutions under many different
guises or marketing packages:
* credit card debt
* personal loans
* bank overdrafts
* credit facilities or lines of credit
* corporate bonds
The interest rates applicable to these different forms may vary depending on the
lender and the borrower. These may or may not be regulated by law. In the United
Kingdom, when applied to individuals, these may come under the Consumer Credit
Act 1974.
Abuses in lending
Predatory lending is one form of abuse in the granting of loans. It usually
involves granting a loan in order to put the borrower in a position that one can
gain advantage over him or her. Where the moneylender is not authorised, it
could be considered a loan shark.
Usury is a different form of abuse, where the lender charges excessive interest.
In different time periods and cultures the acceptable interest rate has varied,
from no interest at all to unlimited interest rates. Credit card companies in
some countries have been accused by consumer organisations of lending at
usurious interest rates and making money out of frivolous "extra charges".
Abuses can also take place in the form of the customer abusing the lender by not
repaying the loan or with an intent to defraud the lender.
United States taxes
Most of the basic rules governing how loans are handled for tax purposes in the
United States are uncodified by both Congress (the Internal Revenue Code) and
the Treasury Department (Treasury Regulations — another set of rules that
interpret the Internal Revenue Code). Yet such rules are universally accepted.
1. A loan is not gross income to the borrower. Since the borrower has the
obligation to repay the loan, the borrower has no accession to wealth.
2. The lender may not deduct the amount of the loan. The rationale here is that
one asset (the cash) has been converted into a different asset (a promise of
repayment). Deductions are not typically available when an outlay serves to
create a new or different asset.
3. The amount paid to satisfy the loan obligation is not deductible by the
borrower.
4. Repayment of the loan is not gross income to the lender. In effect, the
promise of repayment is converted back to cash, with no accession to wealth by
the lender.
5. Interest paid to the lender is included in the lender’s gross income.
Interest paid represents compensation for the use of the lender’s money or
property and thus represents profit or an accession to wealth to the lender.
Interest income can be attributed to lenders even if the lender doesn’t charge a
minimum amount of interest.
6. Interest paid to the lender may be deductible by the borrower. In general,
interest paid in connection with the borrower’s business activity is deductible,
while interest paid on personal loans are not deductible. The major exception
here is interest paid on a home mortgage.
Income from discharge of indebtedness
Although a loan does not start out as income to the borrower, it becomes income
to the borrower if the borrower is discharged of indebtedness. Thus, if a debt
is discharged, then the borrower essentially has received income equal to the
amount of the indebtedness. The Internal Revenue Code lists “Income from
Discharge of Indebtedness” in Section 62(a)(12) as a source of gross income.
Example: X owes Y $50,000. If Y discharges the indebtedness, then X no longer
owes Y $50,000. For purposes of calculating income, this should be treated the
same way as if Y gave X $50,000.
For a more detailed description of the “discharge of indebtedness”, look at
Section 108 (Cancellation of Debt (COD) Income) of the Internal Revenue Code
Consumer debt is consumer credit which is outstanding. In macroeconomic terms,
it is debt which is used to fund consumption rather than investment.
Some consider all debt incurred for anything else other than investments unwise
or detrimental to the economy , while others believe that consumer credit is
beneficial to the economy. Historically, across many cultures, being in personal
debt was considered almost immoral. More recently, an alternative analysis might
view consumer debt as a way to increase domestic production, on the grounds that
if credit is easily available, the increased demand for consumer goods should
cause an increase of overall domestic production. The permanent income
hypothesis suggests that consumers take debt to smooth consumption throughout
their lives, borrowing to finance expenditures (particularly housing and
schooling) earlier in their lives and paying down debt during higher-earning
periods.
Both domestic and international economists have supported a recent upsurge in
South Korean consumer debt, which has helped fuel economic expansion. On the
other hand, credit card debt is almost unknown just across the sea in Japan and
China, one because of long standing historical biases against personal debt, the
other because the economy is still underdeveloped. Theoretical underpinnings
aside, personal debt is on the rise, particularly in the United States and the
UK.
The most common form of consumer debt is credit card debt, payday loans, and
other consumer finance, which are often at higher interest rates than long term
secured loans, such as mortgages. The interest rate charged depends on a range
of factors, including the economic climate, perceived ability of the customer to
repay, competitive pressures from other lenders, and the inherent structure and
security of the credit product. Rates generally range from 0.25% above
base-rate, to well into double figures. Consumer debt can be associated with
Predatory lending, although there is much debate as to what exactly constitutes
predatory lending.
Long-term consumer debt is often considered fiscally suboptimal. While some
consumer items may be useful investments that justify debt (such as automobiles,
which are usually but not always exempted in discussions of consumer debt, and
business suits), most consumer goods are not. For example, incurring
high-interest consumer debt through buying a big-screen television "now", rather
than saving for it, can not usually be financially justified by the subjective
benefits of having the television early. On the other hand, personal finance
advisors like Robert Kiyosaki encourage a more liberal attitude towards taking
on debt if it can be leveraged into a small business or real estate. This
higher-risk, possibly high-outcome, "personal-finances-as-a-game" attitude runs
counter to the traditional mores of rising slowly through the ranks of a company
through discipline and hard work, but may have increasing validity in an age of
globalization.
In many countries, the ease with which individuals can accumulate consumer debt
beyond their means to repay has preciptated a growth industry in debt
consolidation and credit counseling.
Debt is that which is owed; usually referencing assets owed, but the term can
cover other obligations. In the case of assets, debt is a means of using future
purchasing power in the present before a summation has been earned. Some
companies and corporations use debt as a part of their overall corporate finance
strategy.
A debt is created when a creditor agrees to lend a sum of assets to a debtor. In
modern society, debt is usually granted with expected repayment; in many cases,
plus interest. Historically, debt was responsible for the creation of indentured
servants.
Payment
Before a debt can be made, both the debtor and the creditor must agree on the
manner in which the debt will be repaid, known as the standard of deferred
payment. This payment is usually denominated as a sum of money in units of
currency, but can sometimes be denominated in terms of goods. Payment can be
made in increments over a period of time, or all at once at the end of the loan
agreement.
Types of debt
A basic loan is the simplest form of debt. It consists of an agreement to lend a
principal sum for a fixed period of time, to be repaid by a certain date. In
commercial loans interest, calculated as a percentage of the principal sum per
annum, will also have to be paid by that date.
In some loans, the amount actually loaned to the debtor is less than the
principal sum to be repaid; the additional principal has the same economic
effect as a higher interest rate (see point (mortgage)).
A syndicated loan is a loan that is granted to companies that wish to borrow
more money than any single lender is prepared to risk in a single loan, usually
many millions of dollars. In such a case, a syndicate of banks can each agree to
put forward a portion of the principal sum.
A bond is a debt security issued by certain institutions such as companies and
governments. A bond entitles the holder to repayment of the principal sum, plus
interest. Bonds are issued to investors in a marketplace when an institution
wishes to borrow money. Bonds have a fixed lifetime, usually a number of years;
with long-term bonds, lasting over 30 years, being less common. At the end of
the bond's life the money should be repaid in full. Interest may be added to the
end payment, or can be paid in regular installments (known as coupons) during
the life of the bond. Bonds may be traded in the bond markets, and are widely
used as relatively safe investments in comparison to equity.
Corporate finance
Working capital management
Cash conversion cycle
Return on capital
Economic value added
Just In Time
Economic order quantity
Discounts and allowances
Factoring (finance)
Capital budgeting
Capital investment decisions
The investment decision
The financing decision
Sections
Managerial finance
Financial accounting
Management accounting
Mergers and acquisitions
Balance sheet analysis
Business plan
Corporate action
Finance series
Financial market
Financial market participants
Corporate finance
Personal finance
Public finance
Banks and Banking
Financial regulation
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Accounting debt
In national accounting, debts are added according to those who are indebted.
Household debt is the debt held by households. "National" or Public debt is the
debt held by the various governmental institutions (federal government, states,
cities ...). Business debt is the debt held by businesses. Financial debt is the
debt held by the financial sector (from one financial institution to another).
Total debt is the sum of all those debts, excluding financial debt to prevent
double accounting. These various types of debt can be computed in debt/GDP
ratios. Those ratios help to assess the speed of variations in the indebtness
and the size of the debt due. For example the USA have a high consumer debt and
a low public debt, while in eastern European countries, for example, the
opposite tends to be true.
There are differences in the accounting of debt for private and public agents.
If a private agent promises to pay something later, it has a debt, and this debt
is enforceable by public agents. If a public body passes a law stating that
it'll pay something later (a kind of promise), it keeps the right to change the
law later (and not to pay). This is why, for instance, the money governments
promised to pay for retirements does not show up in the public debt assessment,
whereas the money private companies promised to pay for retirements do.
Securitization
Securitization
Securitization occurs when a company groups together assets or receivables and
sells them in units to the market through a trust. Any asset with a cashflow can
be securitized. The cash flows from these receivables are used to pay the
holders of these units. Companies often do this in order to remove these assets
from their balance sheets and monetize an asset. Although these assets are
"removed" from the balance sheet and are supposed to be the responsibility of
the trust, that does not end the company's involvement. Often the company
maintains a special interest in the trust which is called an "interest only
strip" or "first loss piece". Any payments from the trust must be made to
regular investors in precedence to this interest. This protects investors from a
degree of risk, making the securitization more attractive. The aforementioned
brings into question whether the assets are truly off-balance-sheet given the
company's exposure to losses on this interest.
Debt, inflation and the exchange rate
As noted above, debt is normally denominated in a particular monetary currency,
and so changes in the valuation of that currency can change the effective size
of the debt. This can happen due to inflation or deflation, so it can happen
even though the borrower and the lender are using the same currency. Thus it is
important to agree on standards of deferred payment in advance, so that a degree
of fluctuation will also be agreed as acceptable. It is for instance common to
agree to "US dollar denominated" debt.
The form of debt involved in banking accounts for a large proportion of the
money in most industrialised nations (see money and credit money for a
discussion of this). There is therefore a complex relationship between
inflation, deflation, the money supply, and debt. The store of value represented
by the entire economy of the industrialized nation itself, and the state's
ability to levy tax on it, acts to the foreign holder of debt as a guarantee of
repayment, since industrial goods are in high demand in many places worldwide.
Inflation indexed debt
Borrowing and repayment arrangements linked to inflation-indexed units of
account are possible and are used in some countries. For example, the US
government issues two types of inflation-indexed bonds, Treasury
Inflation-Protected Securities (TIPS) and I-bonds. These are one of the safest
forms of investment available, since the only major source of risk — that of
inflation — is eliminated. A number of other governments issue similar bonds,
and some did so for many years before the US government.
In countries with consistently high inflation, ordinary borrowings at banks may
also be inflation indexed.
Debt ratings, risk and cancellation
Risk free interest rate
risk-free interest rate
Lendings to stable financial entities such as large companies or governments are
often termed "risk free" or "low risk" and made at a so-called "risk-free
interest rate". This is because the debt and interest are highly unlikely to be
defaulted. A good example of such risk-free interest is a US Treasury security -
it yields the minimum return available in economics, but investors have the
comfort of the (almost) certain expectation that the US Treasury will not
default on its debt instruments. A risk-free rate is also commonly used in
setting floating interest rates, which are usually calculated as the risk-free
interest rate plus a bonus to the creditor based on the creditworthiness of the
debtor (in other words, the risk of him defaulting and the creditor losing the
debt). In reality, no lending is truly risk free, but borrowers at the "risk
free" rate are considered the least likely to default.
However, if the real value of a currency changes during the term of the debt,
the purchasing power of the money repaid may vary considerably from that which
was expected at the commencement of the loan. So from a practical investment
point of view, there is still considerable risk attached to "risk free" or "low
risk" lendings. The real value of the money may have changed due to inflation,
or, in the case of a foreign investment, due to exchange rate fluctuations.
The Bank for International Settlements is an organisation of central banks that
sets rules to define how much capital banks have to hold against the loans they
give out.
Ratings and creditworthiness
Specific bond debts owed by both governments and private corporations is rated
by rating agencies, such as Moody's, Fitch Ratings Inc., A. M. Best and Standard
& Poor's. The government or company itself will also be given its own separate
rating. These agencies assess the ability of the debtor to honor his obligations
and accordingly give him a credit rating. Moody's uses the letters Aaa Aa A Baa
Ba B Caa Ca C, where ratings Aa-Caa are qualified by numbers 1-3. Munich Re, for
example, currently is rated Aa3 (as of 2004). S&P and other rating agencies have
slightly different systems using capital letters and +/- qualifiers.
A change in ratings can strongly affect a company, since its cost of refinancing
depends on its creditworthiness. Bonds below Baa/BBB (Moody's/S&P) are
considered junk- or high risk bonds. Their high risk of default (approximately
1.6% for Ba) is compensated by higher interest payments. Bad Debt is a loan that
can not (partially or fully) be repaid by the debtor. The debtor is said to
default on his debt. These types of debt are frequently repackaged and sold
below face value. Buying junk bonds is seen as a risky but potentially
profitable form of investment.
Cancellation
Short of bankruptcy, it is rare that debts are wholly or partially forgiven.
Traditions in some cultures demand that this be done on a regular (often annual)
basis, in order to prevent systemic inequities between groups in society, or
anyone becoming a specialist in holding debt and coercing repayment. Under
English law, when the creditor is deceived into forgoing payment, this is a
crime: see Theft Act 1978.
International Third World debt has reached the scale that many economists are
convinced that debt cancellation is the only way to restore global equity in
relations with the developing nations.
Effects of debt
Debt allows people and organizations to do things that they would otherwise not
be able, or allowed, to do. Commonly, people in industrialised nations use it to
purchase houses, cars and many other things too expensive to buy with cash on
hand. Companies also use debt in many ways to leverage the investment made in
their assets, "leveraging" the return on their equity. This leverage, the
proportion of debt to equity, is considered important in determining the
riskiness of an investment; the more debt per equity, the riskier. For both
companies and individuals, this increased risk can lead to poor results, as the
cost of servicing the debt can grow beyond the ability to pay due to either
external events (income loss) or internal difficulties (poor management of
resources).
Excesses in debt accumulation have been blamed for exacerbating economic
problems. For example, prior to the beginning of the Great Depression debt/GDP
ratio was very high. Economic agents were heavily indebted. This excess of debt,
equivalent to excessive expectations on future returns, accompanied asset
bubbles on the stock markets. When expectations corrected, deflation and a
credit crunch followed. Deflation effectively made debt more expensive and, as
Fisher explained, this reinforced deflation again, because, in order to reduce
their debt level, economic agents reduced their consumption and investment. The
reduction in demand reduced business activity and caused further unemployment.
In a more direct sense, more bankruptcies also occurred due both to increased
debt cost caused by deflation and the reduced demand.
It is possible for some organizations to enter into alternative types of
borrowing and repayment arrangements which will not result in bankruptcy. For
example, companies can sometimes convert debt that they owe into equity in
themselves. In this case, the creditor hopes to regain something equivalent to
the debt and interest in the form of dividends and capital gains of the
borrower. The "repayments" are therefore proportional to what the borrower earns
and so can not in themselves cause bankruptcy. Once debt is converted in this
way, it is no longer known as debt.
Arguments against debt
Criticism of debt
Some argue against debt as an instrument and institution, on a personal, family,
social, corporate and governmental level. Islam forbids lending with interest
even today, while the Catholic church allowed it from 1822 onwards, and the
Torah states that all debts should be erased every 7 years and every 50 years.
Debt will increase through time if it is not repaid faster than it grows through
interest. This effect may be termed usury, while the term "usury" in other
contexts refers only to an excessive rate of interest, in excess of a reasonable
profit for the risk accepted.
In international legal thought, Odious debt is debt that is incurred by a regime
for purposes that do not serve the interest of the state. Such debts are thus
considered by this doctrine to be personal debts of the regime that incurred
them and not debts of the state.
In an economy with high interest rates, debt will be more costly to a business
than more flexible dividends on equity investment. It may be easier for a
struggling business to be financed through equity investment as it may be
possible to avoid paying a dividend if times are hard.
Levels and flows
Debt levels and flows
Global debt underwriting grew 4.3% year-over-year to $5.19 trillion during 2004.
It is expected to rise in the coming years as the spending habits of millions of
people worldwide continue the way they do
Debt consolidation entails taking out one loan to pay off many others. This is
often done to secure a lower interest rate, secure a fixed interest rate or for
the convenience of servicing only one loan.
Debt consolidation can simply be from a number of unsecured loans into another
unsecured loan, but more often it involves a secured loan against an asset that
serves as collateral, most commonly a house. In this case, a mortgage is secured
against the house. The collateralization of the loan allows a lower interest
rate than without it, because by collateralizing, the asset owner agrees to
allow the forced sale (foreclosure) of the asset to pay back the loan. The risk
to the lender is reduced so the interest rate offered is lower.
Sometimes, debt consolidation companies can discount the amount of the loan.
When the debtor is in danger of bankruptcy, the debt consolidator will buy the
loan at a discount. A prudent debtor can shop around for consolidators who will
pass along some of the savings. Consolidation can affect the ability of the
debtor to discharge debts in bankruptcy, so the decision to consolidate must be
weighed carefully.
Debt consolidation is often advisable in theory when someone is paying credit
card debt. Credit cards can carry a much larger interest rate than even an
unsecured loan from a bank. Debtors with property such as a home or car may get
a lower rate through a secured loan using their property as collateral. Then the
total interest and the total cash flow paid towards the debt is lower allowing
the debt to be paid off sooner, incurring less interest.
Because of the theoretical advantage that debt consolidation offers a consumer
that has high interest debt balances, companies can take advantage of that
benefit of refinancing to charge very high fees in the debt consolidation loan.
Sometimes these fees are near the state maximum for mortgage fees. In addition,
some unscrupulous companies will knowingly wait until a client has backed
themselves into a corner and must refinance in order to consolidate and pay off
bills that they are behind on the payments. If the client does not refinance
they may lose their house, so they are willing to pay any allowable fee to
complete the debt consolidation. In some cases the situation is that the client
does not have enough time to shop for another lender with lower fees and may not
even be fully aware of them. This practice is known as predatory lending.
Certainly many, if not most, debt consolidation transactions do not involve
predatory lending.[ citation needed ]
Student loan consolidation
USA
In the United States, federal student loans are consolidated somewhat
differently, as federal student loans are guaranteed by the U.S. government. In
a federal student loan consolidation, existing loans are purchased and closed by
a loan consolidation company or by the Department of Education (depending on
what type of federal student loan the borrower holds). Interest rates for the
consolidation are based on that year's student loan rate, which is in turn based
on the 91-day Treasury bill rate at the last auction in May of each calendar
year.[ citation needed ]
Student loan rates can fluctuate from the current low of 4.70% to a maximum of
8.25% for federal Stafford loans, 9% for PLUS loans.[ citation needed ] The
current consolidation program allows students to consolidate once with a private
lender, and reconsolidate again only with the Department of Education.[ citation
needed ] Upon consolidation, a fixed interest rate is set based on the
then-current interest rate. Reconsolidating does not change that rate. If the
student combines loans of different types and rates into one new consolidation
loan, a weighted average calculation will establish the appropriate rate based
on the then-current interest rates of the different loans being consolidated
together.
Federal student loan consolidation is often referred to as refinancing, which is
incorrect because the loan rates are not changed, merely locked in. Unlike
private sector debt consolidation, student loan consolidation does not incur any
fees for the borrower; private companies make money on student loan
consolidation by reaping subsidies from the federal government.
Student loan consolidation can be beneficial to students' credit rating, but
it's important to note that not all federal student loan consolidation companies
report their loans to all credit bureaus.[ citation needed ]
UK
in the UK Student Loan entitlements are guaranteed, and are recovered using a
means-tested system from the students future income. Student Loans in the UK can
not be included in Bankruptcy, but do not affect a persons credit rating because
the repayments are recovered from the students future salary at source by the
employer before any income is paid, similar to Income Tax and National Insurance
contributions. Many students however, are struggling with debt well after their
courses have finished
The level of personal debt in the UK has also risen astonishingly in recent
years:
"Total UK personal debt at the end of February 2008 stood at ￡1,421bn. The
growth rate increased to 8.9% for the previous 12 months which equates to an
increase of ￡111bn.
Concerns
In recent years, reports in the media have raised concerns about the use of
consolidation loans. The worry is that many people are tempted to consolidate
unsecured debt into secured debt, usually secured against their home. Although
the monthly payments can often be lower, the total amount repaid is often
significantly higher due to the long period of the loan. Debt consolidation
sometimes only treats the symptoms of debt and does not address the root
problem. In some circumstances, snowballing debt may be a better solution.
There are other alternatives to a debt consolidation loan, where unsecured debt
is not "shifted" to secured debt, but is eliminated through a settlement or
payment plan. Debt consolidation can be confusing for many people, so it is
helpful to learn about all of your options, and sometimes with the help of an
advisor.
Debt consolidation vs loans
The multiple options available to consolidate ones debts can be quite confusing,
credit counseling programs, debt settlement, debt consolidation loans,
bankruptcy are just a few options available today. Trying to find the best
option to suit your current financial situation can be a difficult task.
Typically, debt consolidation programs are debt repayment programs. They can
consolidate most types of unsecured debts from major credit cards to personal
and student loans. You choose the accounts you want to enter into the program
when joining. Once enrolled, the company will contact your creditors to
negotiate more favorable repayment terms on your accounts and possibly reducing
your interest rates and it may even elimination late fees. You will then send
that company one lump sum payment monthly which they will disperse to the
creditors you enrolled on your account when joining.
Most so called debt consolidation loans are just home equity loans in disguise.
They use the equity built up in your current home loan and use it to repay all
of your unsecured debts. These types of loan options usually come with heavy
application fees and can greatly extend the amount of time it will take you to
pay off those debts. These loans also convert all of your current unsecured
debts into on secured debt which is now backed by your home. If you fall behind
on your payments you could risk losing your property.
Contact Information
Call our office today to set up an appointment. Learn more about how we can
help you, and learn more about the other services that we can offer you. All
messages we receive will be answered as soon as possible. We look forward to
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