A loan is a contract between a borrower and a lender in which the borrower receives an amount of money (principal) that they are obligated to pay back in the future. Most loans can be categorized into one of three categories:
- Amortized Loan: Fixed payments paid periodically until loan maturity
- Deferred Payment Loan: Single lump sum paid at loan maturity
- Bond: Predetermined lump sum paid at loan maturity (the face or par value of a bond)
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Understanding Different Loan Types
Amortized Loan
Paying Back a Fixed Amount Periodically. Used for mortgages, auto loans, student loans, and personal loans.
- Fixed payments until loan maturity
- Includes both principal and interest
- Most common consumer loan type
Deferred Payment Loan
Paying Back a Single Lump Sum Due at Maturity. Common for commercial or short-term business loans.
- Interest accumulates during the loan term
- Single payment (principal + interest) due at end
- Often used for balloon or business loans
Bond
Predetermined Lump Sum Paid at Maturity. Commonly used by corporations or governments.
- Face value repaid at maturity
- May include regular interest (coupon) payments
- Zero-coupon bonds are sold at deep discounts
Loan Basics for Borrowers
Most loans include interest — the lender’s profit. The interest rate is typically expressed as APR (annual percentage rate). Compound interest means interest earned on both the initial amount and accumulated interest over time.
Secured vs. Unsecured Loans
Secured loans require collateral such as a car or house. If the borrower defaults, the lender can seize the asset.
Unsecured loans do not require collateral but often have higher interest rates and shorter terms. Examples include credit cards, personal loans, and student loans.