LENDING NOTES

What Is a Lender?

Lenders are businesses or financial institutions that lend money, with the expectation that it will be paid back. The lender is paid interest on the loan as a cost of the loan. The higher the risk of not being paid back, the higher the interest rate.

Lending to a business (particularly to a new startup business) is risky, which is why lenders charge higher interest rates and often they don’t give small business loans.

Lenders do not participate in your business in the same way as shareholders in a corporation or owners/partners in other business forms. In other words, a lender has no ownership in your business.

Lenders have a different kind of risk from business owners/shareholders. Lenders come before owners in terms of payments if the business can’t pay its bills or goes bankrupt. That means that you must pay lenders back before you and other owners receive any money in a bankruptcy.

Banks follow the following principles of lending:

  1. Liquidity:

Liquidity is an important principle of bank lending. Bank lend for short periods only because they lend public money which can be withdrawn at any time by depositors. They, therefore, advance loans on the security of such assets which are easily marketable and convertible into cash at a short notice.

A bank chooses such securities in its investment portfolio which possess sufficient liquidity. It is essential because if the bank needs cash to meet the urgent requirements of its customers, it should be in a position to sell some of the securities at a very short notice without disturbing their market prices much. There are certain securities such as central, state and local government bonds which are easily saleable without affecting their market prices.

The shares and debentures of large industrial concerns also fall in this category. But the shares and debentures of ordinary firms are not easily marketable without bringing down their market prices. So the banks should make investments in government securities and shares and debentures of reputed industrial houses.

2.   Safety:

The safety of funds lent is another principle of lending. Safety means that the borrower should be able to repay the loan and interest in time at regular intervals without default. The repayment of the loan depends upon the nature of security, the character of the borrower, his capacity to repay and his financial standing.

Like other investments, bank investments involve risk. But the degree of risk varies with the type of security. Securities of the central government are safer than those of the state governments and local bodies. And the securities of state government and local bodies are safer than those of the industrial concerns. This is because the resources of the central government are much higher than the state and local governments and of the latter higher than the industrial concerns.

In fact, the share and debentures of industrial concerns are tied to their earnings which may fluctuate with the business activity in the country. The bank should also take into consideration the debt repaying ability of the governments while investing in their securities. Political stability and peace and security are the prerequisites for this.

It is very safe to invest in the securities of a government having large tax revenue and high borrowing capacity. The same is the case with the securities of a rich municipality or local body and state government of a prosperous region. So in making investments the bank should choose securities, shares and debentures of such governments, local bodies and industrial concerns which satisfy the principle of safety.

Thus from the bank’s viewpoint, the nature of security is the most important consideration while giving a loan. Even then, it has to take into consideration the creditworthiness of the borrower which is governed by his character, capacity to repay, and his financial standing. Above all, the safety of bank funds depends upon the technical feasibility and economic viability of the project for which the loan is advanced.

3.   Diversity:

In choosing its investment portfolio, a commercial bank should follow the principle of diversity. It should not invest its surplus funds in a particular type of security but in different types of securities. It should choose the shares and debentures of different types of industries situated in different regions of the country. The same principle should be followed in the case of state governments and local bodies. Diversification aims at minimizing risk of the investment portfolio of a bank.

The principle of diversity also applies to the advancing of loans to varied types of firms, industries, businesses and trades. A bank should follow the maxim: “Do not keep all eggs in one basket.” It should spread it risks by giving loans to various trades and industries in different parts of the country.

4.   Stability:

Another important principle of a bank’s investment policy should be to invest in those stocks and securities which possess a high degree of stability in their prices. The bank cannot afford any loss on the value of its securities. It should, therefore, invest it funds in the shares of reputed companies where the possibility of decline in their prices is remote.

Government bonds and debentures of companies carry fixed rates of interest. Their value changes with changes in the market rate of interest. But the bank is forced to liquidate a portion of them to meet its requirements of cash in cash of financial crisis. Otherwise, they run to their full term of 10 years or more and changes in the market rate of interest do not affect them much. Thus bank investments in debentures and bonds are more stable than in the shares of companies.

5.   Profitability:

This is the cardinal principle for making investment by a bank. It must earn sufficient profits. It should, therefore, invest in such securities which was sure a fair and stable return on the funds invested. The earning capacity of securities and shares depends upon the interest rate and the dividend rate and the tax benefits they carry.

It is largely the government securities of the center, state and local bodies that largely carry the exemption of their interest from taxes. The bank should invest more in such securities rather than in the shares of new companies which also carry tax exemption. This is because shares of new companies are not safe investments.

What Are the Types of Commercial Loans?

  • Bank financing for small business start-up and working capital
  • Asset financing for equipment and machinery or business
  • Mortgages
  • Credit card financing
  • Vendor financing (through trade credit)
  • Personal (unsecured) loans

The type of lender you will need for a business loan depends on several factors:

  • Amount of loan: The amount of money you want to borrow influences the type of For larger loans, you may need a combination of types of commercial loans.
  • Assets pledged: If you have business assets you can pledge as collateral for the loan, you can get better terms than if your loan is
  • Type of assets: A mortgage is typically for land and building, while an equipment loan is for financing capital expenditures like
  • Startup or expansion: A startup loan is typically much more difficult to get than a loan for expansion of an existing For a startup, you may have to look at some of the more untraditional types of lenders described below.
  • Term of the loan: How long do you need the money? If you need a short-term loan for a business startup, you will be looking for a different lender than for a long-term loan for land and

What are Different Types of Lenders?

The most common lenders are banks, credit unions, and other financial institutions.

More recently, the term “lender” has been expended to refer to less traditional sources of funds for small business loans, including:

  • Peer-to-peer lenders: borrowing from individuals, through online organizations like Lenders
  • Crowdfunding: through organizations like Kickstarter, and The good thing about these lenders is that they don’t require interest payments!
  • Borrowing from family and friends: There are organizations that help sort out the tricky financial and personal issues involved with these transactions. If you are considering a loan from someone you know, be sure to create a loan These agreements are sometimes called private party loans.
  • Borrowing from yourself: You can also loan money to your business as an alternative to investing in it, but make sure you have a written contract that specifically spells out your role as a lender, with regular payments and consequences if the business defaults.

Types of Loans

Loan types vary because each loan has a specific intended use. They can vary by length of time, by how interest rates are calculated, by when payments are due and by a number of other variables.

Debt Consolidation Loans

A consolidation loan is meant to simplify your finances. Simply put, a consolidation loan pays off all or several of your outstanding debts, particularly credit card debt. It means fewer monthly payments and lower interest rates. Consolidation loans are typically in the form of second mortgages or personal loans.

Student Loans

Student loans are offered to college students and their families to help cover the cost of higher education. There are two main types: federal student loans and private student loans. Federally funded loans are better, as they typically come with lower interest rates and more borrower-friendly repayment terms.

Mortgage

Mortgages are loans distributed by banks to allow consumers to buy homes they can’t pay for upfront. A mortgage is tied to your home, meaning you risk foreclosure if you fall behind on payments. Mortgages have among the lowest interest rates of all loans

Auto Loans

Like mortgages, auto loans are tied to your property. They can help you afford a vehicle, but you risk losing the car if you miss payments. This type of loan may be distributed by a bank or by the car dealership directly but you should understand that while loans from the dealership may be more convenient, they often carry higher interest rates and ultimately cost more overall.

Personal Loans

Personal loans can be used for any personal expenses and don’t have a designated purpose. This makes them an attractive option for people with outstanding debts, such as credit card debt, who want to reduce their interest rates by transferring balances.

Like other loans, personal loan terms depend on your credit history.

Loans for Veterans

The Department of Veterans Affairs (VA) has lending programs available to veterans and their families. With a VA-backed home loan, money does not come directly from the administration. Instead, the VA acts as a co-signer and effectively vouches for you, helping you earn higher loan amounts with lower interest rates.

Small Business Loans

Small business loans are granted to entrepreneurs and aspiring entrepreneurs to help them start or expand a business. The best source of small business loans is the U.S. Small Business Administration (SBA), which offers a variety of options depending on each business’s needs.

Payday Loans

Payday loans are short-term, high-interest loans designed to bridge the gap from one paycheck to the next, used predominantly by repeat borrowers living paycheck to paycheck. The government strongly discourages consumers from taking out payday loans because of their high costs and interest rates.

Borrowing from Retirement & Life Insurance

Those with retirement funds or life insurance plans may be eligible to borrow from their accounts. This option has the benefit that you are borrowing from yourself, making repayment much easier and less stressful. However, in some cases, failing to repay such a loan can result in severe tax consequences.

Borrowing from Friends and Family

Borrowing money from friends and relatives is an informal type of loan. This isn’t always a good option, as it may strain a relationship. To protect both parties, it’s a good idea to sign a basic promissory note.

Cash Advances

A cash advance is a short-term loan against your credit card. Instead of using the credit card to make a purchase or pay for a service, you bring it to a bank or ATM and receive cash to be used for whatever purpose you need. Cash advances also are available by writing a check to payday lenders

Home Equity Loans

If you have equity in your home – the house is worth more than you owe on it – you can use that equity to help pay for big projects. Home equity loans are good for renovating the house, consolidating credit card debt, paying off student loans and many other worthwhile projects.

Home equity loans and home equity lines of credit (HELOCs) use the borrower’s home as a source of collateral so interest rates are considerably lower than credit cards. The major difference between the two is that a home equity loan has a fixed interest rate and regular monthly payments are expected, while a HELOC has variable rates and offers a flexible payment schedule. Home equity loans and HELOCs are used for things like home renovations, credit card debt consolidation, major medical bills, education expenses and retirement income supplements. They must be repaid in full if the home is sold.

What is a Security?

 A security is a financial instrument, typically any financial asset that can be traded. The nature of what can and can’t be called a security generally depends on the jurisdiction in which the assets are being traded.

In the United States, the term broadly covers all traded financial assets and breaks such assets down into three primary categories:

  1. Equity securities – which includes stocks
  2. Debt securities – which includes bonds and banknotes
  3. Derivatives – which includes options and futures

Types of Securities

1. Equity securities

 Equity almost always refers to stocks and a share of ownership in a company (which is possessed by the shareholder). Equity securities usually generate regular earnings for shareholders in the form of dividends. An equity security does, however, rise and fall in value in accord with the financial markets and the company’s fortunes.

2.   Debt securities

Debt securities differ from equity securities in an important way; they involve borrowed money and the selling of a security. They are issued by an individual or company and sold to another party for a certain amount, with a promise of repayment plus interest. They include a fixed amount (that must be repaid), a specified rate of interest, and a maturity date (the date when the total amount of the security must be paid by).

Bonds, bank notes (or promissory notes), and Treasury notes are all examples of debt securities. They all are agreements made between two parties for an amount to be borrowed and paid back – with interest – at a previously-established time.

3.   Derivatives

Derivatives are a slightly different type of security because their value is based on an underlying asset that is then purchased and repaid, with the price, interest, and maturity date all specified at the time of the initial transaction.

The individual selling the derivative doesn’t need to own the underlying asset outright. The seller can simply pay the buyer back with enough cash to purchase the underlying asset or by offering another derivative that satisfies the debt owed on the first.

A derivative often derives its value from commodities such as gas or precious metals such as gold and silver. Currencies are another underlying asset a derivative can be structured on, as well as interest rates, Treasury notes, bonds, and stocks.

Derivatives are most often traded by hedge funds to offset risk from other investments.

As mentioned above, they require the seller to own the underlying asset and may only require a relatively small down payment, which makes them favorable because they are easier to trade.

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