Loan definition

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What is a Loan?

A loan is an arrangement under which a lender allows another party the use of funds in exchange for an interest payment and the return of the funds at the end of the lending arrangement. Loans provide liquidity to businesses and individuals, and as such are a necessary part of the financial system.

Loan Terminology

The terms associated with a loan are contained within a promissory note. These terms may include the following:

  • The interest rate to be paid by the borrower, which may be a variable or fixed rate

  • The maturity date of the loan

  • The size and dates of the payments to be made to the lender

  • The amount of any collateral to be posted against the note

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Types of Loans

There are a number of loan types, including the following ones:

  • Demand loan. A demand loan is a type of loan that the lender can require to be repaid at any time, without prior notice. This flexibility allows lenders to manage their risk but can create uncertainty for borrowers. Such loans are typically used for short-term financing needs where both parties agree to the open-ended terms.​

  • Guaranteed loan. A guaranteed loan involves a third party, such as a parent company, assuring the lender that the loan will be repaid if the borrower defaults. This guarantee reduces the lender's risk and can help the borrower secure financing on more favorable terms. It's commonly used in situations where the borrower lacks sufficient credit history or collateral.​

  • Installment loan. An installment loan is repaid over time through a series of scheduled payments, which include both principal and interest. This structure provides predictability for both the borrower and the lender. Examples include mortgages, auto loans, and personal loans.​

  • Line of credit. A line of credit is a flexible loan arrangement that allows the borrower to draw funds up to a predetermined limit, repay them, and borrow again as needed. Interest is typically charged only on the amount drawn, not the entire credit limit. This type of loan is useful for managing cash flow and covering short-term financing needs.​

  • Secured loan. A secured loan requires the borrower to provide collateral, such as property or equipment, which the lender can claim if the loan is not repaid. This reduces the lender's risk and often results in lower interest rates for the borrower. Common examples include mortgages and auto loans.​

  • Unsecured loan. An unsecured loan does not involve collateral, relying solely on the borrower's creditworthiness. Due to the higher risk to the lender, these loans often come with higher interest rates. Credit cards and personal loans are typical forms of unsecured loans.