LOANS AND ADVANCES

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What Is a Loan?

The term loan refers to a type of credit vehicle in which a sum of money is lent to another party in exchange for future repayment of the value or principal amount. In many cases, the lender also adds interest and/or finance charges to the principal value which the borrower must repay in addition to the principal balance. Loans may be for a specific, one-time amount, or they may be available as an open-ended line of credit up to a specified limit. Loans come in many different forms including secured, unsecured, commercial, and personal loans.

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Key Takeaways


  • A loan is when money is given to another party in exchange for repayment of the loan principal amount plus interest.
  • Loan terms are agreed to by each party before any money is advanced.
  • A loan may be secured by collateral such as a mortgage or it may be unsecured such as a credit card.
  • Revolving loans or lines can be spent, repaid, and spent again, while term loans are fixed-rate, fixed-payment loans.

What Is an Advance Rate?

An advance rate is the percentage of the value of the collateral that a lender is willing to extend as a loan. The advance rate helps a borrower determine what kind of collateral to bring to the table to secure the desired loan amount and helps minimize a lender's loss exposure when accepting collateral that can fluctuate in value.

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Key Takeaways


  • An advance rate is the percentage amount of the value of the collateral that a lender is willing to extend as a loan.
  • The risk to a lender is minimized in a default by using an advance rate, particularly when accepting collateral that fluctuates in value.
  • An advance rate also benefits a borrower in that it typically allows for a better interest rate on the loan or a larger loan.
  • Common collateral for an advance rate can include real estate, automobiles, cash accounts, investments, and insurance policies.
  • Determining the advance rate goes hand in hand with assessing the credit risk of a borrower.