A loan is generally understood to be the transfer of money whose duration and conditions are governed by a so-called loan agreement. Loans are usually granted by commercial lenders. There are also non-commercial lenders who grant loans.
From a financial point of view, credit is one of the forms of debt financing, as the borrowed amount is debt capital. While companies borrow to acquire equipment and make investments, households usually finance the construction or purchase of a home, a home renovation or a car with the help of a loan.
On the aspect of maturity, short-term loans are defined as medium and long-term loans. Other distinguishing features are the purpose of the loan and the type of loan.
Maturity of loans – short, medium and long term
Loan sums are always provided with a time limit. The repayment term refers to a fixed period of time in which the borrower has to repay the borrowed amount together with interest. The term of a loan depends primarily on the purpose of the loan.
- Short-term loans usually have a term of less than one year
- For medium-term loans, terms of 1 to 4 years apply
- Long-term loans run for at least 4 years
When it comes to a home loan, the terms are usually between 15 and 25 years, as it is by definition a long-term loan. For mortgage loans, however, it is also possible to agree a period of up to 40 years.
Purpose-built and purpose-free loans
Basically, banking differentiates between earmarked and non-purposive loans.
a) earmarked loans – strictly comply with the purpose of use!
The purpose of the loan is linked to the loan agreement. In general, however, earmarking is already included in the name of the respective type of loan, for example a real estate loan.
b) Purpose Loans – the general purpose loan
By comparison, purpose-free loans can be used for any investment because they are not tied to a specific purpose. Here is, for example, install the installment loan, one of the most common types of credit: The borrowed sum of money is paid out at once and repaid with regular installments, which also include interest.
Banks distinguish between consumer loans for private households (including consumer credit) and productive loans for tradespeople and the self-employed. Small loans differ only by their small loan amount of conventional installment loans.
Lending volume – different loan amounts depending on the loan type
This term refers to the granted loan amount for a loan. The volume of credit always depends on the type of loan chosen: For example, an average credit volume of 500 to 5,000 euros is granted for a small loan. Other installment loans can have a credit volume of up to € 75,000.
Credit line – what is a line of credit?
Whether credit line, credit facility or credit line – they all refer to the maximum amount that a borrower can use in a loan in banking. However, the credit line is differentiated into a loan with a credit line, a loan with a fixed loan amount, a credit line for current account debit (current account), a credit line and a credit card credit facility.
Depending on the loan, a fixed loan amount will not be paid, but the customer will be granted a limited amount of credit. This type of loan is referred to as a so-called current account credit, with the help of which usually small financial bottlenecks should be bridged.
The advantage lies in the flexibility, as the borrower can independently decide when to borrow what sums. In addition, he can also determine whether he makes the repayment in installments or in a single sum. Bank overdrafts are short-term loans, as the respective bank can demand repayment at any time.
This type of credit is more common under the name dispo credit when private individuals apply for it. If companies use a current account overdraft to finance operational activities, they are talking about a company loan. Framework loans are distinguished by lower interest rates and their free availability, but are only suitable for short-term loans with a term of less than one year. An overdraft framework also makes sense for credit cards, so as not to get into debt.
All these forms of credit are only made available indefinitely, as long as the creditworthiness of the borrower is compatible with the specified limit. These are usually revolving loans, which are repaid flexibly and, depending on the economic situation of the borrower, in part and then can be exhausted to the limit.
Borrower and lender
When a loan agreement is concluded, there are always 2 parties involved: the lender and the borrower. The lender is the person or company that provides the loan amount. The role of the borrower usually take over banks or savings banks.
A borrower is again the one who claims the loan and has to repay it within a specified time. For borrowers, a distinction is made between private individuals and companies, which is why the forms of credit are dubbed consumer loans or consumer loans for households or productive loans for companies. In this framework, special types of loans are offered for specific groups of people and tailored to the respective target group. For example, a civil service loan is exactly tailored to the needs of civil servants and employees.
Credit and collateral
Partly, the granting of loans is subject to the conditions to provide collateral to the lender. This circumstance is called credit protection, credit protection or collateral. The whole thing is to protect the creditor against credit risk: if the borrower or the debtor, the loan repayment or interest can no longer settle or only partially repay, the lender is protected by the credit security from harsh economic losses.
What serves to secure credit depends essentially on the financial circumstances of the borrower. Thus, the pledge of the next wage payment for small amounts of credit can act as a hedge. But even valuables such as savings accounts and securities, jewelry or antiques can be deposited as collateral with the bank. In addition, credit institutions may require the debtor to take out a life or residual health insurance (CRS) to cover the cost of the loan against risks such as illness, unemployment or death of the borrower. Alternatively, an existing life insurance can be seized.
The most common credit protection is the mortgage, which transfers the lien on a property to the bank. Even with guarantees, credit institutions can hedge against defaults of the borrower. If the debtor does not comply with his obligation to pay, the creditor has the right, in the context of the credit protection, to use the objects accordingly (unsecured securities). If there is a guarantee in the game (personal security), the registered guarantor will be asked to pay.
From lending to early termination
Of course, a loan application will only be accepted once all required data on the borrower has been verified. As a result, credit institutions usually control the creditworthiness of the applicant. The borrower, in turn, is required to take a closer look at loan terms, lending rates, repayment terms and ancillary agreements. Under certain conditions, even early termination of the consumer loan is possible. You can read more about all these points in the following section.
Creditworthiness – what is important?
The creditworthiness of a borrower provides information about his economic ability and personal willingness to repay a loan. In fact, credit institutions are required by law under §18 KWG to verify the economic solvency and willingness to pay of the applicant. For this purpose, relevant information about the person is obtained and evaluated. The result is then an individual score value that provides information about the creditworthiness of the borrower. The following data is used to determine the creditworthiness:
- credit bureau (previous payment history, existing and canceled accounts, existing and repaid loans, insolvency proceedings, enforcement measures)
- Total amount of monthly expenses
- Standing assets
- Marital / li>
- Job security (probationary period, permanent employment, self-employment) / li>
Conditions – on these details, it depends on the loan
The most important things in a loan agreement logically include the loan terms that are set in it. Basically, credit terms are nothing more than the terms and conditions. These include: loan amount, loan term, interest rate, repayment form, fees and expenses. The loan conditions are thus an important basis for making a decision when comparing different loan offers.
Loan amount – always higher than the payout amount
The maximum amount of credit granted depends on the specific conditions. In order to determine the required credit amount, the credit costs, own financial resources and the net purchase price or expense have to be weighed against each other. Last but not least, the actual payout amount is lower than the actual loan amount, as most fees and expenses are deducted immediately. The monthly repayment installments are usually determined by the loan amount, along with the borrowing costs, term, interest and disposable income. The amount of the individual monthly installments and the remaining debt are specified in the repayment plan.
Credit and Term – determine the appropriate repayment period
Over the duration of the term decides the economic situation of the borrower. Care should be taken in all circumstances to choose an appropriate rate that can actually be used. With regard to the repayment term, the higher the monthly installment, the lower the term – and ultimately the overall financial burden. Although a long term reduces the burden of monthly payments, it also makes the loan more expensive.
Influence on the term also has the purpose and the useful life of the financed property. The fact is: durable goods are steadily losing value. Therefore, the term of a loan should generally not exceed the useful life. An example: If you take advantage of car financing, you can expect an average useful life of 5 years. For furniture, the period of use is usually 10 years, for which a medium-term consumer loan is suitable.
Credit and interest
The payment of interest to the lender serves in return for the release of his capital. An interest rate is agreed that is influenced by the key interest rate and the market interest rate.
The key interest rate indicates the price at which the individual commercial banks can lend money to the European Central Bank (ECB). This in turn affects the level of the market interest rate, which determines the lending rate. The lower the key interest rate, the lower the lending rate.
The market interest rate is a risk-free interest rate, but it is only granted to first-class borrowers. The actual lending rate is thus determined based on the individual credit rating of a person. The lender raises something on the market interest rate to hedge its credit risk. The worse the creditworthiness of the borrower, the higher the lending rate. In addition, in most cases, the higher the loan amount requested and the duration of the repayment term, the higher the interest rate.
In addition to the interest rate but also the type of interest is crucial for the actual cost of borrowing. You can choose between fixed or variable interest rates: while the fixed interest rate remains constant over a set period of time – regardless of how market interest rates develop – the variable interest rate changes depending on the market situation.
If market rates fall, a fixed interest rate may be detrimental. On the other hand, a variable interest rate can have a negative impact if the market interest rate skyrockets. However, an upper limit for the interest can be agreed in the loan agreement. The flexible interest rate is always linked to a reference interest rate, which must be set by contract so that interest rates are not arbitrary. A conventional reference interest rate is, for example, the Euro Interbank Offered Rate, or EURIBOR for short.
The so-called nominal lending rate is always given per year (% pa = per anno) and in percent. The effective annual interest rate is the decisive factor for the actual costs, since this indicates the actual costs per year for the selected loan. In each consumer loan agreement, the effective annual interest rate must be stated. This calls for the Pricing Regulation to allow the borrower to make interest rate comparisons. Of course, the loan amount serves as the basis of the interest calculation.
The cost of a loan
The loan cost of a loan is made up of several factors. An essential aspect are definitely the interest rates. In addition, banks and savings banks may demand provisioning interest if the loan amount is available but has not yet been used.
In this way, the bank would like to offset its interest disadvantage resulting from the delayed payout. In addition, the bank may require costs for credit protection under a credit-debt insurance or a mortgage entry.
Even a premature termination of the credit agreement by the borrower incurs costs in the form of a prepayment penalty, which the Bank uses to compensate for its financial losses as a result of the shorter repayment period. Reminder fees and default interest, on the other hand, are incurred if payments are made late.
Credit Repayment – Possibilities and Special Features
The consumer can perceive different possibilities of the loan repayment. For example, an annuity loan, repayment loan or a bullet loan. In the context of consumer credit, repayments and annuity loans are the most common forms of credit.
In the case of an annuity repayment, the loan amount must be repaid in constant installments (annuities) in which the interest is already included. The amount of the installments remains the same. A repayment loan provides for the division of the loan volume into equally high capital rates, which are settled per period.
Repayments reduce the residual debt, which also reduces interest payments. If the entire loan amount is only repaid at the end of the term, there is a bullet loan. During the term, only interest is payable here, which remains unchanged due to a fixed interest rate and a constant residual debt.
Additional agreements are usually advantageous
It is sometimes worthwhile for borrowers to negotiate additional agreements in order to secure financial flexibility during the term. It is recommended, for example, to agree on special repayments: in this way, in addition to the monthly installments, larger installments can be paid, so that the loan volume is reduced with interest and shortened the entire credit term.
It is also advantageous to be able to individually adjust the amount of the repayment installments at any time. This means that every borrower can respond to changes in income as needed, without having to stall immediately with the repayment. Some banks also offer to suspend monthly payments once a year. However, it has to be taken into account that the term of the loan is extended by the period of suspension and, as a result, the cost of borrowing also increases.
Terminate the loan or contract early
The notice periods for which loans apply depends on the type of loan. Below is a brief overview:
- Current account credit – at any time
- Installment loan (with fixed interest rate) – after 6 months with 3-month notice loan (with variable interest) – at any time with 3-month notice period
- Credit (with fixed interest) – both the end of the fixed-interest period with a one-month notice period and after 10 years with a 6-month notice period
It goes without saying that it is also possible to make use of separate termination rights in addition to the statutory provisions insofar as these have been specified in the credit agreement.
Consumers, however, must consider an important point when they terminate their loan agreement early: the lender has the right to demand early repayment penalty, in order to compensate for its loss of profit. The borrower must then pay this compensation within 2 weeks after the termination has come into force. Otherwise, the termination is invalid.
Are lending rates tax deductible?
Whether lending rates are tax deductible, decides in the end, the purpose of the loan or purpose of the loan. If it is a classic consumer loan, the interest can not be claimed. On the other hand, if financing serves investments or purchases that can be attributed to occupational activity, the lending rates may be deducted as income-related expenses or business expenses.
As income-related expenses, lending rates then reduce taxable income, thereby reducing the tax base for income tax. For example, for a real estate loan: If the apartment or house is rented after the purchase or construction, the loan interest can be offset against the income from the rental. Of course, this only works if the borrower does not use the property for his own living.
A second home in another city, which the consumer needs for professional reasons, can in turn be taxed. The interest on a car loan is also to be enforced in the tax return only if the vehicle is used for profit. The same applies to the self-employed and freelancers, if the loan was used for operating expenses.