- Any person or company that offers money to people with the expectation that it will be paid back. Banks, credit unions, and loan companies are all lenders.
What is a Lender?
A lender is a person, group, or business that loans money to borrowers. Almost all lenders charge for their services, usually asking that the borrower pay them interest on what they borrowed. Many lenders also charge fees in addition to interest.(1)
Lenders typically offer loans or extend lines of credit. (Technically, a line of credit is simply a different type of loan, but they are distinct enough from a regular loan that they should be considered a separate type of lending product.)
What is a Loan?
A loan is a sum of money that a lender issues to a borrower. The amount that is lent is referred to as “the principal.” Loans will almost always come with a “term” that determines the period of time in which the loan has to be repaid. When a borrower cannot repay the loan, the loan goes into “default”. Depending on the type of loan, the lender will have different ways to try and get their money back from the borrower.(2)
What is Interest and how does it work?
For instance, a person who takes out a $100 loan with a monthly interest rate of 10% would owe $110 after one month. After two months, they would owe $120. After three months, $130. A loan with a monthly interest rate of 10% would have a yearly interest rate of 120%.
Because interest rates can seem larger or smaller depending on the period of time that is used to measure them, it’s always a good idea to double check the interest rate when filling out a loan application.
Some loans have “fixed” interest rates that remain the same over the life of the loan. Other loans have “variable” or “floating” interest rates which are subject to change.(4) There is also compounding interest, in which the interest that’s already been accrued becomes a part of the principal; meaning that you get charged interest on your interest.(5)
What are different kinds of loans?
An installment loan is a kind of loan that is structured to be paid back over a series of regular payments, usually on a monthly basis.
What is a Line of Credit?
A line of credit is different from a loan, in that the borrower doesn’t receive a single lump sum of money; instead, they are given a set credit limit and they can borrow up to that limit.(6) A person with a $5,000 line of credit could borrow $50, $500 or $5,000. They simply wouldn’t be able to borrow more than $5,000.
Like loans, lines of credit accrue interest. However, a borrower who has taken out a line of credit will only owe interest on what they have actually borrowed. If a person has a $5,000 line of credit with a 2% monthly interest rate and they borrow $500, they would only owe $10 per month in interest.
With a line of credit, a person will usually be responsible for regular monthly payments. The amount that they owe will depend on how much they have borrowed. However, some lines of credit do not come with a set payment schedule.
What are different kinds of Lines of Credit?
Your basic line of credit allows you to borrow up to the maximum amount. The key feature is that funds do not replenish once they are paid down. Let’s say you borrow $1,000 against a $5,000 limit. You now have $4,000 left that you can borrow from. Even if you make a payment of $500 towards that $1,000 that you borrowed, you still only have $4,000 left that you can borrow, not $4,500.
A revolving line of credit is different in that it does allow those funds to be replenished. So if you borrow $1,000 against a $5,000 limit and then pay off $500, you would have $4,500 left that you could still borrow.
A credit card is a line of credit product that uses a revolving balance. They often come with higher interest rates than other line of credit products.
What are Secured and Unsecured Loans/Lines of Credit?
The difference between a secured and unsecured loan or line of credit is simple: a secured loan is backed by collateral and an unsecured loan is not.(7)
Collateral is a piece of property that belongs to the borrower. The borrower offers that item to the lender so that in the event that the borrower cannot repay the loan, the lender can then seize that item and sell it to recoup their losses.(8) That property could be a house, a car, a boat, real estate, or really anything of value. The lender will not issue a loan that is greater than the value of the collateral. Mortgages and auto loans are two of the most common types of secured loans.
An unsecured loan is issued without collateral, this means that the borrower’s ability to repay is very important to the lender.(9) To determine whether or not they will issue the loan or line of credit, the lender will look at several factors, the most important of which is the borrower’s credit score. Having a poor credit score can negatively impact the kinds of unsecured loans for which a person might qualify, resulting in higher interest rates and fees, and shorter terms.
What are the different kinds of Lenders?
There are two main types of lenders: direct lenders and brokers.
A direct lender will issue you funds that they themselves possess.(10) Payments will, in turn, be made directly to the lender. Banks and credit unions are two of the most common types of direct lenders. There are also many specialty lenders like mortgage, auto and personal lenders that are all direct lenders.
A broker is a lender who facilitates the loan process between a borrower and a third-party.(11) You will most often hear the term “broker” in reference to mortgages, which are very large loans that people take out in order to purchase a house or other type of real estate. While brokers can be useful, people should always make sure that the broker is not adding additional or hidden fees.
Peer-to-peer lenders are a type of broker that usually matches up borrowers with other individual lenders instead of large financial institutions.
There is a third kind of lender that people often forget about: people. A person can get a loan from someone they know: a friend, a mentor, a relative. These loans might be charged interest or they might not. They might come with regularly scheduled payments or they might not. It all depends on the person issuing the loan.
What kind of Lender should I choose?
It is entirely up to you. But there are a number of points to keep in mind:
- Make sure that you choose a safe lender with positive customer reviews and a Better Business Bureau accreditation.
- Lenders evaluate potential borrowers based on both their credit-worthiness and/or the collateral that they offer.
- Make sure to do all your research before taking out a loan. Read the fine print to avoid surprises later.
Deciding how much money you can afford to borrow and working with safe and reputable lenders will always be a safer route than simply going with any store front payday lender. Doing research and being informed will help you choose what kind of lender is best for you and for your financial future.
- “Lender.” Investopedia. Accessed March 24, 2016. https://www.investopedia.com/terms/l/lender.asp
- “Loan.” Investopedia. Accessed March 24, 2016. https://www.investopedia.com/terms/l/loan.asp
- Pritchard, Justin. “What is Interest?” About Money. Accessed March 31, 2016. https://banking.about.com/od/howtobank/a/What-Is-Interest.htm
- “Floating Interest Rate.” InvestingAnswers.com. Accessed March 31, 2016. https://www.investinganswers.com/financial-dictionary/debt-bankruptcy/floating-interest-rate-6182
- Foreman, Gary. “10 Things You Need to Know About Compound Interest.” US News & World Report. Accessed March 31, 2016. https://money.usnews.com/money/blogs/my-money/2012/09/20/10-things-you-need-to-know-about-compound-interest
- “What are the differences between revolving credit and a line of credit?” Investopedia. Accessed March 24, 2016. https://www.investopedia.com/ask/answers/110614/what-are-differences-between-revolving-credit-and-line-credit.asp
- “Secured Debt.” Investopedia. Accessed March 24, 2016. https://www.investopedia.com/terms/s/secureddebt.asp
- “What Is Collateral and Why Is It Important?” North Shore Bank: Blog. August 9, 2013. Accessed March 31, 2016. https://www.northshorebank.com/about-us/connecting-with-you/august-2013/what-is-collateral-and-why-is-it-important.aspx
- “Secured vs. Unsecured Loans.” Green Path Debt Solutions. Accessed March 31, 2016. https://www.greenpath.com/resources-tools/financial-library/loan-types/secured-vs-unsecured-loans
- “Kumok, Zina. “Mortgage Broker vs. Direct Lenders: Which is Best?” Investopedia. September 09, 2015. Accessed March 24, 2016. https://www.investopedia.com/articles/personal-finance/090915/mortgage-broker-vs-direct-lenders-which-best.asp
- “Mortgage Broker vs. Mortgage Lender.” Zillow.com. Accessed March 31, 2016. https://www.zillow.com/mortgage-learning/mortgage-brokers/