Personal Loan Types and Repayment Options on 02/16/2011

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Putting together a personal loan can be a little confusing if it is your first time or you are not very familiar with financial terminology. In reality, the concepts behind a personal loan are very simple and easy to understand. At LoanBack we have developed a very simple and easy to use wizard to walk you through the loan building process. Before you jump in, let’s explain a couple of the terms and concepts you will see in the wizard.

Loan Repayment Options

There are several different repayment options for a personal loan. When you are building your loan you should select the repayment option that works best for both parties.

Amortizing Loan

An amortizing loan is the most common loan type. In an amortizing loan each payment includes a portion of interest and principal so that the loan balance equals zero at the end of the loan term. This type of loan works best when the borrower will have enough income to cover the payments over the term of the loan.

Interest Only Loan

In an interest only loan, the regular payments only include the current interest. At the end of the loan the principal will be repaid in a lump sum. This type of loan would have smaller regular payments than an amortizing loan but requires a larger payment at the end of the loan. This type of loan can work in a situation where the borrower does not have enough income to cover amortizing payments or believes they can refinance the principal with another loan at the end of the term.

Balloon Payment Loan

A balloon payment loan should be considered the most risky of the three types described here. In a balloon payment the borrower does not make any payments during the term of the loan. At the end of the loan the borrower will make one lump sum payment that includes all accrued interest and the underlying principal. Like an interest only loan, the balloon payment loan can work when the borrower does not have enough income to cover amortizing payments or believes they can refinance the principal with another loan at the end of the term.

Loan Collateral Options

If possible, a lender should always ask for collateral or security for their loan. Loan collateral offers a lender piece of mind about their principal and also gives the borrower added motivation to repay the loan. When the loan proceeds will be used to purchase some physical item (e.g. car, boat, home) it is easy to determine the appropriate collateral. In some cases, like a debt consolidation loan, there is no obvious collateral. In a case like this a lender can ask the borrower to offer up some other asset as collateral like their car or a piece of jewelry.

Loan Covenant Options

Loan covenants are conditions or rules that the borrower must comply with over the term of the loan. If the borrower fails to comply with a covenant the lender can immediately request repayment of the loan. When you are building your personal loan the covenant section is an excellent way for the lender and borrower to spell out any special rules they must follow. Some of the most common covenants include the following:

Late Fees

A late fee clause would cover any penalties the borrower would have to pay if the regular payment was not made on time.

Demand Notice

A demand notice allows the lender to “demand” repayment of the loan with some advance notice. For example, the demand clause can say that the lender has the right to demand repayment of the loan within 30 days of the demand notice.

Asset Sale/ Change of Control

An asset sale clause gives the lender the right to demand immediate repayment of the loan in the event that the borrower sells the asset purchased using the loan. For example, if the loan is used to purchase a car and the borrower sells the car, the lender can demand repayment of the loan. The same clause can work if the loan is for a small business. If the borrower sells the business the lender can demand repayment.

Financial Reporting

A financial reporting clause is most commonly included in small business loans. In this case, the lender can require the borrower to provide regular reports on the health of the business or share year-end tax statements. This type of clause can also be included in personal loans, although many borrowers might view this type of requirement too invasive.

Debt Restrictions

A debt restriction clause can be used to restrict a borrower from taking on any additional debt without the lenders permission.

More Information
Lending Glossary – LoanBack
What is a loan covenant? –