Loan

Loan, in Finance, the lending of a sum of money. In common usage, the lending of any piece of property. A loan may be secured by a charge on the borrower’s property (as a house purchase mortgage is) or be unsecured. There will also be a number of conditions attached to the loan: for example when it is to be repaid and the rate of interest to be charged on the sum of money loaned. Almost any person or any organization can make or receive a loan, but there are restrictions on some types of the loan; for example, those made by a company to one of its directors.

Loans can take many forms. Many businesses are financed by long-term loan capital, such as loan stock or debentures. Governments also finance their borrowing requirements by issuing long-term fixed-interest bonds that in the United Kingdom are known as gilt-edged stock (or gilts). These loans will usually have a fixed repayment (or redemption or maturity) date and will earn the lender (owner of the stock/debenture/bond) a fixed rate of interest until that date. In the meantime, the price at which the stock can be traded on a stock exchange will depend on a number of things, including how the interest rate on the stock compares with the current rate available on other loan stock. For example, if interest rates have gone down, the price of the loan stock should go up, because the stock is now earning a higher rate of interest than would be earned on its original value at the current market rate. But the market price of a bond will also depend on its maturity date and its quality. In the United States, bonds issued by companies whose credit ratings are below investment grade are known as junk bonds; these pay a higher rate of interest than “non-junk” bonds but their market value will take into account the deemed higher risk of the bond issuer defaulting on interest payments or on redeeming the bonds at their full redemption value. A company’s loan capital is normally recorded on its balance sheet, at the repayment amount, as long-term liabilities. One of the factors by which investors judge a company and by which lenders decide whether to lend it money is the ratio of its debt to its equity. This is known as gearing or leverage; the higher the proportion of loan finance to equity, the higher the gearing or leverage. One of the other ratios people look at when evaluating a company is the proportion of its profits being used to pay the interest on its loan finance.

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The interest rate payable on loans is usually determined by market forces at the time the loan is taken out. However, governments may give soft loans (loans on more favourable terms than can be obtained in the market) to businesses they wish to support or encourage. The International Development Association, part of the World Bank, is specifically concerned with organizing loans to developing countries on soft terms.