Banks do not make money by taking your deposits and keeping them until you need the money. They earn a lot of money through loans. A bank loan is an arrangement in which a bank gives you money that you repay with interest. Loans are separate from revolving credit accounts, such as credit cards or equity lines of credit, which allow you to borrow and repay continuously up to a certain amount.
Conditions of a typical bank loan
Any loan you contract from a bank will require you to sign a contract, called a loan agreement, promising to repay the money. The contract will specify the specific conditions of the loan. These included:
- the principal, or the amount you borrow.
- the interest rate the bank will charge the loan.
- That you offer collateral for the loan. The guarantee is a good that the bank can seize if you do not repay the loan. With mortgages and auto loans, the guarantee is usually the home or car that you have borrowed to buy.
- the repayment schedule. Typically, you make a series of payments over time, with each payment being partly capital and partly interest. The repayment schedule could only cover a few months or years, as in the case of a personal loan, or last several decades, as in the case of a mortgage loan.
The Federal Law on Truth in Loans obliges banks to clearly explain the terms of the loan, including the total cost of these interests. State laws can also set limits on the amount a bank can charge in terms of interest or other loan terms.
How tariffs are fixed
Interest is the cost you pay for having the privilege of using the funds of the bank. Banks earn money by charging interest on loans at higher rates than they pay for deposits. The interest rate you pay on a bank loan depends largely on two factors:
- The overall cost of loans in the economy.
- How much does the bank think it is risky to lend you money, in particular?
The first of them has nothing to do with you; It is determined by larger forces such as the size of the money supply, aggregate demand for loans, and a range of government policies. These affect the rates everyone pays. The second has everything to do with you. Banks review your credit report and credit score to see how much you have managed your debt in the past. they examine your current income and your financial assets; and they want to know if you offer guarantees. What they are trying to evaluate is the likelihood that you will not repay the loan. The lower the risk that the bank thinks you are asking, the lower the rate you pay. If you are at a higher risk, you will pay a higher rate. In other words, if the bank does not just refuse your loan application.
What happens if you do not pay
As long as you make payments on your loan in accordance with the contract, your debt will decrease and the loan will eventually be repaid. But if you default on the debt – that is, stop making payments – then you have problems. Usually, the bank will contact you to find out if everything is ok and remind you to pay according to the loan agreement. Miss several payments, and the bank will conclude that you do not intend to pay.
If the loan is secure means that you have a guarantee to pay the debt, the bank will seize it, for example by taking possession of a car or by seizing a house, then selling it. If it can not sell it enough to cover the amount you owe, the bank may be able to sue you for the difference, or sell the debt to a collection agency. If the loan is unsecured, meaning that there is no guarantee, the bank can go directly to the trial or entrust it to the collections.