In simple terms, a loan is borrowed money. It is a type of debt wherein financial assets between the borrower (one who receives the financial asset) and the lender (one who extends the loan) are redistributed over time.

Initially, the borrower will receive the money borrowed from the lender. The borrower will then be obliged to repay the total amount due, which is usually done in equal instalments. The total amount of money that the borrower will pay will consist of the principal and interest. The principal is just equal to the amount lent by the lender, while the interest is the amount of money charged to the borrower for the privilege of borrowing the money and is usually expressed as an annual percentage rate.

The basic elements of a loan are:

  1. Principal – amount of money borrowed by the borrower from the lender
  2. Interest Rate – the rate of the interest to be charged to the borrower
  3. Term – defined as the period of time from when the money was lent to the borrower until the borrower fully pays the loan amount with interest.
  4. Payment Frequency – number of amortization payments until the loan matures or reaches the end of its term
  5. Payment Media – Type of acceptable payments that the borrower can use to pay for the loan.

In lending, lenders are usually the one who face certain risks since they are the ones who lend their money/assets. These risks include: (1) not being able to recover the money they lent; (2) non-realization of income; and (3) there is no collateral from the borrower to offset the remaining money that has not been paid.

To mitigate these risks, certain measures can be done:

  1. Make sure that the borrower has a stable source of income, either through employment or through business.
  2. Check the financial background of the borrower, including spending habits, credit history, and existing loans.
  3. Check borrower’s properties and assets and make sure that the collateral will be enough to offset the possible losses.
  4. Limit the money to be lent to only what the borrower can afford to pay.
  5. Lastly, make sure all information that the borrower gives is backed up by legitimate documents to avoid incorrect/misleading information.
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