Loan is an important aspect of finance, which is given from one entity to another entity and a certain interest rate is charged on that loan. The interest rate is nothing but a fee that is charged by the creditor to the debtor. The debtors can be an individual, a business or even a government.
Some of the common types of formal loans that are taken by individuals, are, mortgage loans, car loans and credit card debts. There are some informal loans as well which people take from their friends and relatives.
In 2011, it was reported that about 8% European Union could not pay back their loans to friends or relatives within their scheduled time. In case of business firms, they take different kinds of loans in order to finance their operations as per their strategy. Even government takes loans for financing their ongoing projects.
Types of debt financing
In order to pay back loans along with the interest, the debtors (individuals and businesses) undertake different types of methods.
Debt financing based on assets
Here, the asset is used as the security of the loan. In this case the process of financing will depend largely on the type of asset, i.e., whether it is a car, real estate, property, machinery, etc. The terms and amount of the loan will depend on the time for which the asset remains useful. Along with this asset some other kind of security might also be needed. The debtors will also have to show that they have the cash flow to repay the loan.
These asset based finance facilities can be further subdivided.
Different types of methods are used for equipment finances Some of the methods which can be used for financing the debt are hire, purchase, chattel mortgage and leasing. It is always advisable for you to take suggestions from experts.
This is a very popular kind of asset-based financing. Business firms or individuals often take up this property financing. Here, the amount that is provided as advance depends on the type of the property (i.e., whether the property type is agricultural, industrial or commercial). The amount of the loan also depends on the class of assets the bank is looking for.
Refinancing is referred to the process of replacing one debt obligation with another one under different terms and conditions. One of the ways of refinancing the loans is debt consolidation. Debt consolidation loans are nothing but the process of taking loans in order to pay off some other loans.
A loan might be refinanced for several reasons:
- You might choose to refinance if you come across some better interest rates, which may be a reduced interest rate or reduced terms.
- If you have several loan burdens with different interest rates and terms, you can opt for refinancing them and make it one single loan with a particular interest rate and term.
- If you have to pay a variable interest rate, you can switch to a fixed interest rate to reduce the risk factor.
Especially for personal loan it becomes easier for the individual to manage his debt. If the person is facing a credit card debt, which is quite high generally in UK, the person can bring it down to home mortgage only. This will prove beneficial for the debtor as he will be able to pay off his loan for a longer period of time. For home mortgages the debtors may also receive tax advantages in the UK.
However, those who will opt for fixed loans should know about the risk involved in it. There are some fixed term loans which have certain penalty clauses. These clauses are applied in cases of early repayment of loans. You will also have to pay the charge for transaction in order to refinance. However, the penalties will have to be paid only if the loans are paid before the term gets completed. If the loan is paid off upon maturity, it will no longer be considered as refinancing, then it will become a new financing.
For people who have enough assets can easily opt for refinancing and clear their existing debts faster. Mortgaging your property may involve lots of risk as well. This, is mainly because, if the monthly payments are not cleared on time, your property will be at risk.