Take loan and give: debtor or creditor?
Since the beginning of the exchange and money transactions, there are people who have more goods or money than others. This is how credit transactions arose in the earliest times. Those who have more give something away to those who have less and get something bigger for it. In times of famine, periods of drought and war that is also understandable. But what drives people today to provide their money and why do others borrow this money?
All facts about the guide “taking and giving credit” at a glance:
- Loans can be forgiven on the basis of social motivation.
- With the granting of loans, a higher credit interest can be achieved than with traditional investments.
- Private individuals take out loans because their capital is not sufficient to meet their consumer needs.
- Companies can invest in lucrative projects with borrowed money.
1. Why lend a loan?
Being a lender on the market sometimes has something to do with social thinking, for example, because you want to help a friend out of financial distress. Here one grants him then a credit, which lies far below the debit interest. People who have too much money may also benefit disadvantaged people with a low-interest loan.
But all in all, that’s the exception. Most lenders also want to make money by lending money themselves. Much like a store’s price tags work, lenders work with interest rates. Interest is nothing but the price of lending money. Therefore, the repaid amount is always larger than the loan amount received. Of course, this also compensates for inflation over a longer period of time. But most of the interest payments are the price that the borrower has to pay for the loan.
For example, assuming a loan of 20,000 euros, with a total effective interest rate of 8 percent, the borrower must pay 1,600 euros at the end of the term. This amount includes inflation averaging 2 percent. This depreciation would only amount to 400 euros after one year and not 1,600 euros. The difference of 1,200 euros is the price that the borrower has to pay for the loan.
Private lenders sprout up like mushrooms whenever the interest rate on investments in the market is particularly low. Credit interest is the price paid by a capital provider for the money, while borrowing rate is the price that a borrower has to pay the capital service for the money.
The comparison lags, but imagine the money as a raw material, which is bought by the capital service providers for the credit interest. To lend the money to borrowers, a certain effort must be made. The creditworthiness has to be checked, discussions must be conducted and bureaucratic effort must be made. This can be paid by the capital service providers through a higher borrowing rate. Like wheat, which only becomes flour when it is ground. Finally, the miller can pay for this.
Some lenders prefer to go the direct route and seek contact with potential borrowers. This can be done via credit portals. Here, borrowers describe their situation and hope to find sponsors. Innovative ideas can thus be promoted and under certain circumstances a longer-term cooperation is also created. Others simply need the money to buy a new kitchen and can not get credit from the bank for lack of collateral. Here, the risk for the lender is increased, but he may also demand interest rates that are higher than the market borrowing rate.
The span between having and debiting as motivation
Ultimately, the enlightened lender will only enter into loan agreements where he earns more interest than the providers of capital offer. Even if even a rational lender experiences satisfaction by doing a “good deed” and lending to unworthy persons, there is and remains a risk. Over the centuries, capital providers have developed strategies, models and concepts to protect against losses. The private person stands alone with his potential losses.
2. Why take a loan?
Taking out a loan can be necessary for reasons of necessity or can be a rationally calculated business. True to the motto “every good merchant has debts”, the motives can also be purely financial.
If private individuals have to resort to a loan, it is mostly because they pursue a consumption goal that they can not satisfy with their own funds. Simply put, these people like to buy a new stove, but the money they save is not enough, which is why they need to borrow money from a lender. Whether it really is a stove, a car or a house is irrelevant in principle.
Many lenders require the availability of equity to provide a loan. Hereby, the borrower must already have proven in advance that he is able to save and so far he has not had enough time to raise the full amount. If sufficient equity is available, other factors are reviewed before a loan is granted.
If, for whatever reason, credit institutions fail to provide credit, the borrower can look around the private sector. Theoretically, every person can take a loan. The question is only at what price, so how high the interest is. The higher the risk for those who give the loan, the higher the interest rate will be.
However, companies may also want to take a loan at low interest rates as they have invested in high credit interest. This is where the so-called opportunity costs come into play. Opportunity costs always arise if one could do something with his money that brings in a higher profit.
In practice, this may look like this: The company has an amount of 100,000 euros available which it should actually use to legally required formation of reserves. But at the same time there is an investment opportunity in which this amount would interest at 12 percent. However, borrowing money costs only 5 percent at this time. So the company lends the 100,000 euros for 5 percent and reinvested them for 12 percent. The result is an increase of 7 percent.
This example is very simplified and omits many noteworthy factors. However, to illustrate the reasons that speak for taking a loan, the explanations should suffice.
Accordingly, two motivations can be stated why private individuals and companies fall back on loans. On the one hand, the need is due to a lack of equity and, on the other hand, in financial calculations. The one needs the money to be able to afford certain things and the other wants the money to make certain investments!
3. Legal basis of loan agreements
Credit agreements are questions of the law of obligations. Therefore, loan agreements may be freely designed at the discretion of the contracting parties. The debtor is protected by § 138 BGB by broaching the immoral legal transaction of usury.
You can find more information on how a loan agreement should look in the guideline “Credit agreement by means of templates, templates & forms for download”. In addition, here are important notes which factors must be clarified in advance in order to experience any nasty surprises. Essentially, this is the regulation of installment payments, what happens in the event of late payment and what collateral is deposited.
4. The conclusion: With credit agreements there can be win-win situations.
Credit agreements can bring benefits for both sides. In this case one speaks of win-win situations. This may be the case, on the one hand, when private lenders and borrowers know each other and choose an interest rate below the customary borrowing rates customary in the market and above the usual market interest rates. Companies can benefit from loans when better investment opportunities arise and at the same time the lender receives the usual market interest rate.