Bank Lending

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How Bank Lending Works

When you take out a loan from a bank, there are many different options available to the borrower. Bank lending allows you to get a large sum of cash in advance, with the agreement that you will pay this amount off over time. You also agree when you get a loan from the bank that you will pay them interest on the loan. Loan Interest is a necessary thing, because it allows the Bank that is Lending you the money to have some reasonable assurance that the arrangement will be profitable. Bank Mortgage Rates, for example, are based on the long-term profitability of these loans, and with a longer term to pay off the loans, some banks will try to offer you the best mortgage rates possible to help secure your business for the life of the loan.

Bank Lending is a mutually beneficial arrangement: the borrower gets what they want (up front cash, to be used for whatever they need), and the lending bank eventually will get what they want (a healthy return on their investment).

Bank Lending - Risk to the Bank or Lending Institution

Banks need profit to survive, and by lending money, the bank is taking a certain amount of risk. The risk to the bank is very real, because the borrower can potentially default on the loan at some point in the future. Credit Scores exist to help banks ascertain this risk, and make a calculated decision on if lending money to a particular borrower is a good decision or not. The credit score also helps the lending bank to determine how much money would be appropriate for an individual in certain credit situations, and also an appropriate interest rate to charge for the loan.

These calculations are developed to at least make an effort to assure profitability for the bank. Without basing lending, loan amounts, and interest rates on some measure of the person's credit worthiness (their credit score), the bank has no guarantee that the borrower will be reasonably able to pay back the loan in the future. And in some cases, if a borrower does default on a loan, they might eventually declare bankruptcy. In certain of these cases, the bank lending the money might not be able to collect anything further. Bank lending rates are based on a fairly complex series of calculations, but are designed to protect the banks themselves from becoming insolvent.

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Bank Lending - Understanding loan rates for the borrower

The borrower needs to understand that any loan taken from a bank is typically a bad decision, financially. There are certain situations where it might not be avoidable (such as in the case of a large purchase, like a bank mortgage or other home loan, or a car loan). But in all cases, loans and their corresponding interest rates are designed to return profit to the bank, beyond the principal of the loan itself. This means that most loans are a losing proposition, short term.

Regardless, there are "good" loans, and "bad" loans. Good loans would usually be those that are tied to physical assets, such as a house (definitely, mortgages are widely considered to be a necessary investment, and since home values generally appreciate in a good economy, the value of the asset attached to the loan also increases). In other cases, car or truck loans can be considered semi-good loans (minor point, but because most vehicles depreciate rapidly, even with low interest rates this is a losing proposition, because the borrower can never really gain back the full value of the purchased property.

BAD loans would be credit cards, unsecured loans for any purpose, store charge cards, and payday loans. Unfortunately, credit cards are a necessary evil, but using them properly WILL actually help your credit score over time. Other loans might help in very short term emergencies, but they can have outrageous interest rates... store charge cards can carry 15%-25%, and payday loans can carry VERY stiff penalties if they are not paid off in time. A person can be very easily ruined financially if they fail to pay these types of bank loans.

Bank Lending overall has good points and bad points. Bank Lending allows us to enjoy certain things immediately that we might not be able to get otherwise; failing to consider consequences of certain loan types, or failing to pay back loans can have very bad consequences, so the borrower is always encouraged to consider the necessity of the loan, and the conditions of paying the bank back for the loan BEFORE they borrow. Borrowers should also be encouraged to pay more than the minimum rates, which will help lower the interest paid to the bank over the life of the loan.