What Is a Loan? (Explained Simply)
A loan is when you borrow money and agree to pay it back over time.
Loans are used for big purchases like cars, homes, education, or to cover unexpected expenses.
How a Loan Works
Every loan has a few basic parts:
- Principal – the amount you borrow
- Interest – the cost of borrowing the money
- Term – how long you have to pay it back
- Payment – how much you pay each month
When you make payments, part goes toward the principal and part goes toward interest.
Simple Example
You borrow $5,000 for three years.
- Loan amount: $5,000
- Interest rate: 8%
- Loan term: 36 months
You make monthly payments until the loan is fully paid off.
Common Types of Loans
- Personal loans – used for many purposes
- Auto loans – used to buy vehicles
- Student loans – used for education
- Mortgages – used to buy homes
Secured vs Unsecured Loans
Loans fall into two main categories:
- Secured loans – backed by something valuable (like a car or house)
- Unsecured loans – not backed by collateral
Secured loans usually have lower interest rates because they are less risky for lenders.
Why Interest Matters on Loans
Interest determines how much extra you pay over time.
A lower interest rate or shorter loan term usually means paying less overall.
Why People Use Loans
- They don’t have the cash upfront
- They want to spread payments over time
- They want to keep savings intact
Loans can be useful tools when used carefully.
Bottom Line
A loan is simply borrowing money with a promise to pay it back.
The most important things to understand are interest, term, and total cost.
Always know what you’re agreeing to before signing a loan.