Question

what are the components when financing a loan? explain each one and how they make up a loan.

Answer 1

Financing a loan consist of 3 main components, it includes:

• Principal: It is the main amount that is being borrowed from the bank or financial institution. It is the amount that one will have to pay back along with the interest. It is the main component of a loan and determines the other components like interest. Interest charged will largely depend on the amount borrowed.
• Interest: It can be termed as the amount that is being paid by the borrower to the lender for using the money of lender for a specified period of time. It is charged at a specific rate to the borrower. The rate of interest is also decided by the capacity of borrower to pay back the principal amount. If the risk is low, the rate of interest will be low, however, if the risk is high then rate of interest will be substantially higher. Interest can be simple or compounding. The absolute amount in compound interest will be higher and in simple interest it will be lower.
• Fees: The cost of the loan can increase substantially by the fees that is being paid to the lender for availing the loan. This fees can be charged either at the origin or the during the tenure of loan. These fees includes processing fees, prepayment fees, origination fees etc.