A loan is money, property or other material goods that is given to another party in exchange for future repayment of the loan value amount along with interest or other finance charges. A loan may be for a specific, one-time amount or can be available as an open-ended line of credit up to a specified limit or ceiling amount.
The terms of a loan are agreed to by each party in the transaction before any money or property changes hands. If the lender requires collateral, this requirement will be outlined in the loan documents. Most loans also have provisions regarding the maximum amount of interest, as well as other covenants such as the length of time before repayment is required. A common loan for American consumers is a mortgage – a loan taken out to purchase a property.
Loans can come from individuals, corporations, financial institutions, and governments. They offer a way to grow the overall money supply in an economy as well as open up competition and expand business operations. The interest and fees from loans are a primary source of revenue for many financial institutions such as banks, as well as some retailers through the use of credit facilities.
The Difference between Secured Loans and Unsecured Loans
Loans can be secured or unsecured. Mortgages and car loans are secured loans, as they are both backed or secured by collateral.
Loans such as credit cards and signature loans are unsecured or not backed by collateral. Unsecured loans typically have higher interest rates than secured loans, as they are riskier for the lender. With a secured loan, the lender can repossess the collateral in the case of default. However, interest rates vary wildly depending on multiple factors.
Revolving vs. Term Loans
Loans can also be described as revolving or term. Revolving refers to a loan that can be spent, repaid and spent again, while term refers to a loan paid off in equal monthly installments over a set period called a term. A credit card is an unsecured, revolving loan, while a home equity line of credit (HELOC) is a secured, revolving loan. In contrast, a car loan is a secured, term loan, and a signature loan is an unsecured, term loan.
Loan financing includes both secured and unsecured loans. Security involves a form of collateral as an assurance the loan will be repaid. If the debtor defaults on the loan, that collateral is forfeited to satisfy payment of the debt. Most lenders will ask for some sort of security on a loan. Few, if any, will lend you money based on your name or idea alone.
Here are some types of security you can offer a lender:
- Guarantors sign an agreement stating they’ll guarantee the payment of the loan.
- Endorsers are the same as guarantors except for being required, in some cases, to post some sort of collateral.
- Co-makers are in effect principals, who are responsible for payment of the loan.
- Accounts receivable allow the bank to advance 65 to 80 percent of the receivables’ value just as soon as the goods are shipped.
- Equipment provides 60 to 65 percent of its value as collateral for a loan.
- Securities allow publicly held companies to offer stocks and bonds as collateral for repaying a loan.
- Real estate, either commercial or private, can be counted on for up to 90 percent of its assessed value.
- Savings accounts or certificate of deposit can also be used to secure a loan.
- Chattel mortgage applies when equipment is used as collateral–the lender makes a loan based on something less than the equipment’s present value and holds a mortgage on it until the loan’s repaid.
- Insurance policies can be considered collateral for up to 95 percent of the policy’s cash value.
- Warehouse inventory typically secures up to only 50 percent of the loan.
- Display merchandise such as furniture, cars and home electronic equipment can be used to secure loans through a method known as “floor planning.”
- Lease payments can be assigned to the lender, if the lender you’re approaching for a loan holds the mortgage on property you’re trying to lease.
Project finance is the financing of long-term infrastructure, industrial projects and public services using a non-recourse or limited recourse financial structure. The debt and equity used to finance the project are paid back from the cash flow generated by the project. Project financing is a loan structure that relies primarily on the project’s cash flow for repayment, with the project’s assets, rights and interests held as secondary collateral. Project finance is especially attractive to the private sector because companies can fund major projects off-balance-sheet.
Key Elements of BOT Project Finance
Project finance for BOT projects generally include a special purpose vehicle(SPV). The company’s sole activity is carrying out the project by subcontracting most aspects through construction and operations contracts. Because there is no revenue stream during the construction phase of new-build projects, debt service only occurs during the operations phase.
For this reason, parties take significant risks during the construction phase. The sole revenue stream during this phase is generally under an off-take or power purchase agreement. Because there is limited or no recourse to the project’s sponsors, company shareholders are typically liable up to the extent of their shareholdings. The project remains off-balance-sheet for the sponsors and for the government.
Project debt is typically held in a sufficiently minority subsidiary not consolidated on the balance sheet of the respective shareholders. This reduces the project’s impact on the cost of the shareholders’ existing debt and debt capacity. The shareholders are free to use their debt capacity for other investments.
To some extent, the government may use project financing to keep project debt and liabilities off-balance-sheet so they take up less fiscal space. Fiscal space is the amount of money the government may spend beyond what it is already investing in public services such as health, welfare and education. The theory is that strong economic growth will bring the government more money through extra tax revenue from more people working and paying more taxes, allowing the government to increase spending on public services.
When defaulting on a loan, recourse financing gives lenders full claim to shareholders’ assets or cash flow. In contrast, project financing provides the project company as a limited-liability SPV. Therefore, the lenders’ recourse is limited primarily or entirely to the project’s assets, including completion and performance guarantees and bonds, in case the project company defaults.
A key issue in non-recourse financing is whether circumstances may arise in which the lenders have recourse to some or all of the shareholders’ assets. A deliberate breach on the part of the shareholders may give the lender recourse to assets. Applicable law may restrict the extent to which shareholder liability may be limited. For example, liability for personal injury or death is typically not subject to elimination.