What Is a Lender?
A lender is an individual, a group (public or private), or a financial institution that makes funds available to a person or business with the expectation that the funds will be repaid. Repayment will include the payment of any interest or fees. Repayment may occurin increments (as ina monthly mortgage payment) or as alump sum. One of the largest loans consumers take out from lenders is amortgage.
Key Takeaways
- A lender is an individual, a public or private group, or a financial institution that makes funds available to a person or business with the expectation that the funds will be repaid.
- Repayment includes the payment of any interest or fees.
- Repayment may occurin increments (as ina monthly mortgage payment) or as alump sum.
Understanding Lenders
Lenders provide funds for a variety of reasons, such as a home mortgage, an automobile loan, or a small business loan. The terms of the loan specify how it must be satisfied (e.g., the repayment period) and the consequences ofmissing payments and default.A lender may go to a collection agency to recover any funds that are past due.
How Do Lenders Make Loan Decisions?
Individual borrowers
Qualifying for a loan depends largely on the borrower’s credit history. The lender examines the borrower’s credit report, which details the names of other lenders extending credit (current and previous), the types of credit extended, the borrower’s repayment history, and more. The report helps the lender determine whether—based on current employment and income—the borrower would be comfortable managing an additional loan payment. As part of their decision about creditworthiness, lenders may also use the Fair Isaac Corporation (FICO) score in the borrower’s credit report.
The lender may also evaluate the borrower’s debt-to-income(DTI) ratio—which compares current and new debtto before-tax income—to determine theborrower’s ability to pay.
When applying for a secured loan, such as an auto loan or a home equity line of credit (HELOC), the borrower pledges collateral. The lender will make an evaluation of the collateral’s full value and subtract any existing debt secured by that collateral from its value. The remaining value of the collateral will be the equity thataffects the lending decision (i.e., the amount of money that the lender could recoup if the asset were liquidated).
The lender also evaluates a borrower’s available capital, which includes savings, investments, and other assets that could be used to repay the loan if income is ever cut due to a job loss or other financial challenge.The lender may ask what the borrower plans to do with the loan, such as use it topurchase a vehicle or other property. Other factors may also be considered, such as environmental or economic conditions.
Business borrowers
Different lenders have different rules and procedures for business borrowers.
Banks, savings and loans, and credit unions that offer Small Business Administration (SBA) loans must adhere to the guidelines of that program.
Private institutions, angel investors, and venture capitalists lend money based on their own criteria. These lenders will also look at the purpose of the business, the character of the business owner, the location of business operations, and the projected annual sales and growth for the business.
Small-business owners prove their ability for loan repayment by providing lenders both personal and business balance sheets. The balance sheets detailassets, liabilities, and the net worth of the business and the individual. Although business owners may propose a repayment plan, the lender has the final say on the terms.
Where Can I Get a Small Business Loan?
One good lender option for small business borrowers is the Small Business Administration (SBA), a U.S. government agency that promotes the economy by assisting small businesses with loans and advocacy. The SBA has a website and at least one office in every state.
What Are the Different Types of Mortgage Lenders?
The three most common options for borrowers seeking a mortgage lender are mortgage brokers, direct lenders (e.g., banks and credit unions), and secondary market lenders (e.g., Fannie Mae and Freddie Mac).
How Can I Get a Mortgage with Bad Credit?
Getting a mortgage when you have bad credit is possible, but a larger down payment, mortgage insurance, and a higher interest rate will likely be required.
The Bottom Line
When you need to borrow money for a personal purchase or jumpstart your business, there are many options. When choosing a lender, look at their reputation and longevity—banks and other financial institutions are the traditional choices, but angel investors and online micro-lenders are gaining popularity. Before borrowing, make sure you understand the full breadth of your loan agreement and can afford to repay it.
FAQs
Key Takeaways
How do lenders make their decisions? ›
A lender will analyze the customer's historical income and expenses and the projected cash flow needs. The customer's ability to meet projections is often related to a sound marketing plan. Forward contracting and the futures markets are examples of making pricing decisions before the commodity is actually delivered.
What is the definition of a lender? ›
A lender refers to an individual or financial institution that provides loans to an individual, corporation, or public department in exchange for the principal and interest. A lender could be a bank, an insurance company, or a government agency.
What are the three types of lenders? ›
Direct lenders originate their own loans, either with their own funds or borrowing them elsewhere. Portfolio lenders fund borrowers' loans with their own money. Wholesale lenders (banks or other financial institutions) don't work directly with consumers, but originate, fund, and sometimes service loans.
What is loan definition and types? ›
A loan is a sum of money that an individual or company borrows from a lender. It can be classified into three main categories, namely, unsecured and secured, conventional, and open-end and closed-end loans.
What four factors do lenders generally use in their loan making decisions? ›
What Are the Four Cs of Credit?
- Capacity.
- Capital.
- Collateral.
- Character.
Key Takeaways
Lenders will consider a prospective borrower's income, credit score, and debt levels before deciding to offer them a loan. A loan may be secured by collateral, such as a mortgage, or it may be unsecured, such as a credit card.
What is a lender in a loan? ›
A lender is a financial institution that lends money to a corporate or an individual borrower with the expectation that the money will be repaid at a later date. Lenders require borrowers to pay interest on the amount borrowed, usually charged at a specific percentage of the total amount of loan.
What is the definition of lender or creditor? ›
A creditor or lender is a party (e.g., person, organization, company, or government) that has a claim on the services of a second party. It is a person or institution to whom money is owed.
Why is a lender important? ›
One of the main reasons that lenders are better than banks for a mortgage is that they offer a more flexible and personalized approach to lending. Lenders typically work with a variety of different banks and financial institutions to find the best mortgage products for their clients.
Understanding How Borrowing (and Lending) Works
Usually, lenders are reimbursed by ongoing, monthly payments made by the borrower until the total amount owed is received. In return for lending the money, the lender charges the borrower a percentage of the amount borrowed, which is known as an interest rate.
What are the 3 C's of lending? ›
Character, capital (or collateral), and capacity make up the three C's of credit. Credit history, sufficient finances for repayment, and collateral are all factors in establishing credit. A person's character is based on their ability to pay their bills on time, which includes their past payments.
What are the lenders also known as? ›
Credit is extended by a creditor, who is also known as a lender. Credit can be of two types: formal and informal. Credit is lent to a debtor, who is also known as a borrower.
What are the three most common types of loans? ›
Grace Enfield, Content Writer. Three common types of loans are personal loans, auto loans, and mortgages. Most people will buy a home with a mortgage and purchase a new or used car with an auto loan, and more than 1 in 6 Americans had a personal loan in Q1 2023.
What is the classification of a loan? ›
A loan classification system is an essential part of a bank's credit risk assessment and valuation process–-a process that classifies loans and groups of loans having similar credit risk characteristics, according to the level of risk posed.
What is the basic definition of a loan? ›
Key Terms. Loan. A loan is when money is given to one party in exchange for repayment of the loan principal, plus interest. A loan may or may not be secured by collateral and loan options and interest rates depend on the prospective borrower's income, credit score, and debt levels.
How long does it take for a lender to make a decision? ›
Some lenders may take 1 - 2- days, others may take as long as a few months to give their final approval. The delay could be due to the borrower's financial situation, or just the business of the market and the lender.
How long does a lender have to make a decision? ›
1. Timing of notice - when an application is complete. Once a creditor has obtained all the information it normally considers in making a credit decision, the application is complete and the creditor has 30 days in which to notify the applicant of the credit decision.
How do lenders operate? ›
Key Takeaways
A lender is an individual, a public or private group, or a financial institution that makes funds available to a person or business with the expectation that the funds will be repaid. Repayment includes the payment of any interest or fees.
Who makes the final decision on a loan? ›
So, when you apply for a mortgage or auto loan, an underwriter will determine if you qualify for financing. The goal is to establish if a loan is safe for all parties involved: you as the borrower and the lender. Loan underwriters review information such as your income, credit score, debt-income ratio and other assets.
