Credit – banknotes, material assets that the lender provides for a specific (agreed) period for use by the borrower – at interest.
Many citizens and organizations prefer to take out loans from microfinance organizations or banks to resolve their financial issues, overcome difficulties in this regard, or in order to temporarily improve their well-being. In general, anyone can take money in cash or receive it on a card for their own purposes. There are conditions: interest rate, and the lender also sets the repayment period of the debt. Everything is recorded by software for creditors.
The lender is usually a financial institution, corporation, or government that advances a certain amount of money to the borrower. The latter agrees to the proposed set of conditions: this includes all expenses of the financial plan, interest, loan repayment period, and other nuances.
If banks do not lend money, you can contact a microfinance organization, a loan donor, or a pawnshop.
What type of loan is most common?
In modern conditions, this is a consumer loan. Today it is becoming increasingly widespread and is important for creating demand for durable goods. Banks provide this type of lending to consumers (individuals)-borrowers for the purchase of consumer products, ordering services, work), that is, to satisfy needs that are not related to independent, entrepreneurial, professional activities or the performance of the duties of an employee.
Private lenders: algorithm for raising capital
To issue loans, you need capital. How is it attracted to private lenders?
This happens when debt instruments are involved. This “technique” is known as debt financing. This is a common technique for private lenders to obtain additional financing to operate their business.
Earning money on loans: the essence of the issue
In a matching business, the lender provides cash to the borrower. The latter pays interest.
The borrower undertakes to repay the funds received on credit at an inflated interest rate (compared to the amount paid to him). The banking institution profits from the difference in interest rate spread. That is, this is the difference in the interest amount between what was paid to the borrower and what was received from him.
Also, for providing the ordered amount, the borrower pays established commissions. There is also a commission for other expenses of the lender. As the borrower repays the loan amount, the lender receives a profit from the interest. The latter has more capital available for other loans.
About private lenders
Private lenders can make significant profits by charging higher interest rates. Such lenders also control their investments, determine the terms of the loan, and the due diligence procedure. This is possible thanks to software for lenders. Since private loans are typically secured by real estate, lenders have a tangible asset to support their investment.
About Mortgage Lenders
They can make money through a variety of methods, including loan origination fees, servicing fees, discount points, yield spread premiums, closing costs, and mortgage-backed security (MBS).
For example, the yield spread is the difference between the rate a lender pays for finance borrowed from larger banking institutions and the rate it charges the borrower.
The closing fee (when the lender can make money) includes fees for application, processing, underwriting, locking the loan, and other fees.
A valuable asset backed by a mortgage provides an opportunity for lenders to profit from the sale of loans. You can also earn money by servicing issued loans.
Bank lenders
Banking institutions are essentially lenders. As a rule, they earn money by borrowing money from investors and compensating them at a certain interest rate. Banks provide finance to borrowers by charging them an inflated interest rate, making money on the difference in the latter.
In general, the banking business of generating finance using software for lenders can be divided into the following components: income from interest (actually, lending), in the capital markets and from commissions.
Interest income of banks
This is the main method of earning finance for many commercial banks. The algorithm ends with taking money from those investors who do not currently need it. In exchange for the deposited funds, depositors are given compensation – a set interest rate. Also, depositors receive guarantees from the bank about the safety of their own funds.
Next, the bank has the opportunity to issue invested funds to those borrowers who need them here and now. A condition for lending for the borrower is the obligation to repay borrowed funds at an inflated interest rate (compared to that paid to depositors). Thus, the bank makes money on the interest rate spread (with the help of software for lenders) – the difference between the interest paid and received.
Interest rates: their importance
It is obvious that the interest rate is important for the bank as the main source of income. This is the amount of debt as a percentage of the principal (the one borrowed or deposited into the account).
In the long term, such rates are set under the pressure of supply and demand. Great demand for debt instruments in the long term leads to higher prices and lower interest rates. And on the contrary, a small demand for debt instruments in the long term causes a decrease in prices and an increase in interest rates.
In the short term, these rates are set by central banking institutions, which regulate their level to maintain a healthy economy and control inflation.
Earnings of banks on loans with zero interest rates
Even in this way (on loans with an interest rate of 0) banks have the opportunity to earn money. These loans also charge interest, despite their name. The borrower simply does not pay this interest if he makes payments on time before the debt is repaid.
Financial institutions’ calculation in this case is based on the percentage of borrowers who either miss payments or default on their obligations. The bank makes money on these loans.
About risks
The credit campaign is beneficial for banks. And this is obvious. A money lending business, when carefully managed, can generate large profits from both the interest and fees charged on loans. Banks benefit by paying depositors low interest rates and being able to charge borrowers higher rates.
But it should be understood that this type of business is fraught with significant risks. Banks should manage credit risk — the likelihood that a borrower will fail to meet its obligations. This also includes the default of those who took out a loan. Changes in market conditions cannot be ruled out, which could significantly affect the demand for loans.