Posts Tagged ‘debt’
What is a Loan?
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower. The borrower initially receives an amount of money from the lender, which they pay back, usually but not always in regular instalments, to the lender. This service is generally provided at a cost, referred to as interest on the debt.
Acting as a provider of loans is one of the principal task for financial institutions. For banks loans are generally funded by deposits. For other institutions issuing of debt contracts, such as bonds is a typical source of funding.
Other types of debt include mortgages, credit card debt, bonds, and lines of credit. A mortgage is a very common type of debt instrument, used by many individuals to purchase housing. In this arrangement, the money is used to purchase the property. The bank, however, is given the title to the house until the mortgage is paid off in full. If the borrower defaults on the loan, the bank can reposess the house and sell it, to get their money back.
The abuse in the granting of loans is known as predatory lending. It usually involves granting a loan in order to put the borrower in a position that one can gain advantage over them.
Related Blogs
- Related Blogs on debt
- Non Profit Debt Consolidators | Little Steps Comics Maniac
- DebtGoal » Blog Archive » Advice, Tips, and Techniques to …
- Distressed Debt Specialists See “Bonanza Year” in 2009 - A.E. Feldman
- More People Look For Credit Card Debt Management After The Holiday …
- Related Blogs on loan
- Do You Know How Much You Can Borrow? Bay Area Loan Limits Much …
- Goldman Sachs Predicts Loan Losses Will Top $2 Trillion …
What is a Standard of Deferred Payment?
A standard of deferred payment is the accepted way (in a given market) to settle a debt. For example, while the gold standard reigned, gold or any currency convertible to gold at a fixed rate constituted such a standard. As of 2003, the US dollar and the euro are the most generally accepted standards for international settlements.
However, for certain kinds of transactions (such as for illegal goods like narcotics or weapons), gold or diamonds may be preferred as the medium of exchange — there being no recourse in case of counterfeit currency being used — and there is rarely any deferral of payment: if there is, it will most likely be stated in dollars.
This is distinct from the store of value function which relates to the saving, storing, and retrieval of value, and from the unit of account function which requires fungibility so accounts in any amount can be readily settled. It is also distinct from the medium of exchange function which requires durability when used in trade, and a minimum of opportunity to cheat others — as the diamond or gold example makes obvious.
When currency is stable, money can serve all four functions. When it isn’t, or when complex and volatile forms of financial capital are involved, it becomes important to identify a single standard of deferred payment to avoid cheating by selecting a denominator of debt that one knows is dropping in value.
Historically, there have been many times when creditors have had to hide from debtors to avoid being paid off in near worthless currency.
Time-based currency such as Ithaca Hours establishes fixed amounts of human labour as the only standard of deferred payment.
What is Debt?
Debt is that which is owed. People or organisations often enter into agreements to borrow something. Both parties must agree on some standard of deferred payment, most usually a sum of money denominated as units of a currency, but sometimes a like good. For instance, one may borrow shares, in which case, one may pay for them later with the shares, plus a premium for the borrowing privilege, or the sum of money required to buy them in the market at that time.
There are numerous types of debt obligations. They include loans, bonds, mortgages, promisary notes, and debentures. It is very common to borrow large sums for major purchases, such as a mortgage, and pay it back with an agreed premium interest rate over time, or all at once at a later date. The amount of money outstanding is usually called a debt. The debt will increase through time if it is not repaid faster than it grows. In some systems of economics this is usury, in others, this refers only to the excessive rate of interest, in excess of a reasonable profit for the risk accepted.
As noted above, debt is normally denominated in a particular monetary currency, and so changes in the valuation of that currency can change the effective size of the debt. This can happen due to inflation or deflation, so it can happen even though the borrower and the lender are using the same currency. Thus it is important to agree on standards of deferred payment in advance, so that a degree of fluctuation will also be agreed as acceptable. It is for instance common to agree to “US dollar denominated” debt.
The form of debt involved in banking gives rise to a large proportion of the money in most industrialised nations (see money and credit money for a discussion of this). There is therefore a complex relationship between inflation, deflation, the money supply, and debt. The store of value represented by the entire economy of the industrialized nation itself, and the state’s ability to levy tax on it, acts to the foreign holder of debt as a guarantee of repayment, since industrial goods are in high demand in many places worldwide.
Lendings to stable financial entities such as large companies or governments are often termed “risk free” or “low risk” and made at a so-called “risk free interest rate”. This is because the debt and interest are highly likely to be repaid. However, if the value of a currency has changed in the meantime, the purchasing power of the money repaid may vary considerably from that which was expected at the commencement of the loan. So from a practical investment point of view, there is still considerable risk attached to “risk free” or “low risk” lendings, even though in terms of the amount of a currency that will be returned there may not be. The Bank for International Settlements is an entity that sets rules to define what loans qualify as “risk free” or not. It is a very powerful institution, formed by the Bretton Woods agreements, which has had a pivotal position in central banking since 1947 when it opened.