Interest Rate And Loan Guarantee

Applying for a loan is one of the last options a person may choose amidst difficult financial situations

. However, many Americans end up in debt just to meet necessary expenses that are eventually not covered by their budget. This is also their means of adjusting to sudden inflation.

Loans have been widely used because of the mushrooming of many lending companies. In the past three years, since the beginning of the recession, many households have been found with increasing debt rate. Lending companies have served as avenues for their survival. They have provided instant cash advances for different sectors of the society.

The growth of a lending business is based on two things: interest rate and loan guarantee. The interest rate is a fixed amount added to the total loan amount, while the loan guarantee refers to the collateral in times of default. Default happens when the borrower is not able to return the full amount plus the interest rate on the due date. The loan guarantee is adopted to keep the financial reputation between the lender and the borrower.

Interest rates and loan guarantees are adopted to protect the lender from market failure. Market failure happens when investment circulation is not efficient because of the failure of borrowers to pay for loans on time. With interest rate rising to a determined scale, a borrower will be forced to pay on time to avoid increasing debt. This is very effective with small loans like payday loans.

On the other hand, a loan guarantee is an assurance that if the borrower fails to pay or is in default, there is definite collateral of the same convertible value. The collateral is usually a piece of property or real estate. This is stipulated in a contract or loan agreement, confirmed by a government agency specializing in property, and commonly witnessed by a notary public. For payday loans, which normally involve small amounts of money, the loan guarantee is based on the accumulated interest rate.

Defaults and market failures seldom happen in microloans like payday loans. The implementation of loan guarantees and relatively high interest rates usually takes place in big business loans, where more financially-capable parties are involved. However, market failures in this kind of loan usually results in bankruptcies that affect even the small markets.

by: Sofia Britts

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