Loan definition

Debt Term

A loan (noun) provides money from one party to another with the expectation that the money will be repaid over time, usually with interest.

More broadly, an asset can be loaned (verb) from one party to another with the expectation that the asset will be returned in the future. A public library loans books to its members.

There is usually an agreement between the lender providing the money and the borrower receiving the money. That agreement specifies terms such as the frequency of repayment, the interest rate and how it will be calculated, and what happens if repayment doesn’t occur according to the terms. If you have a friends and family loan, make sure you have a written agreement!

Loans typically start with one big payment from lender to borrower, followed by lots of smaller payments from borrower back to lender. In this respect a loan differs from a line of credit or a credit card, in which the money goes back and forth on a more dynamic basis.

The terms loan, debt and note are used in different contexts in ways that may seem confusing. For example:

  • A mortgage is a type of loan, but legally a promissory note specifies the loan terms while the mortgage document specifies the property securing the loan.
  • In some contexts a note specifies a type of loan in which no principal is repaid until the end of the loan period, and sometimes no interest either, including convertible notes for young companies and Senior Notes for very large companies.
  • A convertible note (a legal document) creates convertible debt (a more general way of discussing the type of financing).
  • This blog post from Legal Templates differentiates IOUs, Promissory Notes and Loan Agreements, although it’s not clear if anyone else uses this distinction based on the types of terms in the agreements.

Don Gooding

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