Borrowing and Loans

A loan is money that you borrow from a bank or financial institution with a legal promise to pay it back later. Most people don't have enough cash sitting in their pockets to buy 'big-ticket' items all at once. Loans allow people to use the bank's money now to improve their lives or invest in their future. Common reasons for loans include buying a home (this specific loan is called a mortgage), purchasing a car, or paying for college tuition. Because the bank is taking a risk by letting you use their money, they usually charge a fee called interest, but the core of the deal is the agreement to return the original amount.

When you talk about loans, the most important number is the principal. The principal is the original amount of money you borrow before any fees or interest are added. For example, if you sign a paper to borrow $5,000$ to buy a used motorcycle, your principal is exactly $5,000$. As you make payments over time, the principal amount goes down until it reaches $0$. Understanding the principal helps you know exactly how much 'debt' you have taken on.

When you take out a loan, you become a borrower. This comes with serious responsibilities. First, you must follow a repayment schedule, which is a plan showing when you will make payments (usually once a month). Second, you are legally obligated to pay back the full amount. If a borrower stops paying, it is called defaulting. Defaulting is serious because it makes banks lose trust in you, which means they won't lend you money in the future when you might really need it for an emergency or a new home.