Elements of a loan

This section contains the main elements of a loan, which are the following:

• Contracting parties: The most prominent element of a loan is that of the contracting parties. There are two minimum players for any loan: The lender (the financial institution that lends the money) and the borrower (natural or legal person who receives the money from the financial institution, forcing himself to return it along with the payment of interest). Incidentally, a guarantor may also be involved in a loan. Particularly in the case of personal loans, the role of the guarantor is of special interest, insofar as the latter undertakes to be liable towards the financial institution for possible default by the borrower with its own assets. The guarantor may be bound to less, but not more. than the principal debtor.
• Loan amount: The determination of the loan amount is achieved through an agreement between the parties based on the applicant’s repayment capacity, on the one hand, and the collateral value of the asset, on the other hand. To this end, the lender must carefully assess the borrower’s ability to pay, represented by their ordinary and usual income, and it can be provided for collateral. It is common that the resulting instalment of the loan that is requested does not exceed one third of the income of the borrower.
• Term: It is a fundamental element in loans. Logically, it may be difficult for the borrower to return the entire borrowed amount increased with interest at once, so the repayment of the principal and the gradual payment of interest are distributed over time by making multiple payments to the lender.

There is an inverse relationship between the number of instalments and the amount of each instalment, that is, the higher the number of payments the amount of the instalment decreases.

• Amortization method: There are different amortization methods, although one of the most widespread is the so-called French amortization method. Its main characteristic is that the amount that must be paid for the sum of amortized capital and interest on each instalment does not vary, so the amount remains constant (as long as the interest rate remains constant, that is, throughout the term of fixed-rate loans, or in each revision period in variable-rate loans).

This means that, of the money paid by the borrower over time, the amount destined to the payment of interests decreases and the part allocated to repay the capital increases, since interests are calculated based on the outstanding capital.

• Supporting documentation: In most cases, these are standard-form contracts, insofar as they are not individually negotiated by the client and the financial institution.

For this reason, two types of clauses or conditions can be distinguished within loan contracts: General clauses (those that the financial institution stipulates for the generality of customers in a transaction with identical characteristics) and special or individual clauses (those that arise, for each specific case, from the negotiation between the client and the financial institution, referring mostly to the economic and time-dependent terms: Loan amount, repayment period, interest rate, etc.). The involvement of specially qualified officials is usually mandatory, such as Notaries Public and registrars, who must ensure compliance with the law, especially for the benefit of the consumer, avoiding possible abuses by the lender.

• Collateral: Two types of guarantees are distinguished:
  • Personal guarantee: The whole of the assets of the borrower are liable for the loan in a general way.

Especially in the case of personal loans, the role of guarantors-sureties is of special relevance, insofar as they undertake to be liable towards the financial institution for possible default by the borrower with their own assets.

• Real asset as a guarantee: In this case, a specific asset or right is subject to the payment of the loan, in the event that the borrower cannot meet the obligations undertaken.
• Rate of interest: The interest rate is the percentage that is applied to the outstanding principal of a loan to calculate the interest that must be paid. Interest represents the price the borrower pays the lender for the money they receive.

The interest rate can be fixed for the entire life of the loan or variable.

In the first case, the borrower will pay a predefined percentage, calculated on the outstanding capital, during the entire term of the contract (for example, 5% or 8% annual); in the second, the percentage is revised periodically, every six months, every year or within the period, lower or higher, agreed by the parties.

The variable rate is made up of two elements, which are the reference rate and the spread.

The reference rate fluctuates up or down, and will increase with the agreed spread, so the clients will only know how much they will pay in each interest period (monthly, quarterly, semi-annually, annually, etc.), but not in successive periods.

If the reference rate goes up, the loan will become more expensive, but if it goes down, the borrower will benefit from this circumstance by paying lower repayment instalments.

• Commissions: Any commission relates to a service actually provided to the client for services supplied for in the contract. Various commissions must be paid by the borrower at the beginning or the end of the transaction:
  • The arrangement fee remunerates the bank for arrangements and analysis that it must carry out to verify its client’s solvency and the terms of the requested transaction. It is usually charged only if the loan is granted, as a percentage of the amount requested.
  • The origination fee remunerates the bank for the procedures that it must carry out corresponding to the formalization and making available to the client of the funds loaned. This fee is usually a percentage of the amount that is loaned and it is usually paid at once, when the transaction is concluded.
  • The prepayment fee is a compensation for the interest risk taken. That is, it compensates the institution for what it ceases to earn —loss of earnings— due to ceasing to receive interest on the outstanding principal of the loan.
• Expenses: The expenses relate to services provided by an external company, not related to the financial institution and some of them are borne by the borrower. The most frequent are the following:
  • For the appraisal of the asset given as collateral.
  • Those necessary for the verification of the existence of other charges by consulting the Property Registry.
  • Notary fees, provided that the notary public takes part in the formalization, which can happen in the case of some personal loans, and in every mortgage loan.
  • The registration fees, when the property registrar is involved to register the ownership of the acquired asset or the granting of the mortgage.
  • The expenses for the procedures that a third party develops on behalf of the borrower, such as those for the filing of documentation before the Property Registry, or the payment of accrued taxes.

A relevant expense for the borrower is the one consisting in the taking out of an insurance. In general, the only mandatory insurance in the case of home mortgages is fire insurance, which does not necessarily have to be taken out through the institution granting the loan.

• The tax impact: Finally, the tax implications that a loan transaction may have, especially in the case of a mortgage, must also be considered. Thus, it is necessary to quantify the possible tax burden associated with the credit transaction, both upon its conclusion and its completion. Likewise, it is necessary to analyse if the interests paid by the borrower can be deductible in the income tax or if there is any deduction linked to the total payments made as amortization and interest on loans, as can happen, in certain cases, in relation with the acquisition of the main residence.