A loan is money that a borrower receives now and agrees to pay back later. Loans matter because they help people and businesses afford things they cannot pay for all at once, such as equipment, education, inventory, or a building. For entrepreneurs, a loan can provide the startup money needed to launch or grow a business.
The important tradeoff is that borrowed money usually costs extra because of interest.
Key Facts
- Principal is the original amount borrowed.
- Interest is the cost of borrowing money, usually written as a percent.
- Simple interest formula: I = PRT, where P is principal, R is annual interest rate, and T is time in years.
- Total amount repaid with simple interest: A = P + I.
- A loan payment often includes both principal repayment and interest.
- A lender takes risk when giving a loan, so credit history, income, collateral, and business plans can affect approval.
Vocabulary
- Loan
- A loan is money borrowed from a lender that must be paid back, usually with interest.
- Borrower
- A borrower is the person, business, or organization that receives money and promises to repay it.
- Lender
- A lender is the person, bank, or organization that provides money to a borrower.
- Principal
- Principal is the original amount of money borrowed before interest is added.
- Interest Rate
- An interest rate is the percentage used to calculate the cost of borrowing money over time.
Common Mistakes to Avoid
- Confusing principal with total repayment is wrong because principal is only the starting amount borrowed, while total repayment includes interest and sometimes fees.
- Ignoring the interest rate is wrong because even a small percentage can add a large cost when the loan lasts for many months or years.
- Assuming all loans have the same cost is wrong because loan terms, fees, interest rates, and repayment schedules can be very different.
- Borrowing without a repayment plan is wrong because missed payments can create extra fees, damage credit, and make future borrowing harder.
Practice Questions
- 1 A student entrepreneur borrows $500 for one year at a simple annual interest rate of 8%. How much interest will they pay, and what is the total amount repaid?
- 2 A small business borrows $2,000 at 6% simple interest for 3 years. Use I = PRT to calculate the interest, then find the total repayment amount.
- 3 A business owner can buy supplies slowly using savings or borrow money to buy all supplies now. Explain one possible benefit and one possible risk of choosing the loan.