How Do Bank Loans Work?
Lender banks follow this basic process in extending financial loans to borrowers
The Borrower Applies for a Loan
To get a bank loan process started, a borrower usually approaches the bank and submits a formal loan application. The application may be taken in several different ways (in person at a bank branch, online, or even over the phone), but it always contains some very key information. To process a loan, the bank requires--at a minimum--the borrower's name, address, employer and employment history, current income, outstanding obligations and some piece of identifying information like a driver's license number. Bank loan applications also require a valid social security number, as the number will be used to verify the applicant's information and perform a credit check with at least one major credit bureau.
The Bank Evaluates the Loan
Once the application is received, bank loan officers carefully evaluate the application data to determine whether the applicant is likely to repay the loan. Some banks use advanced automated programs that perform electronic evaluations and instantly return a decision to approve or decline the application. Other banks, as is more common in small communities or personal banking situations, assign a loan officer to manually evaluate the information on the application and determine whether the bank should take a risk on the customer. If the bank decides that the applicant is not likely to repay the loan, it issues a "declined" status and notifies the applicant that the process has ended. If it deems the borrower likely to repay, it approves the application and begins to close the loan.
The Bank Closes and Funds the Loan
If the loan application is approved, the bank calculates the borrower's monthly repayment amount. This amount must be high enough to cover the total principal amount plus the bank's interest. The applicant must accept the payment amount and sign paperwork indicating that the amount will be repaid. The bank then funds the loan by issuing a check or crediting the borrower's bank account. Although repayment plans vary, the borrower generally begins making regular monthly payments starting two months after the loan is closed.
The Bank May Sell the Loan
Although many banks close the loan and collect payments in order to increase profits, some financial institutions sell the loans to investors to recoup their funds more quickly. The banks may sell the loans to a single investor or to a group of investors (in small portions of the loan amount known as "securities"), and distribute payments to the investors as funds are received from the borrower. This process creates profits for the bank and the investor, as institutions that sell securities offer them at a price higher than their invested principal but lower than the amount of the total to be repaid. In many cases, this process is completely transparent to the investor, as regular monthly payments are still remitted to the bank that issued the loan.