General information about borrowing money

Borrowing money is a form of loan in which a sum of money is granted by the lender to a borrower. According to the terms of the loan (§§ 488 ff. BGB), borrowing is only possible for temporary use within a previously agreed framework. The borrower is therefore obliged to return the monetary debt to the lender when it falls due.

Furthermore, the lender has the option to charge an agreed interest for the duration of the loan. For this, an agreement between the parties must first be reached. The amount of money, the period of the loan and the level of interest are regulated in a written or oral contract.

Obligations when borrowing money

Unless individual conditions have been agreed, the borrower is obliged to pay the interest after the end of each full year and finally with the last instalment. In addition to setting the interest rate, the lender may also charge an additional fee for the loan. In both cases this is referred to as a reciprocal (synallagmatic) contract.

A gratuitous loan, by contrast, describes an interest- and fee-free contract that usually takes place between relatives and acquaintances. Repayment therefore only covers the amount of money borrowed. If the time of repayment is not determined, maturity can only be triggered by a notice of termination from one of the parties involved. In principle the notice period is set to at least three months.

An early termination is also possible if the term of the loan has already been agreed. In this case the statutory regulations (§§ 488 ff. BGB) and the provisions of the contract at the time the loan was concluded apply.

Seven types of borrowing

In a market economy, many variants and models of borrowing are distinguished. These are generally divided into seven types.

1. A large group includes the "bullet loan" (endfällige Geldleihe). Here the borrowed capital is only repaid after a fixed term or upon termination. During the term only the interest due is paid to the lender.
2. For an "annuity loan" (Annuitätenkredit), the instalments are due at regular intervals. They remain the same amount and consist of both interest and repayment of the loan.
3. A similar concept applies to the "repayment loan" (Tilgungskredit). Here it should be noted that the level of interest continuously decreases, resulting in a reduction of the instalments.
4. In an "instalment loan" (Ratenkredit), repayment and interest are combined into a single amount in advance and then paid off in uniform instalments.
5. If, in addition to the instalments, a profit share for the lender is agreed by the parties, this is called a "participating loan" (partiarische Geldleihe). A fixed share of the profit generated by the use of the capital is then handed over.
6. In contrast, an "on-demand credit" (Abrufkredit) is a less common form of borrowing. This is offered by banks to give their customers a fixed credit limit that can be used without an additional contract.
7. A "revolving loan" (rollierende Geldleihe) finally describes a concept in which flexible repayment of instalments and interest is possible.

The costs of borrowing money

When looking for a cheap loan, the effective interest rate plays an important role as a cost indicator. It includes all significant costs associated with taking out the loan. In finance, this calculated value is expressed as an effective annual interest rate as a percentage of the disbursed amount.

The calculated effective interest rate must be stated as binding when the loan is granted and is therefore suitable as a comparison value for alternative offers. Additionally, the effective interest rate has the advantage that all inflows and outflows with their respective terms can be overviewed.

The disbursements generally include the amounts of the loan that are handed over to the borrower. The most important inflows, by contrast, are all accrued interest, repayments and bank fees. Often the costs of insurance and residual debt insurance are also added. From these inflows and outflows the effective interest rate can then be determined exactly using uniform calculation formulas.

Securities when borrowing money

In addition to the level of the effective interest rate, securing the loan is also given great importance. One of the most common loan securities is the transfer of ownership of valuables as security (Sicherungsübereignung von Wertgegenständen). In this case the borrower usually remains in immediate possession of the object but transfers ownership to the lender if repayment of the loan cannot be made. In many cases a third-party guarantee (Bürgschaft) may alternatively be required.

If the borrower becomes unable to pay, the debt is then transferred to the guarantor under the terms of the contract. Loan security can also be based on the assignment of claims or the transfer of ownership of real estate as security.

From application to repayment

In principle, a loan can already arise through a spontaneous transfer of assets between two private individuals. Repayment is then governed by the orally or written agreed conditions. For loans between private individuals, bureaucratic hurdles such as a Schufa check are often waived. Private loans and private credits also offer advantages beyond avoiding Schufa: there are usually no fees and loan approval can happen more quickly. However, interest rates are often higher and loans within a family or among friends often create unwanted dependencies.

In the financial industry, several steps must typically be completed before a loan can be granted, especially for large amounts. The loan process begins with the customer's loan application, followed by mutual negotiation of the terms. Once an agreement is reached, the customer's credit capacity and creditworthiness are reviewed. After successful verification and evaluation of the offered loan securities, the lender issues a loan commitment.

The terms of the loan are then confirmed with a legal contract. Finally, the borrower fulfils the loan securities so that the funds can be made available. The provided capital is generally not subject to any restrictions. The borrower can therefore freely dispose of the amount of money without having to justify possible expenditures.

Exceptions only apply if the purpose of the loan has already been specified in the contract. According to the contractual framework, the customer is subsequently obliged to repay the loan. After the last instalment is paid, the loan contract is fulfilled. Afterwards, an upgrade or downgrade of the creditworthiness of both parties may occur. State and private credit reporting agencies play an important role in this.