What Is a Purchase Loan?

Kathy Heydasch

A purchase loan is any amount of money that is loaned to a borrower to purchase something. Common purchase loans include those for homes, cars and boats, although a purchase loan can be for anything. One can expect to put up some form of collateral for major purchases in lieu of or in addition to background credit checks and a personal guarantee.

A person with a poor credit history is unlikely to be approved for a purchase loan.
A person with a poor credit history is unlikely to be approved for a purchase loan.

When one needs to make a purchase and can not afford to spend the money for it, he or she may decide to approach a lender and borrow the money for the purchase. A lender can be a friend or co-worker, or a professional loan officer at a bank or other financial institution. The lender will then decide, based on the debtor's personal information, whether or not to grant the money for the purchase.

A contract should be drawn up for any purchase loan, even if it is among friends or family members. A contract protects the interests of both parties. The creditor wants to make sure there are stipulations for re-payment, and the debtor wants to make sure the money is guaranteed to come through and that no terms of the agreement will change once the purchase is made. A typical contract for a purchase loan includes the amount of money being loaned, the purpose for the loan, any interest payments the debtor will pay the creditor, and the term of the loan.

If the creditor is a bank or other financial institution, one can expect a background credit check. There are three major credit reporting agencies and one institution which produces an actual credit score, called a FICO score. If one has borrowed money in the past from a financial agency which reports to one of the three credit bureaus, there is a record of all details of the loan, including whether it was paid back and whether all payments were made on time. A person with a poor credit history is unlikely to be approved for the purchase loan, or may suffer much higher interest rates if the loan is made.

A purchase loan can build credit as well. If a person has no credit history, he or she may want to take out a purchase loan, make all the payments on time, and thus help build a credit history. This is only advisable if the debtor is able to make the payments in full and on time. Otherwise, the process will backfire, and will be reflected negatively on his or her credit report.

This type of loan is different from credit cards in that credit cards are revolving debt. This means that the outstanding balance on the loan does not have to be paid in full each month and only minimum payments are required. Revolving debt can carry on for months or years with no fixed end of the loan. A purchase loan typically has fixed payments that reduce the principal every month, and it has a set end date when the loan will be satisfied in full.

Purchase loans can vary in the amount of interest they charge. This is mostly based on a person's credit history, but in some cases, a debtor can shop around for more ideal interest rates. A bank or other financial institution must remain competitive with its rates, but it also wants to make the most money possible from the transaction.

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