How Loans Work
Loans are an inseparable part of the modern economy. They make it possible to finance all kinds of needs – from buying a flat, through buying a car, to making the dream of running your own business come true. Thanks to a loan, you can have something before you have even saved up for it. Like any tool, a loan can be useful, but it can also do harm. That is why, before you find out which bank is best to take a loan from, you first need to understand how loans work.
A loan is a contract between a borrower and a financial institution, most often a bank, in which the borrower commits to repaying the borrowed amount together with interest within a set period. There is no point in asking which bank is best to take a loan from if you have not pinned down exactly what it is for. Banks offer a wide range of loan products and each bank approaches assessing a client differently.
To grant a loan, banks calculate creditworthiness and a credit score, drawing on credit history. A solid grasp of these concepts can significantly improve your chances of securing favourable loan terms, for example on a loan to build a house.
In this chapter of the Financial Primer you will not, admittedly, find a direct answer to the question of which bank is best to take a loan from, but you will find something far more important: you will understand how loans work. As a result you will be able to prepare for choosing the most advantageous loan offer, the one that best matches your needs and your financial means. So how about it – worth spending a few minutes reading?
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Loan versus borrowing
For many people, a bank loan (kredyt) and a borrowing arrangement (pozyczka) are synonyms. At first glance they may indeed seem to be the same thing, but the differences between them are significant. So what is a kredyt and what is a pozyczka? A kredyt (bank loan) is a financial obligation granted exclusively by banks, in line with banking law and taking the required reserve into account. A pozyczka (borrowing) consists of making a specific sum of money belonging to the lender available to the borrower.
Still complicated? Then here it is as simply as possible: a pozyczka is lending out money that belongs to a given company, while a kredyt is making available to someone money that other people have deposited at the bank. A lending company lends its own money; a bank makes available the money of its clients.
A bank loan is a form of money creation, which means that by granting a loan the bank introduces new money into circulation. Borrowing arrangements can be provided by a range of entities, including lending companies, financial institutions, and even you or me. Only banks can grant bank loans.
Loans are often purpose-tied, which means banks may require the funds to be used for a specific purpose, for example buying a flat (a mortgage), a car (a car loan), or repaying other loans (a consolidation loan). Borrowing arrangements, on the other hand, can be more flexible, and the borrower may use the funds received however they wish.
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How does a bank grant a loan?
The process of granting a loan may seem complicated, but in reality it rests on a few key steps. The first of them is taking in deposits from clients.
When you deposit money in your account or in a savings deposit, the bank can use those funds to grant loans to other clients. But do not worry, the bank will not take the money out of your account to grant a home loan to someone else. Instead, it will conjure it up out of nowhere. Sorry, I meant to say: it will carry out money creation.
When a bank grants a loan, it creates new money in the economy. Imagine the bank grants you a loan for a flat. The loan amount is transferred to the seller’s account. And now the question is: where did the bank transfer that money from? The savings deposits and the balances on other clients’ accounts are untouched. The bank did not use its own money. So from which account did the person selling the flat receive the money? From none at all. By granting you a loan for the flat, the bank „created” that money. You could say it conjured it up out of nowhere. Although that money did not physically exist, it is now part of the economic circulation. This is exactly what we call money creation – banks create new money by granting loans.
Why are banks allowed to do this? It is all thanks to the required reserve. This is the rule that banks must hold only part of their deposits as a reserve, while they can use the rest of the funds to grant loans. Thanks to this system, banks can support the growth of the economy by granting loans not only for a home but also for investments, purchases or consumption, even though they do not hold that money themselves.
Creditworthiness versus credit history
There are three aspects banks take into account when deciding whether to grant a loan: creditworthiness, the credit score and credit history. How banks approach these matters often determines which bank is best to take a loan from.
Creditworthiness
Creditworthiness refers to a client’s current financial situation and their ability to repay the obligation taken on. The bank score is an assessment of socio-demographic characteristics. Credit history is the information gathered by BIK (Poland’s credit information bureau).
Banks determine creditworthiness by analysing income, expenses, the number of dependants and other obligations. A key indicator in this assessment is DTI (Debt-to-Income), which expresses the ratio of debt to income. If the DTI ratio is low, it means the client has a greater capacity to repay the loan. This boosts not only their chances of a positive decision from the bank but also the available loan amount.
DTI expresses the ratio of the instalments on all loans to the income earned. The smaller the loan instalment, the higher the borrowing capacity will be, which is why mortgage borrowing capacity is usually the highest. A mortgage is granted for a long period and its interest rate is low, which translates into a smaller monthly instalment and higher creditworthiness.
Credit history
Credit history is a record of earlier financial obligations and how they were repaid, registered by the Credit Information Bureau (BIK). It shows whether the client paid their obligations on time, whether they had delays in repayments or other problems related to loans. The better the credit history, the better.
Credit score
Credit history is often confused with the credit score. This is a points-based assessment of credit risk that takes into account everything the bank is able to learn about you. And where can it learn it from? Above all from the loan application, the BIK report and account statements.
The methods for calculating the score are strictly confidential. It is an open secret that the bank can assess literally anything, even the place and amount of cash withdrawn from an ATM or the brands of the shops where you do your shopping. In short, the score can have anything built into it that, in the view of a handful of bank employees, affects credit risk (that is, the risk that you will not repay the loan for your home or another purpose).
It is best to prepare for taking out a mortgage well in advance. It is best to start as early as a year before the planned property purchase, because building a credit history and score can take some time.
Secured versus unsecured loans
Secured and unsecured loans differ in how they are granted, in their cost and in the risk for the bank.
A secured loan is one that requires collateral in the form of assets, for example a property or a car. An example of a secured loan is a loan for a flat, where the collateral is the property being bought. Thanks to this the bank can be sure that, in the event of repayment problems, it can recover its money by selling the collateral. Secured loans are usually cheaper – a lower interest rate reflects the smaller risk for the bank. It is similar with purpose-tied loans (that is, loans for a specific purpose, e.g. a loan for a home). If the purpose of the loan is specifically defined, its interest rate will be lower, because the bank bears lower risk.
An unsecured loan does not require any assets as collateral. Examples of unsecured loans are credit cards and cash loans. Because the absence of collateral increases the risk for the bank, such loans usually carry a higher interest rate. This is how the bank offsets the potential risk of the client not repaying the loan.
The smaller the risk for the bank, the cheaper the loan. Banks prefer secured loans because they give them a greater sense of security and confidence that the funds will be recovered. With unsecured loans, banks have to rely solely on a bailiff to recover unpaid funds.
It is worth stressing that with a secured loan the bank does not become the owner of the flat or the car. You are the owner. The bank encumbers the item with a property right, such as a mortgage or a pledge, which would simplify enforcement in the event of non-repayment of the loan. Nonetheless, the bank may require you to take proper care of the item used as collateral, for example by buying third-party and comprehensive motor insurance or mortgage insurance.
Types of loans
On the financial market there are many types of loans, which differ from one another in their structure, cost and intended use. In this section we will look at the main types of loans, to help you choose the one that best matches your needs. I will show the most popular types of loans, such as a cash loan, an account overdraft, a credit card, a mortgage or a car loan.
Knowing the differences between the various types of loans, it will be easier for you to decide what you need and to work out which bank is best to take a loan from, one that will meet your expectations.
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Cash loan
A cash loan is one of the most popular forms of financing available on the market. It is an unsecured loan, which means it does not require owning a property and is available to a broad range of clients. It is advertised as a loan for any purpose, but that is not entirely true. It is a loan for any purpose unrelated to business activity or to repaying other obligations (that is what a consolidation loan is for). You can use it for a flat renovation, a holiday, buying a coffee machine or fulfilling a dream, but you cannot use it to pay off debts, put it towards growing a business or investing on the stock market.
A cash loan is flexible. The bank will ask what you want to use it for, but at the same time it gives you a great deal of freedom. The process of applying for a cash loan is usually simple and quick. Many banks offer the option of applying online, and a loan decision can be received within as little as a quarter of an hour – provided no additional documents are required.
The interest rate on cash loans is at an average level. It usually reaches twice the reference rate (the interest rate announced by the NBP, Poland’s central bank, which at the time of writing this chapter is 5.75%). It is more expensive than secured loans (such as a loan to build a house), but cheaper than an account overdraft or the interest rate on a credit card. And it is certainly cheaper than non-bank loans. If you use solutions of that kind, it is worth considering a consolidation loan, which will let you reduce their interest rate.
A major advantage is that, with regular income from an employment contract, the bank into which your salary is paid can prepare a pre-approved offer for you, that is, pre-calculated creditworthiness. In that case you will not have to provide an employment certificate, and you can get the loan within a few minutes of submitting the application.
As this is a very profitable form of loan from the bank’s perspective, banks outdo one another in advertising their offers. It is hard to say unequivocally which bank is best to take a cash loan from – the offers change like a kaleidoscope.
Account overdraft
An account overdraft is the colloquial name for a current account credit. The bank makes a credit line available to you, that is, it grants a loan that you can use to the extent that you need it. It is a fairly costly solution, although useful in certain circumstances; above all when your income is irregular.
You do not need to ask which bank is best to take a current account credit from; the answer is clear: where you have your bank account. As the name itself suggests, this is a loan linked to your current account (that is, your bank account).
How an account overdraft works is simple. The bank sets the maximum amount by which you can go below your account balance, based on your creditworthiness. How can you check your creditworthiness for free? I recommend starting with your bank’s website – in the case of an account overdraft, banks very often provide simple creditworthiness calculators. When the account balance drops below zero, the overdraft is triggered automatically, which allows you to keep making payments or withdrawing cash from an ATM.
Interest is charged only on the portion of the overdraft you have used, which does not mean that you do not pay for the unused funds (more on that shortly). The bank charges interest at a scheduled settlement time, usually at night.
The downside of this solution is the high interest rate, often around the maximum loan interest rate (roughly three times the reference rate). And as if that were not enough, there is also an annual fee for renewing the overdraft. Still not enough? Well yes, there is also a fee for not using the overdraft. A damnably expensive solution, to be used only when you really have to.
Credit Card
A credit card, although it is sometimes confused with a debit card, is a solution similar to a current account credit. All right, but how does a credit card differ from a debit card? Explaining the difference between a credit card and a debit card is trivial: a debit card is simply a card linked to your account, whereas a credit card has its own dedicated bank account, on which the bank has made a credit limit available.
A credit card has a huge advantage over a current account credit: it can be entirely free, thanks to the combination of an interest-free period and a waiver of the annual fee in exchange for a certain level of turnover. As you can see, a credit card versus a debit card is not only about differences but also about similarities. Very often, after all, the fees for a debit card also depend on turnover.
What is an interest-free period?
An interest-free period is the time during which no interest is charged on the amount of credit used. You buy something on credit, and the bank does not charge you for it. A good arrangement, is it not? Depending on when you pay for something with a credit card, the interest-free period will be from 27 to 56 days.
If the billing cycle of the credit card ends on the 10th of the month, and you make a transaction on 9 March, it will be included in the billing cycle ending on 10 March. You will have 26 days from the end of the billing cycle to repay the entire balance without interest being charged. If, however, you make the transaction on 11 March, the billing cycle will end on 10 April, and from that moment the bank will not charge interest for a further 26 days. That is, 30 + 26 = 56 days without interest.
Another difference between a credit card and a debit card is the safeguards. In the case of unauthorised transactions or problems with online purchases, recovering the money is usually easier and quicker. Another difference between a credit card and a debit card is the much more attractive loyalty programmes of the cashback type. This makes using a credit card not only convenient but also rewarding.
It is worth remembering, however, that a credit card is a loan, and a debit card is not. If the balance is not repaid on time, the interest can be high, and the costs of using the credit can quickly mount up. That is why it is important to use a credit card prudently, keeping your spending under control and regularly repaying the balance.
Car loan
A car loan is a popular form of financing the purchase of a vehicle, which allows the cost to be spread over convenient instalments. It is a secured loan, which means the car being bought serves as collateral for the bank. Thanks to this, car loans offer a lower interest rate than cash loans, because the risk for the bank is smaller.
A lower interest rate also means smaller profits for the bank. In this segment there is therefore not as much competition as with cash loans, so it is worth doing a thorough analysis of which bank is best to take a car loan from.
When you decide to take out a loan for a car, the bank usually requires a down payment, which amounts to between a few and a dozen or so per cent of the vehicle’s value. The repayment period of a car loan is usually from 2 to 7 years. A car loan can be used to buy both a new and a used vehicle.
Alternatives to a car loan
How to pay for a car in another way? Alternatives to a car loan are leasing and long-term rental. Leasing means that you rent the vehicle from a leasing company for a set period, and at the end you have the option to buy the car outright for a low amount.
With a loan for a car, you are the owner of the vehicle, and the bank establishes a registered pledge – something like a mortgage, only for a car. With leasing, however, you are not the owner. The car belongs to the leasing company, and you sort of rent it (although you have the right to buy it once the lease ends).
In terms of price it is hard to judge which is better. Leasing gives greater flexibility, because you set three parameters: the initial payment, the leasing instalment and the buyout. If you do not want to buy the car out, it is worth setting the buyout fee as high as possible – then the instalment will be lower, and leasing more cost-effective than a loan. If you do plan to buy it out, the price difference is small and may tip in favour of either solution.
There is also long-term rental: you pay a fixed monthly fee for the use of the vehicle, but you have no buyout option. The instalment is higher than with leasing or a loan, but a major advantage is that the lessor covers all the costs of third-party and comprehensive motor insurance, repairs, and so on. You only pay for the petrol. When you tally it all up, it turns out that rental is not actually much more expensive, and considerably more convenient.
Remember that when you take out a car loan, the bank obliges you to buy comprehensive motor insurance – just as compulsory insurance applies to a mortgage, the same is true for a car loan. The car must be insured so that its value is preserved and it can serve as collateral for the bank.
Mortgage
The bank can grant you a loan for a house or a flat. It is a loan secured by a mortgage, where the property being bought serves as collateral for the bank. Thanks to this, banks offer an attractive interest rate and a long repayment period, reaching even 30 years, which makes a mortgage one of the cheapest forms of financing large investments, and mortgage borrowing capacity is much higher than for other types of loans.
When deciding on a mortgage, it is worth using the help of an experienced credit expert, who will assist in finding the best offer on the market, tailored to your individual needs and financial means.
As a credit expert, I have broad knowledge of the various bank offers and of the requirements concerning mortgage borrowing capacity and the necessary documentation. My aim is to find for you the most advantageous loan terms, which will allow you to make the dream of your own house or flat come true.
A mortgage can be used not only to buy a new or used flat, but you can also take out a loan to build a house, or to renovate or modernise it. In the process of applying for a loan for a flat or a house, the bank examines not only your creditworthiness but also the purpose of the financing (that is, it values the property you are buying) and the collateral (usually the same property, but you can register the mortgage against another one that you already own).
Where to look for help in obtaining a mortgage?
Working with a credit intermediary brings many benefits. Starting with the fact that this is the best way to check your creditworthiness for free, through help in preparing the necessary documents, all the way to securing the best possible loan terms. My experience and knowledge of the financial market mean that the process of obtaining a mortgage becomes simpler and less stressful. And you get all of this for free, because credit intermediation costs nothing!
After just a short conversation with you I will know which bank is best to take a loan from in your case, I will help you prepare your applications, including to backup banks, and because I have the authorisation to process loan applications, I will accept those applications from you myself and pass them directly to the credit analysts. So if you are wondering which bank is best to take a mortgage from, or you have questions about the whole process, I encourage you to get in touch. I will gladly help you find the ideal solution that will let you carry out your housing plans.
Summary
Understanding what a loan is, how a credit card differs from a debit card and how loans work is essential for managing your finances consciously and making responsible decisions. With a knowledge of the basics of loans, you will be able to determine for yourself which bank is best to take a loan from.
Remember that loans, unlike borrowing arrangements, are granted exclusively by banks and constitute a form of money creation. The process of granting them rests on an analysis of the client’s creditworthiness, credit score and credit history.
Loans can be secured or unsecured, and purpose-tied or non-purpose-tied. The most common form of loan is the cash loan, granted for almost any purpose unrelated to business activity. An account overdraft provides quick access to additional funds – you can use them and repay them as needed. A credit card works in a similar way, with the difference that it can be a free solution if it is repaid regularly. Remember too that a credit card and a debit card are two different things.
The most popular purpose-tied loans are the car loan – for buying a car (its alternatives are leasing and long-term rental) – and the mortgage, that is, a loan for a house or a flat. There is also the consolidation loan, which is used to repay other loans and borrowing arrangements.
As an experienced credit expert, I can help you determine which bank is best to take a loan from, matched to your expectations. My experience and knowledge of the market will make it possible to find the best solutions for you effectively, as well as to support you in preparing the necessary documents.
If you need help choosing a loan, you want to find out which bank is best to take a loan from, or you have questions about the application process, I encourage you to get in touch. Together we will find the solution that best matches your financial needs and lets you carry out your plans.
In brief
Loans make it possible to meet a range of needs – from buying a flat, through buying a car, to financing the dream of running your own business. A loan is a contract between a borrower and a bank, in which the bank makes funds available that the borrower commits to repaying together with interest. Before you decide which bank is best to take a loan from, it is important to understand how loans work and what the differences are between them and borrowing arrangements. A borrowing arrangement consists of lending out money belonging to the lender, whereas a loan is a form of money creation carried out by banks, which depends on the amount of deposits paid into the bank.
Creditworthiness, the credit score and credit history are the key factors that banks take into account when assessing loan applications. Creditworthiness is an assessment of the current financial situation and the ability to repay the loan, the credit score is an assessment of the borrower, while credit history is a record of earlier obligations and how they were repaid, registered by the Credit Information Bureau (BIK). Loans can be secured, like a mortgage and a car loan, where the collateral is the property or vehicle being bought, which lowers the interest rate thanks to the smaller risk for the bank. Unsecured loans, such as credit cards and cash loans, carry a higher interest rate because of the absence of collateral.
A variety of loan types are available on the market, which can be tailored to your needs. A cash loan offers flexibility and can be used for any purpose. An account overdraft provides quick access to additional funds, and a credit card lets you use a current account credit with an interest-free period and attractive loyalty programmes. A car loan is a convenient solution for buying a vehicle, and a mortgage allows you to finance a property purchase on favourable terms. As an experienced credit expert, I can help in finding the most advantageous offer matched to your needs and financial means. If you need support in choosing a loan, I encourage you to get in touch – together we will find the best solution for you.
Key terms
Loan, borrowing, interest, deposits, money creation, economic circulation, required reserve, creditworthiness, DTI, credit history, Credit Information Bureau, credit score, secured loan, collateral, unsecured loan, risk for the bank, property right, cash loan, consolidation loan, loan decision, loan application, interest rate, reference rate, non-bank loan, pre-approved offer, employment certificate, account overdraft, current account credit, credit line, maximum loan interest rate, credit card, debit card, interest-free period, billing cycle, car loan, leasing, registered pledge, initial payment, leasing instalment, buyout, long-term rental, comprehensive motor insurance, mortgage, credit broker, credit analyst.