Intertemporal Choice

Introduction

The significance of lending and borrowing

Lending and borrowing are crucially important economic activities:

• individuals borrow to pay for education, provide for themselves and their families until their next paycheck, make large purchases (like a house), and start business ventures
• companies borrow money to fund their growth
• the government borrows money to finance its budget deficit

What is a loan?

A loan is a financial arrangement in which a lender provides a specific amount of money to a borrower, who agrees to repay the borrowed amount (principal) along with interest. Loans are commonly used by individuals, businesses, and governments to fund various expenses, investments, or projects when immediate funds are needed but not readily available. The terms of a loan, including interest rates, repayment schedule, and collateral requirements, vary based on many factors like:

• Risk Assessment: borrowers with a lower likelihood of repayment are charged higher interest rates.
• Market Conditions: banks increase or decrease rates for everyone in response to central bank policies and factors like inflation.
• Discrimination: financial institutions have historically limited and denied loans, insurance, and other financial services to some people and communities.
• Access to Traditional Loans: low-income borrowers who don’t qualify for traditional loans are sometimes targeted by lenders who offer them short-term, high-interest loans that exploit their limited financial literacy. These loans are hard to pay back and risk catapaulting the borrower into a cycle of debt.

Examples of loans

A mortgage is a loan made to households or businesses to purchase a property. The borrower pays back the loan with interest over a period of many years. The property serves as collateral, meaning that it can be seized by the lender if the borrower fails to make scheduled payments.

A mortgage is one of the many types of loan in the economy. Click on the tabs below to explore some real-world applications.

Personal Finance

Individuals borrow money to pay for major purchases such as homes, cars, or education. They can also lend money by putting funds in savings accounts, purchasing bonds, or extending loans to family and friends.

Business Financing

Companies will often borrow to finance operations or invest in projects. They do this by seeking loans from banks or raising funds from investors.

Government Borrowing

Governments often borrow to finance public spending on infrastructure, social programs, and other initiatives. They issue government bonds to manage budget deficit.

Real Estate

Lending and borrowing are central to real estate. Individuals and businesses obtain mortgages to purchase residential or commercial properties.