Lenders: Definition, Types, and How They Make Decisions on Loans

What Is a Lender?

A lender is an individual, a group (public or private), or a financial institution that makes funds available to a person or business with the expectation that the funds will be repaid. Repayment will include the payment of any interest or fees. Repayment may occur in increments (as in a monthly mortgage payment) or as a lump sum. One of the largest loans consumers take out from lenders is a mortgage.

Understanding Lenders

Lenders provide funds for a variety of reasons, such as a home mortgage, an automobile loan, or a small business loan. The terms of the loan specify how it must be satisfied (e.g., the repayment period) and the consequences of missing payments and default. A lender may go to a collection agency to recover any funds that are past due.

How Do Lenders Make Loan Decisions?

Individual borrowers

Qualifying for a loan depends largely on the borrower’s credit history. The lender examines the borrower’s credit report, which details the names of other lenders extending credit (current and previous), the types of credit extended, the borrower’s repayment history, and more. The report helps the lender determine whether—based on current employment and income—the borrower would be comfortable managing an additional loan payment. As part of their decision about creditworthiness, lenders may also use the Fair Isaac Corporation (FICO) score in the borrower’s credit report.

When applying for a secured loan, such as an auto loan or a home equity line of credit (HELOC), the borrower pledges collateral. The lender will make an evaluation of the collateral’s full value and subtract any existing debt secured by that collateral from its value. The remaining value of the collateral will be the equity that affects the lending decision (i.e., the amount of money that the lender could recoup if the asset were liquidated).

The lender also evaluates a borrower’s available capital, which includes savings, investments, and other assets that could be used to repay the loan if income is ever cut due to a job loss or other financial challenge. The lender may ask what the borrower plans to do with the loan, such as use it to purchase a vehicle or other property. Other factors may also be considered, such as environmental or economic conditions.

Business borrowers

Different lenders have different rules and procedures for business borrowers.

Banks, savings and loans, and credit unions that offer Small Business Administration (SBA) loans must adhere to the guidelines of that program.

Private institutions, angel investors, and venture capitalists lend money based on their own criteria. These lenders will also look at the purpose of the business, the character of the business owner, the location of business operations, and the projected annual sales and growth for the business.

Small-business owners prove their ability for loan repayment by providing lenders both personal and business balance sheets. The balance sheets detail assets, liabilities, and the net worth of the business and the individual. Although business owners may propose a repayment plan, the lender has the final say on the terms.

The Bottom Line

When you need to borrow money for a personal purchase or jumpstart your business, there are many options. When choosing a lender, look at their reputation and longevity—banks and other financial institutions are the traditional choices, but angel investors and online micro-lenders are gaining popularity. Before borrowing, make sure you understand the full breadth of your loan agreement and can afford to repay it.