Loan Lingo: Lending vs Borrowing: What’s the Difference?
Lending and borrowing are two important terms to know. The most important thing to understand is that they are part of the same transaction. In the transaction, the lender is in a resource surplus while the borrower is in a resource deficit.
To put it very simply, the lender lends money/securities and the borrower borrows money/securities.
Borrowing is one of the most popular types of transactions. Last year, over 83 million Americans \ borrowed personal loans.
There is more to understand when it comes to lending vs borrowing than just definitions. Read on, and we’ll go more in-depth on these terms and provide examples as well.
The Anatomy of a Loan
Loans are made up of three main parts. First, there is the loan amount. This is how much of the resource a borrower needs to borrow in order to cover their resource deficit. It is also how much a lender will lend from their resource surplus to the borrower.
Second is repayment. Whenever a borrower takes out a loan, they agree to pay back the value of the loan within a certain timeframe. If they fail to pay back according to their agreement with the lender, then they could face a variety of punishments.
Finally, there is interest. When repaying a loan, it will be at an agreed upon interest rate. Interest rates can vary significantly between financial institutions. They can be a big reason why a borrower does or does not borrow from a specific lender.
Lending vs Borrowing
Let’s look at how things work out on both the lender’s side and the borrower’s side.
In terms of risk exposure, lenders are usually at a higher risk than borrowers. This is because once a loan is made, the borrower has gained money while the lender has lost money.
Now, the lender is at risk of the borrower defaulting and not returning the loan as promised. This is known as “credit risk“.
With that said, the lender typically has more say when it comes to designing the repayment plan. The lender has to be careful not to make the interest rate too high though or they risk losing the opportunity to lend to the borrower.
Examples of Lending and Borrowing
A fast-food chain, Burger World, is planning on opening a new restaurant. They need funding of $50 million so that they can afford to build the restaurant. They visit ABC Bank in hopes of borrowing a loan. ABC Bank lends Burger World the $50 million after the chain agreed to ABC Bank’s repayment terms.
In this example of lending vs borrowing, Burger World is the borrower and ABC Bank is the Lender.
In securities trading, borrowers borrow resources like stocks for a temporary amount of time before they go back to the lender. This is known as a stock loan and is often used for short-selling.
In short-selling, an investor borrows stock from a lender/broker, hoping that the value of the stock will go down. The investor/borrower then buys the stock at a hopefully cheaper price and pays the difference back to the broker.
Is Borrowing Right for You?
When it comes to lending vs borrowing, it is important to remember that one cannot happen without the other. In that way, they are intrinsically linked.
In an ideal scenario, lending and borrowing is not a zero-sum game where one party wins and the other loses. For many individuals, lending can be a relatively safe and smart way to accomplish resource-dependent goals.
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