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Very Short Question and Answers - Terms of Credit

Q 1.
What are 'terms of credit' in a loan?

Ans:

They are the detailed conditions agreed upon by the lender and borrower, including interest rate, collateral, documentation, and repayment schedule.

Q 2.
Name the four main components of the terms of credit.

Ans:

Interest rate, collateral, documentation required, and repayment schedule.

Q 3.
What is the interest rate and why is it important?

Ans:

It is the extra amount paid over the principal for borrowing; it represents the cost of borrowing for the borrower and the return for the lender.

Q 4.
Differentiate between fixed and variable interest rates.

Ans:

A fixed rate stays the same throughout the loan period; a variable rate can change over time based on market or policy rates.

Q 5.
Convert 5% per month to an annual rate and explain its impact.

Ans:

5% per month equals about 60% per year; such a high rate can make repayment very difficult and may lead to a debt cycle.

Q 6.
Why can high interest rates trap borrowers in a debt cycle?

Ans:

Because large interest payments reduce the borrower’s ability to repay the principal, often forcing them to borrow again to meet repayments.

Q 7.
What is collateral? Give two examples.

Ans:

Collateral is an asset pledged as security for a loan. Examples: land papers for a farm loan and gold jewelry for a small loan.

Q 8.
How does collateral reduce the lender’s risk?

Ans:

If the borrower fails to repay, the lender can sell the collateral to recover the loan amount.

Q 9.
Why is lack of collateral a barrier for poor borrowers to access formal loans?

Ans:

Many poor borrowers do not own assets to pledge, so banks may refuse loans due to higher risk.

Q 10.
List any three documents banks commonly require for a loan.

Ans:

Proof of identity (Aadhaar/PAN), proof of address, and income or bank statements; collateral ownership papers if applicable.

Q 11.
How do documentation requirements differ between banks and moneylenders?

Ans:

Banks require formal legal and financial documents, while moneylenders often rely on personal trust and may not require any paperwork.

Q 12.
What is a repayment schedule? Give one example from formal lending.

Ans:

It is the plan for when and how the loan is repaid. Example: monthly EMIs over a fixed period.

Q 13.
How can rigid repayment schedules lead to defaults?

Ans:

If schedules do not match borrowers’ cash flows (e.g., seasonal incomes), they may miss payments and default.

Q 14.
Compare typical bank and moneylender terms for a small shopkeeper’s loan.

Ans:

Bank: lower annual interest, collateral and documentation required, regular EMIs. Moneylender: very high monthly interest, little/no documentation, flexible or lump-sum repayment.

Q 17.
In a car loan, what typically serves as collateral?

Ans:

The car itself usually acts as the collateral.

Q 18.
Which sector is more likely to use verbal agreements with no documents: formal or informal? Why?

Ans:

Informal sector (e.g., moneylenders), because they rely on personal relationships rather than formal procedures.

Q 19.
How do collateral and documentation together reduce the lender’s risk?

Ans:

Documentation legally binds the borrower to the agreed terms, and collateral provides a recoverable asset if the borrower defaults.

Q 20.
What is meant by 'social collateral' in SHGs?

Ans:

Instead of physical assets, the group’s peer pressure and mutual accountability ensure members repay on time.

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