Account For A Loan – When a loanable fund is approved for a customer, a separate account for the loan is opened for the customer, this is considered as standard procedure applicable by any bank.
This account for that is approved for lending is different from the regular current account. Thus, the customer has two different accounts, the current account and the account. Once the loan is approved, the loan account is debited with the account and the the lending, while the corresponding credit is made on the customer’s current account.
The credit on the current account allows the customer to draw his cheque on the account to make withdrawals, or to issue other debit advises. As the customer issues a cheque, the current account is debited with the value of the cheque when presented for payment. The corresponding credit may be made when in the bank’s cash account, another customer’s account, or other accounts.
How Account For A Loan Works In Commercial Banks
The customer can choose withdraw the whole loan or part of the loan as issued by the bank as at that time. If the customer makes a loan repayment, the customer’s current account is debited and the loan account credited. If the credit to the loan account is enough to cover the outstanding balance on the loan account, that loan is said to be fully repaid.
It is normal to debit the loan interest to the current amount. Such interest may be charged on monthly, quarterly or half-yearly, the effect is usually to increase the real annual interest payments. This is because of the compounding effects.
Instead of debiting the current account with the interest of bank charges, a bank may decide to debit the account for a loan with the interest charges. The effect of this will be to increase the amount of loan outstanding.
As interest is added to the principal, each loan repayment will cover part of the principal and the interest. To ensure that loan repayments actually reduces the principal, the amount repaid must be more than the interest that is due.
Differences Between A Loan And An OverDraft
- Overdraft – These are arranged through an informal and less rigorous process
- Loans – These are arranged in a more formal way and the process is more rigorous
- Overdraft – Separate accounts are not needed except for the customers current account.
- Loans – Separate loan accounts are required.
- Overdraft – There are no requirement on a formal agreement, legal documentation or otherwise.
- Loans – This process requires formal loan agreement, documentation etc
- Overdraft – It is legally repayable on demand
- Loans – This is only repayable as stipulated in the agreement
In conclusion, both the loan and advances and overdraft has similar functions, the only difference is the fact that both has operates a separate terms of agreements.