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A demand loan is a type of loan that has low interest and no repayment plan. The parties agree to it with the understanding that the borrower will pay back the money whenever the lender asks for it. The borrower benefits by having a sum of money without the stress of payments or high interest rates. The lender benefits because he or she can recoup the money at any time without waiting for the payment period to expire. The disadvantages are that the lender might ask for payment at an inconvenient time or that the borrower might never pay back the loan.
Most loans are granted by banks or lending agencies. The lender is given a certain amount of money with the understanding that the money will be paid back over time and with interest. Interest rates are set by the government — or are based on rates set by the government — and the pay schedule is set by the bank or lending agency. The borrower usually is expected to pay a portion of the original loan amount, known as the principal, and a portion of the interest each month. Demand loans are different because they do not have payment schedules, and the interest rates usually are lower than those offered by banks or lending agencies.
To understand how a demand loan works, one could consider two friends who know each other well. Friend A might borrow money from friend B. At some point in the future, friend A will pay the money back, but if friend B needs the money, then he can ask for it. These two friends have entered into a very simple type of demand loan agreement. This arrangement only works if the two people involved trust each other.
The borrower who enters into a demand loan benefits by not having to make payments. Often, money borrowed through a demand loan is used to start a business or buy goods or property that will improve an existing business. The up-front costs might prevent him or her from having enough money to make regular payments. Instead, the borrower can wait until the investment has started to make money before making any payments on the loan.
The disadvantage for the borrower is that the lender can ask for full payment at any time. If the lender is having money trouble, he or she can get the loan, plus interest, back from the borrower. The lender also might ask for payment if he or she thinks that the borrower is headed for financial trouble, to have the loan paid back before the borrower goes bankrupt or suffers other financial misfortune and the money is lost.