What Is a Loan Scenario?
A loan scenario is a type of financial management tool that allows both the lender and the borrower to identify various options around arranging a loan, and then project the outcome of going with a particular option. The benefit of exploring the scenario is that both parties have an idea of what is likely to happen if a specific set of circumstances ensue, how those circumstances would affect each party, and if the desired outcome would be best achieved with that particular course of action. Typically, this approach can help minimize the possibility of making the wrong choice in terms of financing, saving both lender and borrower a lot of trouble.
One of the easiest ways to understand how a loan scenario works is to consider a borrower who wishes to buy a home. The borrower will approach a banker to determine the best way to go about obtaining a mortgage. Together, they will explore a number of scenarios, including fixed versus variable interest rates, the duration of the financing, what type of up-front fees will be bundled into the amount borrowed, and even the amount of the monthly mortgage payment. Several different combinations will be suggested, with both parties evaluating the pros and cons of each. Once it becomes apparent that there is one particular mortgage loan arrangement that is a good fit for both the borrower and the lender, the two parties can use that loan scenario to craft the mortgage contract and establish the loan.
The loan scenario is easily one of the more commonly employed financial management tools. Individuals will use this process to consider different ways of financing all sorts of purchases, including automobiles or even funding a college education for a child. Businesses will make use of the loan scenario to explore ways to finance product launches, ad campaigns, or expansion of company facilities, ultimately going with the scenario that is seen as the most cost effective and productive. The key to the process is to carefully evaluate each scenario, understand both the benefits and the drawbacks, then choose the approach that is most likely to produce the desired outcome.
There is no one ideal loan scenario that will always be the best option. This is because some of the elements are somewhat subjective in terms of their desirability. For example, a scenario on a mortgage may call for a term shorter than the traditional 30-year mortgage, such as 15 years. For one borrower, this would be ideal since it would save a great deal of interest and allow the debt to be retired faster. Another borrower would find the mortgage payments with this scenario difficult to manage and would prefer a 30-year mortgage instead.
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