A demand loan is a type of loan that can be called for repayment by the lender at any time, without providing a reason. This is in contrast to term loans where the repayment schedule is fixed over a specific period of time.
Demand loans can be secured or unsecured. Secured loans are backed by collateral, such as real estate or other assets, while unsecured loans are not.
The interest rate on a demand loan may be fixed or floating, with the interest typically payable in arrears. The interest is calculated on the outstanding balance, making it advantageous to repay the loan as soon as possible.
Demand loans are typically used in short-term financing situations, or where the lender and borrower have a close relationship and there is a high level of trust. They offer flexibility for the borrower in terms of repayment, but they also carry the risk that the lender may demand repayment at an inconvenient time.
It’s important to note that while the lender can demand repayment at any time, this doesn’t mean the borrower has to come up with the entire repayment amount instantly. Usually, a reasonable period of time is given for the borrower to repay the loan once it’s been called. The specifics would depend on the terms and conditions set out in the loan agreement.
Example of a Demand Loan
Let’s say a small business owner, John, needs quick access to funds to cover an unexpected expense – maybe a piece of essential equipment broke down and needs to be replaced immediately. John approaches his bank and is granted a demand loan of $20,000 to cover the cost.
The terms of the loan indicate that it can be repaid at any time without penalty, but it can also be called in by the bank at any time. The loan comes with a floating interest rate, which is calculated on the outstanding balance and payable in arrears.
John uses the loan to purchase the equipment and continues to operate his business, paying off a portion of the loan whenever possible. After several months, the bank decides to call in the loan, giving John a reasonable period, say 30 days, to repay the remaining balance.
The ability to call the loan gives the bank flexibility and reduces its risk. On the other hand, John was able to quickly get the money he needed in an emergency, and he had the flexibility to repay it on his own schedule, as long as the loan wasn’t called.
Remember, this is a simplified example. In reality, the terms and conditions of a demand loan can be quite complex and would be spelled out in a loan agreement. Both the lender and the borrower would need to understand these terms and conditions before entering into such an agreement.