Time is Life: Loan Period Means a Lot

Lending behavior is very common in our lives, and each of us is intentionally or unintentionally related to lending behavior. The lending behavior is also accompanied by risks. The degree of risk is determined by various factors of the lending behavior, such as the amount of loan, the quality of the borrower, and the interest rate, etc. Among them, the loan period is also a very important factor, and the impact on lending behavior is in all aspects.

First, the loan period will affect the interest rate. We all know that, in general, the longer the loan period lasts, the higher the interest rate is. On one hand, the longer the funds are lent, the greater the risk that the loaner will bear. On the other hand, because the funds are loaned out, it means that the funds have completely lost their liquidity and can’t be used for other investments or production & operation. This is why interest exists: to pay “liquidity compensation” to the loaner. The longer the loan period lasts, the longer the liquidity loss, and the greater the liquidity compensation is required.

However, one of the exceptions is short-term bridge funding. For a variety of reasons, companies or individuals may need a very short-term funding, which may be as short as a few days or ten days. According to what we said above, the interest on such loans should be low, but in fact it is not. The interest rate of such short-term funds may be very high.

The reason is that the loan period is very short, and if the interest rate is also very low, the loaner can receive little interest after the loan behavior, so the willingness of the loaner to provide funds is very low. On the other hand, such short-term funds are often used for turnover, and failing to finance may cause very large losses, so the borrower's demand is strong. As a result, the demand of the supply side is very weak, and the demand of the borrower is very strong, in order to reach a transaction, the price has to be raised - in the case of lending, it is interest.

In addition, loan period will also affect the loan-to-value ratio in mortgage lending. As mentioned above, the longer the loan period lasts, the greater the risk loaner will suffer. In order to control the risk, naturally, as the loan period becomes longer, the loan-to-value ratio will also decrease. This is especially true for collateral with relatively unstable value.

Take cryptocurrency mortgage lending as an example. The most important problem in this type of business is the decline in the value of collateral. It is true that the interests of the loaners can be protected by setting a warning line and a forced liquidation mechanism, so that the loaner will not suffer losses, but if the forced liquidation occurs frequently, it will definitely cause bad user experiences for the loaner and the borrower. Therefore, it is necessary to scientifically determine the loan-to-value ratio when designing the product.

In our previous article we mentioned that the loan-to-value ratio setting can be done by Monte Carlo method, and we know the more random events that the Monte Carlo method simulates, the more accurate the results will be. Then, when the loan period is lengthened, the random period available for simulation is reduced, and the simulation accuracy is reduced. Obviously, for cryptocurrency mortgage lending, the lengthening of the loan period is an important concern for the increase in risk.

Therefore, in cryptocurrency mortgage lending, the loan period should not be too long, and can generally be controlled within 6 months. For loans with different loan periods, different loan-to-value ratio should also be set. The longer the loan period, the lower the loan-to-value ratio, so as to better ensure the financial security of the loaner.