What is a Demand Loan?

A demand loan is a borrowing instrument that allows the lender to recall a loan on short notice. Once notified, the borrower must repay the full amount of the loan and any associated interest. This arrangement also allows the borrower to repay the loan at any time without an early repayment penalty. This arrangement varies from the normal lending approach, where there is a predetermined maturity date and a schedule of payments to be made.

Demand loans are most common for short-term needs, where the borrower only requires the funds for a short period of time. The lender may extend the loan without collateral, or will demand collateral in order to reduce its risk of nonpayment. A collateralized obligation will likely result in a lower interest rate, while a higher rate is charged when there is no collateral.

Example of a Demand Loan

An example of a demand loan is an overdraft arrangement. In this case, a bank is providing sufficient funds to cover any checks presented to the bank for payment, despite there not being sufficient cash in the maker’s account to pay for the checks. The bank will charge a fee for this service, and will demand immediate repayment of the account overage.

Advantages of a Demand Loan for the Lender

The key advantage for the lender of issuing a demand loan is that it can demand the repayment of a loan if it sees the financial situation of a borrower worsening. This is especially important when a borrower’s situation appears to be worsening rapidly, so that the lender can avoid having its funds tied up in a bankruptcy.