Unit 4: Long-Term and Short-Term Funds

Lesson 4.3
Obligations of Borrowers
Contents
Introduction 1

Learning Objectives 2

Quick Look 3

Learn the Basics 4

Borrower 5
Creditors 7
Obligations of Borrowers and Creditors 10
Obligations of Borrowers to Creditors 10
Obligations of Creditors to Borrowers 11

Case Study 13

Keep in Mind 14

Try This 15

Practice Your Skills 16

Challenge Yourself 18

Photo Credit 19

Bibliography 19
Unit 4: Long-Term and Short-Term Funds

Lesson 4.3

Obligations of Borrowers

Introduction

Filipino citizens have certain obligations that they need to perform. One of these is paying
their income taxes. The income tax rate imposed in the Philippines is progressive, which
means that taxes are based on the person’s ability to pay. The more one earns, the more
taxes one should pay.

Paying taxes allows the government to provide essential services for the collective good.
These services include education, healthcare, and infrastructure. It is part of the fiscal social
contract where citizens contribute and, in return, gain something from the taxes they pay.
Since payment of taxes plays a significant role in the functioning of the whole system of
governance, the state also imposes penalties and punishment on those who fail to perform
this obligation.

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This dynamic between taxpayers and the government illustrates the concept of obligation.
An obligation morally and legally binds individuals to perform certain acts of duty and
commitment. Failure to do so would result in consequences and repercussions. Applying
this concept to the relationship between borrowers and lenders, what do you think are their
obligations to each other?

Learning Objectives DepEd Competency

List down obligations of entrepreneurs to

At the end of this lesson, you should be able to
creditors (ABM_BF12-IIIe-f-16).
do the following:
● Differentiate the types of borrowers
and creditors.
● Enumerate the obligations of
borrowers and creditors.
● Recommend actions based on
borrower's obligations.

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Quick Look

Story Time!
There is nothing wrong with borrowing things from friends or family members. It can be a
great way to save money and get the items you need without buying them outright.
However, it would be best to keep a few things in mind when borrowing. Consider the story
below and answer the questions that follow.

Tommy was a shy boy who always kept to himself. He was never the type to borrow
things from others. He is aware that some people are hesitant to lend their valuable
items, worrying that these will not be returned.

One day, however, Tommy found himself in a bind. He had forgotten his scientific
calculator at home and desperately needed one for a test. Tommy did not want to
ask anyone to borrow their calculator but had no other choice.

Tommy reluctantly asked Jane, a student from another class, if he could borrow her
calculator. She lent him her calculator with a smile and told him to return it when he
was done. Tommy was so grateful that she had helped him out. He appreciated
Jane's kindness and understood the importance of maintaining a good relationship
between borrowers and lenders. After using the calculator for his exam, he
immediately gave it back to Jane.

If students who have the means lend their resources, they can help those in need. If
those who borrowed things returned them promptly, lenders would be more
encouraged.

Questions to Ponder
1. Think about a time when you had to borrow something from someone. Did you
return it to them in the same condition that you received it in? Why or why not?
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2. Think about a time when you had to lend something to someone. Were you able to
get it back in the same condition? How did it make you feel?
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3. What do you think is the best way to handle borrowing things from others?
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Learn the Basics

At this point in the course, you already understand that entrepreneurs and businesses can
borrow funds to finance their startups and other development and expansion plans. You are
now aware of the various financial institutions that offer different types of loans that
respond to different needs. These institutions require borrowers to submit basic loan
requirements and other documentation to ensure that borrowers will repay these loans.

One of the considerations that institutions look into when approving loans is the applicant's
character. More specifically, the borrower's behavior and history are essential factors in
assessing creditworthiness. Bad credit history and score would discourage lenders from
approving a loan request. Thus, borrowers need to perform their obligations to their lenders.
Failing to do so has consequences and implications, not just on the individual borrower but
also on the entire financial system.

Essential Question

How can borrowers’ obligations affect the entire financial system?

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Borrower
A borrower is an individual, company, or institution that obtains money, goods, or services
in the form of a loan from another party. The borrower then becomes obligated to repay the
loan, usually with interest. The party lending the money, goods, or services is known as the
lender.

There are many different types of loans that a borrower can receive, including personal
loans, home loans, auto loans, and business loans. The terms of a loan will vary depending
on the type of loan and the lender. However, all loans typically involve the borrower making
regular payments to the lender until the loan is repaid in full.

Interest is often charged on loans, which means that the borrower will not only have to
repay the original amount of the loan but will also have to pay back a certain amount in
consideration of the time value of money. The interest rate on a loan is typically determined
by the lender and will vary depending on factors such as the type of loan, the length of the
loan, and the borrower's credit history.

Loans can be a helpful way for borrowers to obtain funds they need for various purposes,
but it is important to remember that loans must be repaid. Borrowers should carefully
consider their options and choose a loan that is right for their individual needs.

There are two main types of borrowers in finance: commercial borrowers and retail
borrowers.

Figure 1. The two main types of borrowers

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Commercial borrowers are business entities that borrow money to fund startups,
operations or expansions. Mature businesses typically have more experience with borrowing
than retail borrowers. They may be able to get better terms on their loans because they may
be seen as less of a risk. Commercial borrowers also tend to have more collateral, which can
be used to secure a loan.

Closer Look

Purposes of Commercial Loan

Company ABC is a logistics company expanding its services to a new
location. To ensure smooth operations and efficient customer service, the
company identified several essential acquisitions. However, since the
company wants to maintain a healthy financial flow, it decided to apply
for financing from a bank offering business loans.

Through the bank loan, Company ABC will purchase new delivery trucks,
an existing building to serve as its warehouse and base of operations, and
equipment for QR code assignment and scanning. They will also construct
a parking lot for its motorcycle riders.

Retail borrowers are individuals who borrow money for personal purposes, such as to buy a
home or a car. Retail borrowers may not have as much experience with borrowing compared
to mature businesses. They may also have less collateral to offer as security for a loan.

When it comes to borrowing money, both commercial and retail borrowers need to consider
the terms of the loan, the interest rate, and the repayment schedule. They also need to think
about whether their cash flow is enough to cover the monthly payments and whether their
assets are enough to repay the loan in full. Borrowers should also be aware of the fees
associated with a loan (e.g., processing fees) or penalties for late or default payments.

Commercial borrowers may want to consider using a business loan calculator to help them
determine the terms of their loans. Retail borrowers can use a personal loan calculator.
These calculators can help borrowers see how much they will need to pay each month and

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how long it will take to repay the loan. Borrowers should also be sure to shop around for the
best rates and terms before they commit to a loan.

When it comes to borrowing money, it is important to consider all options and find the best
loan that meets one’s needs.

Check Your Progress

How do commercial and retail borrowers differ?

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Creditors
A creditor is a person or organization that has money owed by another person or
organization. The debt may be in the form of a loan, credit, or other financial obligation.
Creditors are typically repaid through periodic payments that include interest charges.
Creditors have a legal right to collect the money that is owed to them.

There are many different types of creditors, each with their own unique way of managing
money owed to them. The most common type of creditor is a bank financial institution. This
type of creditor typically work with debtors to establish a repayment plan that is affordable
for both parties.

Other types of creditors include government agencies, utility companies, medical providers,
and landlords. Each type of creditor has its own process for collecting debts, so it is
important to understand the policies of a specific creditor before entering into a loan and
repayment agreement. The figure below illustrates the different types of creditors.

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Figure 2. The four main types of creditors

Real creditors are those who have a legal claim on borrowers’ assets and properties.
Creditors may take these assets to repay what is owed to them. Real creditors may include:
● Banks and other financial institutions
● Credit card companies
● The government (for taxes)
● Mortgage company
● Utility companies
● Medical providers

Personal creditors are individuals whom borrowers owe money to, such as friends, family,
or businesses. Personal creditors cannot take the borrowers’ property to pay off debt, but
they can sue them in accordance with the existing laws.

Secured creditors are creditors who have a security interest in the borrowers’ properties,
which means that if the borrowers do not pay their debts, the creditors can take and sell
these properties to get their money back. Secured creditors include bank and nonbank
financial institutions that lend money for purchasing of cars and real estate.

Unsecured creditors are creditors who do not have a security interest in the borrowers’
properties. This means that if the borrowers do not pay their debts, the creditors cannot take
their properties. The most common type of unsecured creditors are credit card companies,
medical providers, and utility companies.

The danger that a creditor may lose all of his money if a debtor cannot repay him in full, even
if the debtor's assets are liquidated, is known as solvency risk. This is also known as
counterparty risk by traders (Vernimmen 2005).

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Closer Look

Consumer Finance Provider

Retail borrowers seeking to purchase appliances and mobile devices can
avail of the services of a consumer finance provider company. This
company offers non-cash, no-collateral in-store financing. It works this
way:
1. a consumer can visit an appliance store to find the items he or she
needs;
2. before check out, the consumer can approach the booth of the
finance provider and apply for a loan;
3. the staff of the finance provider will ask for the borrower’s
personal, financial, and credit information, and the company will
evaluate on the spot whether the applicant is qualified or not; and
4. the staff then explains to the borrower the payment schedule, the
benefits of paying on time, and the consequences of not doing so.

The company is an unsecured creditor and can not take away the
borrower’s property in case of default in payments. However, since they
obtained the borrower’s personal and employment information, they can
contact the borrowers and their employers to have the loan repaid.

Check Your Progress

1. What are some ways that creditors can collect on delinquent

accounts?
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2. What are the legal implications for businesses who fail to settle their
obligations to creditors?
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Obligations of Borrowers and Creditors

Creditors and borrowers have a shared responsibility to ensure that loans are repaid in a
timely and responsible manner. By working together, they can help ensure that loans are
managed in a way that is best for both parties. A good relationship between creditors and
borrowers also helps keep the financial system healthy.

Obligations of Borrowers to Creditors

Entrepreneurs have certain obligations to their creditors. These include:

1. Repaying any debts that are owed.

Repaying any debts that are owed is a moral, legal, and ethical obligation. It shows
that an individual is organized and capable of handling their money in a responsible
way. Additionally, it can help improve one's credit score and make it easier to qualify
for loans in the future. Not repaying debts can have major consequences, including
wage garnishment, legal action, and damage to one's credit score. Therefore, it is
always best to repay any debts owed as soon as possible.

2. Providing accurate and timely financial information.

It is the obligation of the borrower to provide accurate and timely financial
information to creditors. This includes information on income, expenses, assets,
liabilities, and any other relevant financial matter. Providing accurate and timely
financial information helps creditors assess the risk associated with lending money to
the borrower and make informed decisions about whether or not to extend credit.

3. Maintaining open communication channels.

Maintaining open communication channels with creditors is an important obligation
of borrowers. This means keeping creditors updated on the status of repayments and

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providing timely information about any changes in financial circumstances. Open

communication helps to build trust and confidence between borrowers and creditors,
which can make it easier to negotiate repayment terms if necessary. It also helps to
avoid misunderstandings and potential conflict.

4. Avoid defaulting debt payments.

Defaulting borrower’s debt payments can also have a negative impact on his personal
credit score. This could make it difficult to obtain new financing in the future. It is
important to remember that creditors are not always willing to work with businesses
that are in financial distress. If the borrowers are having difficulty meeting his
obligations, it is important to reach out to his creditors as soon as possible to discuss
his options.

Check Your Progress

What happens if a borrower does not repay a loan?

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Obligations of Creditors to Borrowers

Creditors also have important obligations to borrowers. It is their duty to provide borrowers
with accurate and up-to-date information about their rights and responsibilities. This
includes informing borrowers of any changes to the terms of their loan, such as interest rate
changes or new fees. Creditors must also give borrowers clear instructions on how to make
payments, and they must respond promptly to any questions or concerns borrowers may
have.

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Closer Look

Importance of Issuing a Repayment Schedule

In the best interest of lenders and borrowers, borrowers must fully
understand the obligations associated with the loan that they are
applying for. Borrowers should base their loan on full knowledge of the
principal, interest, monthly amortization, and other charges. However,
not all borrowers know how compound interest works. Thus, credit
institutions must provide a repayment schedule or amortization schedule
before clients confirm their loan applications. The general format of a
repayment schedule looks like this:
LOAN AMORTIZATION SCHEDULE
Loan amount:
Loan term:
Interest:
Payments per year:

Payment Payment Principal Interest Total Balance

Date interest

Check Your Progress

What are the best practices for managing creditor relationships?

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Case Study

Responsible Sovereign Lending and Borrowing

There are three key reasons for seeking a clear understanding of both
sovereign borrowers' and lenders' responsibilities.

Firstly, the flow of capital to sovereign debtors plays an immensely

important role in the global economy. Developed countries rely on it to
finance their budget deficits, while developing countries need it to fund
their development. When either sovereign debtors or creditors behave in
a disruptive manner, it throws this key component of the international
financial system into chaos, making credit harder to come by and more
expensive.

Secondly, sovereign finance is much less forgiving of mistakes than other

types of debt. There is no formal bankruptcy mechanism accessible to
sovereigns to control unsustainable liabilities according to preset norms.
From a legal standpoint, this means that sovereign debts can only be
wiped out if creditors agree to them. However, the process by which this
consent must be sought – through sovereign debt restructuring – is often
unpredictable and disorderly.

Finally, the human cost of reckless sovereign borrowing, reckless lending,

or inept public debt restructuring is enormous. A quick scan of any major
international newspaper on any given day will illustrate this point. The
majority of people on earth will be directly impacted by agreement on the
duties of both sovereign borrowers and lenders, as well as changes in
how sovereign loans are planned, performed, documented, and
restructured when appropriate.

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Responsible Sovereign Lending and Borrowing

Lee Buchheit, and G. Mitu Gulati, “Responsible Sovereign
Lending and Borrowing,” The United Nations Conference on
Trade and Development (2010),
https://unctad.org/system/files/official-document/osgdp2010
2_en.pdf, last accessed on May 07 2022.

Keep in Mind

● Borrowers are people who receive loans from lenders. To qualify for a loan, borrowers
usually have to meet specific criteria, such as having a good credit score and a steady
income. Creditors set these criteria to determine whether a borrower can repay the
loan and has good behavior.
● Borrowers with good credit behavior are those who perform their obligations based on
their agreement with the creditor. Some of the most critical obligations of borrowers
are:

● Borrowers who fail to meet these obligations may be subject to late fees, penalties, etc.
Depending on the type of creditor, whether real, personal, secured, or unsecured, they
can exert efforts to collect from delinquent borrowers. These may include seizure of
properties and collateral and legal actions.

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● Creditors have an obligation to provide accurate and up-to-date information to the

borrowers. It includes the terms, principal, interest, monthly payment, and other
charges associated with the loan. They should also inform the borrower of their actions
in the case of defaults in payment.
● The excellent relationship between borrowers and lenders ultimately affects the health
and efficiency of a financial system.

Try This
A. Identification. Write the correct answer on the provided space before each number.

_________________ 1. These borrowers include small businesses, large corporations,

and other entities such as partnerships and limited liability
companies.

_________________ 2. A creditor who has a security interest in the debtor's property,

which gives the creditor certain rights in the event that the
debtor defaults on payments.

_________________ 3. A creditor who does not have a security interest in the

debtor's property and does not have the same legal rights as
a secured creditor in the event of a default.

_________________ 4. This creditor is someone to whom you owe money but is not
related to your business. This could be a family member, a
friend, or even a credit card company.

_________________ 5. These creditors offer more affordable and manageable terms

and also report your payments to the credit bureaus, so you
can improve your credit score.

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B. Identification. Identify whether the obligations are for the borrowers or creditors.
Choose the correct word from the box and write the correct answer on the blank
before each number.

Borrower Creditor

_______________ 1. Repay the loan in full, with interest.

_______________ 2. Notify the other party of any changes to the terms of the loan.

_______________ 3. Keep the collateral in good condition.

_______________ 4. Report payments to credit bureaus in a timely and accurate

manner.

_______________ 5. Get the other party’s permission before taking any action that
could reduce the value of the collateral.

Practice Your Skills

Understanding Borrowers and Creditors

Determine which type of borrower or creditor is described in the following scenario. Justify
your answer by providing a 1-2 sentence explanation.

1. Mr. Dela Cruz is the sole proprietor of a small grocery store. He decided to expand
the selection of items available in his store. He went to a commercial bank to look for
available loans to fund the purchase of inventories. What kind of borrower is Mr.
Dela Cruz? What consequences might await him if he fails to pay the debt he owes
from a commercial bank?
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2. Mang Tomas is a member of the ABC Cooperative Bank. The said financial institution
offers loans to its members to buy agricultural equipment to help raise productivity
in their area. Mang Tomas will be provided with the machinery he needs and an
amortization schedule to follow. The bank explained to him that if he defaulted on
payment, the institution would seize the equipment from his possession. What kind
of creditor is the ABC Cooperative Bank? Justify your answer.
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3. Jenna is a savings account holder in a commercial bank. The said bank told her that
she was qualified for a quick loan. The amount borrowed will be credited to her
account, and the bank will automatically deduct the amount due based on the
monthly amortization schedule. What kind of creditor did Jenna apply from? Justify
your answer.
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4. Aling Susan is a retired government employee. She used her retirement pay to lend
money to individuals and small businesses in their barangay. What kind of creditor is
Aling Susan? What can she do to collect from borrowers who failed to pay her on
time?
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5. EFG Company handles the generation and distribution of water in the local water
district in the province. The said company offers a credit line for small businesses
engaged in the agricultural production and cottage industries. When a business fails
to settle their obligations, the company simply terminates the water services for the
client. What kind of creditor is EFG Company?
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Challenge Yourself

Analyze the given situations. Recommend an action based on borrower’s obligations.

Provide explanations and justifications for your answers.

1. Suppose you applied for a secured auto loan from a commercial bank two years ago.
The said loan has a term of five years. Unfortunately, a strong storm hit, and it
heavily damaged the car. What should you do as a borrower?
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2. Dan visited the office of a financial institution to apply for a personal loan worth
₱100,000. The institution’s representative showed him the different types of loans
they offer. Dan chose the one he preferred most and submitted his personal and
financial documents. He was ecstatic to find out that he qualified for the said loan.
When Dan claimed the loaned amount, he was surprised to receive only ₱95,000. He
found out that there was a processing fee of ₱5,000. Which obligations did the
creditor and the borrower fail to perform in this scenario?

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3. You have a ₱3,000 amount that is due this week to repay a personal loan that you
asked for from a close friend. You already have this amount available. However, you
saw that a pair of shoes were on sale. You wonder if you can buy the pair of shoes
and ask your friend for an extension of the deadline for payment. What would you
do? Justify your answer.
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Photo Credit
Tax Form by 401(K) 2012 is licensed under CC BY-SA 2.0 via Flickr.

Bibliography

McLaney, Eddie. 2009. Business Finance Theory and Practice 8th Edition. Financial Times
Prentice Hall. https://dut.edu.ua/uploads/l_1872_56653010.pdf.

Vernimmen, Pierre. 2005. “Corporate Finance: Theory and Practice.” John Wiley & Sons, Ltd.
2005.
http://www.untag-smd.ac.id/files/Perpustakaan_Digital_1/FINANCE%20Corporate%20
Finance%20Theory%20and%20Practice.pdf.

Buchheit, Lee, and G. Mitu Gulati. 2010. “Responsible Sovereign Lending and Borrowing..”
https://unctad.org/system/files/official-document/osgdp20102_en.pdf.

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