People take loans from financial institutions in order to meet their individual needs such

as building the house, buying the vehicle, educational purpose, fulfilling social obligations,

healthcare expense, etc. Further, they also take the loan for investment purpose when they find

an investment alternative that pays higher than the cost of the loan.

There is several loans that a person can have; it can be a business loan, secured loan,

unsecured loan and personal loan. These loan can be lend by the borrower from different

financial institutions it can be on formal financial institutions such as commercial banks,

cooperatives, financing institutions. A borrower can also lend on informal credit groups,

particularly friends and family or other informal financing sectors (Sunil, 2018).

The study of Sunil (2018), also indicate that the decision of a borrower in choosing

between formal and informal financial institutions are affected by several factors such as loan

covenants and installment structure. Loan Covenant is the terms and conditions of the loan

contracting document between the customer and the banks and financial institutions apply to the

loan covenants. A major factor that defines the customer's loan decision is the conditions referred

to in the loan document. On the other hand, installment terms or repayment terms is the period

from the starting point of credit to the final maturity of a transaction.

According to Atieno (2001), interest rate and insurance or guarantees affect the decision

of the borrower when deciding which credit institution they will choose. Interest rate is the rate

at which the lender is offering and the buyer or the borrower is accepting to purchase the loan for

a definite time period. While Insurance or guarantees are the insurance to be done or guarantees

to be obtained for the collateral that is going to be possessed by the bank in order to protect the

bank against potential loss in the future purchase the loan for a definite time period.
 Interest rate and collateral is very integral or important factors when choosing a credit

option, most often if the financing institution requires a collateral and high interest rate the

borrower is hesitant on accepting the offer of a financing institution Atieno (2001). For them

excessive borrowing cost, high interest rate with a requirement of collateral for a loan is a burden

and it is difficult to pay.

In addition to this, Rahima et al. (2015) also states that the financing decision of a

borrower directly affected by the interest rates and collateral. The size of the loan are directly

linked to the interest rate and collateral. When the borrower wants a small loan most of the time

they will refuse to accept a loan with a collateral. Rahima et al. (2015) also states that more often

if the borrower just only need a small loan they tend to borrow to an informal credit sector,

because even though sometimes it has a high interest it does not require a lot of requirements and

it is easy to access.

On the other note, research by Wiyani and Prihantono (2016) utter that transaction cost

affects the determination of borrower where he or she will loan. The cost of borrowing funds

acted as one part of the process to obtain loans from various types of financial institutions. In the

context of lending, transaction costs occurred as a result of the process to obtain information for

the achievement of a loan contract between the debtor with financial institutions. Transaction

costs for borrowers is all kinds of costs beyond the interest that must be borne by a prospective

borrower to obtain a loan, began to come to a financial institution to obtain information

regarding the requirements apply for a loan, when applying, until the stage pay off the cost of

cash or its equivalent rupiah from the time loss over the whole process of borrowing.
 For that matter, high transaction cost is the main reason why a person refuse to loan on a

formal financing institution like a commercial bank. Even though the interest rate of a bank is

much lower than an interest rate on informal sector, acquiring a personal loan in banks is costly,

because of expensive transaction cost. Before a person fully acquired a loan on a bank he or she

must submit a lot of papers, legal requirements and it has a cost. Moreover, inquiring loans is

time consuming and tedious (Wiyani & Prihantono, 2016).

On the side note, Santos (2019) cited Cross on his research explain that the following that

these following factors affect why third world country like Philippines more often borrowed

additional funds on informal sector; Cost, Patience, Sympathy or Humanity, Discretion.

Filipino preferred to loan on informal credit sector like; lending, 5-6, friends and family because

it does not need any formal requirements and it is easy to access. It has a lower cost compare to

the commercial banks, most often it did not require the borrower to pay on a certain date.