The loopback interface is a virtual interface that is always up and available after it has been configured. Note that the loopback interface is not tied to the address 127.0.0.1. It's an interface like any other, and can be assigned its own address. A loopback interface is often used as a termination address for some routing protocols, because it never goes down.
Another common use of a loopback address is to identify a router. For example, say you want to find out whether a particular router is up. You know that the router has an ethernet0 interface with an IP address of 10.10.1.1. You ping 10.10.1.1 and don't get a response. Does this mean your router is down? It's possible that the router is up and that the ping reached the router on another interface, but you didn't receive a response because ethernet0 is down. To find out unambiguously whether the router is alive, you have to ping another interface. But that interface might be down, causing the same scenario to occur. To avoid this problem, you can configure the router's loopback interface with a unique address. Then, when you want to telnet or ping your router, use the loopback interface's IP address. This method ensures that you will get a response no matter how your packets reach the router.
Here's how to assign an IP address to a loopback interface :
interface loopback 0 ip address 10.10.1.2 255.255.255.255
Other ways to use the loopback interface include:
IOS Images and Configuration Files
Basic Router Configuration
IP Routing Topics
Interior Routing Protocols
Border Gateway Protocol
Quality of Service
Specialized Networking Topics
Switches and VLANs
Troubleshooting and Logging
Appendix A Network Basics