What do Terms Used in Loans Mean?

Taking out a loan seems like a straightforward process. Find a lender, fill out an application, and get the money.
 
However, if you don’t know what to look for, you may be shooting yourself in the foot. The terms that are discussed in a loan can dictate how much you end up paying.
 
If you don’t know what to look for in a loan document, you won’t understand the fees or interest charges. This can result in you paying more than you planned for or having payments change at some point during the loan term.
 
And if you can’t afford the loan at any point during the term, you may default (be unable to pay), which can destroy your credit.
 
Keep reading our loan glossary for all the basic terms you should know.

What Are Loan Terms?

Your loan terms dictate how much you will pay and how much the loan will cost you. While the definitions stay the same no matter who you are, the exact figures will vary depending on your income, credit score, type of loan, and other factors.
 

Annual Percentage Rate (APR) and Interest Rate

The interest rate dictates how much interest you’ll be charged on the loan. The Annual Percentage Rate (APR) reflects the interest rate, as well as any required fees.
 
When comparing multiple types of loans, it’s best to compare the APR, not just the interest rate. The APR is a more accurate reflection of the total amount you’ll pay on the loan.
 
Most lenders provide an APR range for the loans they offer. The exact APR you qualify for will depend on the loan amount, term length, credit score, income, and whether or not you have a consigner.
 

Prepayment Penalty

A prepayment penalty is when the lender charges you a fee because you pay off the loan ahead of schedule. Lenders may do this so they won’t lose money if you pay off a loan early. If possible, try to find a lender that doesn’t charge a prepayment penalty. Sometimes you may be assessed a prepayment penalty if you refinance your loan with a new lender.
 

Late Payment Penalty

If you miss the due date, you will often be assessed a late payment fee, which will be added to your total bill. Some lenders will waive the first late payment. Late payment fees vary depending on the lender, but can range between $25 and $50. If you are charged a late fee, you may be able to call the lender and ask them to waive the fee.
 

Fees

Most loans charge a number of fees. However, this depends on the type of loan, your credit score, and your lender.
 
Here are some common types of fees you might find:

• Origination fee – An origination fee is a fee that a lender charges in order to create the loan. This fee is often assessed as a percentage of the loan amount.
• Annual fee – Some loans or credit cards charge an annual fee while the account is active.
• Application fee – Some lenders charge an initial application fee, which may or may not be refunded once the loan is finalized. It’s often seen as a deposit on the loan.
• Closing costs – When you take out a mortgage, you will have to pay a variety of fees known as closing costs. These include things such as real estate appraisals, title fees and underwriting fees.

 
Not all types of loans come with the same types of fees. For example, mortgages usually have origination fees while student loans rarely have origination fees.
 

Fixed and Variable Interest Rates

There are two kinds of interest rates that can be assigned to a loan: fixed or variable. A fixed-rate loan will charge the same interest rate during the entire loan term, while a loan with a variable rate will have a rate that fluctuates during the loan term. The loan documents will state how often the rate will change.
 
Mortgages, student loans, personal loans, and home equity loans can have fixed- or variable-rate loans. Interest rates on credit cards also usually vary.
 

Term Length or Loan Repayment Period

The term length is the amount of time that you will have to make payments on the loan. The loan repayment timeline will depend on the type of loan. For example, mortgage terms usually range from 15 to 30 years, while auto loans are shorter, and tend to be for four to seven years.
 

Principal

The principal refers to the loan amount that you borrowed, not including any fees or interest charges. When you make a loan payment, part of the amount will go toward the principal and part will go toward the interest. For most types of loans, the amount paid toward principal will increase as time goes on.
 

Monthly Payment

The monthly payment is the amount that is due every month. Most of the time, there is a minimum monthly payment you must pay to stay current on your loans. However, you can also pay extra every month to pay down the loan faster.
 

Secured and Unsecured Loans

There are two main types of loans: secured and unsecured loans. A secured loan has collateral behind it which the lender can repossess if you default. Mortgages and auto loans are the most common types of secured loans. Unsecured loans have no collateral and, as a result, often have higher interest rates than secured loans. Personal loans and student loans are two examples of unsecured loans.
 

Balloon Payment

Some loans will only require that you make small payments and then one large lump sum payment at the end. This is known as a balloon payment. These are most common with commercial or business loans and less so with loans for individuals.
 

Personal Guarantee

If you make a personal guarantee on a loan, that means you will be held liable for defaulting on it. These guarantees usually apply to business loans. If you’re a business owner taking out a loan, you may have to offer a personal guarantee to qualify for the loan. This means you’ll still be on the hook for the loan, even if you’re not using the funds for personal reasons.

Can You Negotiate the Terms of a Loan?

Some lenders have price-matching programs where they match a competitor’s interest rate – or even beat it. Not every lender will offer that kind of program so shop around to find the best deal. Sometimes your current bank or credit union may provide a better deal because you’re already a customer.
 
Credit unions usually have lower interest rates than major national banks, so start there whether or not you’re already a member.