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Terminologies You Should Know Before Taking Out a Loan

Loans are generally thought to be negative, but the truth is that they can be fantastic instruments to help you with larger financial goals such as funding a car or a home renovation project. If you are unfamiliar with specific loan terms, however, you may be at a disadvantage when assessing a loan or comparing terms from different lenders.


The following are some popular loan phrases that can help you broaden your loan vocabulary. It can make a better-educated choice when borrowing money and ensure that you know exactly what you’re in for when signing the dotted line.


Annual Percentage Rate (APR) - The annual cost of your loan proceeds computed over the loan's duration is your APR. This rate includes loan interest and any upfront financing costs, such as loan origination or application fees.


Charge-off: A charge-off is an accounting phrase that usually refers to a debt that has grown severely overdue. When a lender charges off a loan, it implies the debt is written off as an accounting loss for the business. However, the borrower is still liable for repaying the owed amount. A charged-off debt usually stays on a borrower's credit history for seven years and hurts credit scores throughout that period.


Collateral: Property that a borrower pledges as security for the repayment of a loan is referred to as collateral. If the loan is not paid in full or the borrower defaults, the lender may seize and sell the collateral to recoup their losses.


Cosigner: In addition to the primary borrower, a consigner is a person who files a loan application alongside the principal borrower. The cosigner's income and credit score are also considered, enhancing the likelihood of the loan being accepted.


Credit: Credit refers to the capacity to borrow money to buy products or services now and pay for them tomorrow.


Credit score: A credit score is a rating that informs lenders about your likelihood of repaying the loan on schedule. The three main credit bureaus generate their scores based on the information in your credit report so that you may have three different credit scores.


Creditworthiness: Creditworthiness is the capacity of a borrower to repay debts in the future. A person's creditworthiness is determined by several variables that lenders use to assess whether borrowers will fulfill their credit obligations.


Daily Simple Interest: Daily Simple Interest is a technique of computing loan interest based on the loan's current unpaid principal amount. Payments are applied first to any additional costs specified in your loan agreement, then to the interest accumulated, and finally to the principal amount. More of your payment goes to the principal when you pay early, and when you pay late, more of your money goes to interest. More of your monthly payment is allocated to the principal as the amount lowers. In your monthly statement, the amount of your payment allocated to interest shows as a different line item.


Debt Consolidation: Obtaining a new loan to pay off one or more existing obligations is a process referred to as debt consolidation. Credit cards, personal loans, and vehicle loans are examples of debts that may be consolidated.


Deferment: Due to financial difficulty, deferment is the capacity to postpone paying a loan payment until later temporarily. A loan deferral may help a borrower keep their account current while avoiding penalties such as late fees.


Fixed payments: Fixed payments are agreed-upon fees that remain constant throughout the life of a loan as long as the borrower pays regular installments on time.


Fixed-rate: A loan with a fixed interest rate does not vary throughout the loan term. This is typical in the case of personal loans.


Installment loan: Installment loans are predetermined sums of money borrowed and returned with interest via regular monthly installments. Mortgages, car loans, personal loans, and student loans are the most common installment loans.


Interest rate: An interest rate is the fee that a lender charges a borrower for taking out a loan, typically stated as an annual rate applied to your outstanding principal debt.


Lien: Lien is a legal claim on a consumer's property by a lender to pay outstanding debt.


Origination fee: An origination fee is a one-time and an upfront operating fee charged by a lender to cover loan processing expenses.


Precomputed interest: Calculating the interest that will be payable throughout the period in which interest is recalculated at the time of loan origination to estimate the total amount you will pay back. This sum is shown as the "Total of Payments" on your loan agreement. Your monthly payments are then applied to additional charges specified in your loan agreement, and the "Total of Payments" number is reduced.


Prepayment fee: Some lenders impose a one-time fee for paying off a loan ahead of schedule. The world does not charge a fee for prepayment.


Prequalification: Prequalification is a fast method for lenders to assess what kind of loan a borrower may be eligible for, if any. It is critical not to mistake prequalification with pre approval, which is a more official promise from a lender and often requires extra paperwork.


Principal: A loan’s principal is the amount of money you borrowed from a financial company. It does not include interest and any other fees.


Refinancing: Refinancing is the act of paying off a previous debt with a new loan to save money on interest, reduce monthly payments, or get better loan conditions.


Secured loans vs. unsecured loans: Secured loans are those whose repayment is guaranteed by collateral. Unsecured loans do not need collateral, are typically granted based on the applicant's creditworthiness and may have higher interest rates than secured loans.


Signature loan: A signature loan is a kind of unsecured loan in which the borrower's credit history, income, and signature guarantee that they would return the debt. It is sometimes referred to as a "good faith loan" or a "character loan."


Term: A loan’s term is the number of months or years upon which the borrower agrees to repay the principal.


Variable-rate: An interest rate that may fluctuate over time in reaction to market fluctuations. A loan payment with a variable interest rate may increase or decrease when the prime rate changes.


These terminology and definitions are intended to provide basic, informal meanings for words and phrases that you may see on your loan documents that seem unfamiliar to you. However, the precise meaning of a word or phrase is determined by where and how it is used.


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