Learn the language of loans

If you’re getting ready to take out a loan, it’s important to understand what you’re signing up for. While your lender should address all your questions and concerns, it’s a good idea to do some quick studying on your own so you can be your own advocate every step of the way. We’ll touch on some important loan concepts and terms to give you the foundation you need to go about the loan process with confidence. 

Why take out a loan? 

There are many reasons you may need a loan, such as buying a car or house or starting a business. People commonly take out loans to: 

• Make major purchases 
• Consolidate debt 
• Pay for tuition 
• Cover emergency expenses 

Whatever your loan might be for, it’s important to understand the terms and conditions before you sign on the dotted line. Plus, you’ll want to be sure you can afford your loan payments  and have a solid plan to pay them off. 

Important loan language: mini glossary

Looking over a loan agreement for the first time can be a bit overwhelming, but a quick look at common loan vocabulary can help immensely. Here are some key terms you might hear: 

• APR: Annual percentage rate, or the amount of interest you'll pay on your loan each year. 
• Borrower: The person borrowing money from a lender (in this case, you). 
• Co-borrower: An individual who is jointly responsible for paying back the loan with you such as two spouses who own a home together.  
• Co-signer: An individual who agrees to sign on a loan to help someone who has a lower credit score, or inadequate credit history qualify for a loan. Co-signers are held responsible for repaying the loan if the primary borrower misses a payment or defaults on the loan ; this affects the co-signer’s credit score as well. 
• Collateral: An asset you'll use to secure the loan. If you default on the loan, the lender can seize the collateral. We’ll touch on more details about collateral later. 
• Credit score: Lenders will check your credit score to determine how risky you are as a borrower. Your score will likely come from one of three nationwide reporting bureaus – Equifax, TransUnion or Experian – and is based on factors like your payment history, the amount of debt you already have and the length of your credit history. The higher your score, the more likely it is your interest rate will be competitive. 
• Fees: There are multiple fees you may be required to pay throughout the loan process, which we’ll explain shortly. 
• Grace period:  A set length of time after the payment due date has passed during which payment may be made without a penalty or late payment fee being applied. Most lenders offer a typical grace period of 10 - 15 days depending on the type of loan. 
• Hard credit check: A formal credit inquiry that has a small impact on your score. This happens when you apply for a loan, and it usually drops your credit score by a few points and remains on your credit report for one to two years. 
• Interest: The fee you'll pay to the lender for borrowing the money. 
• Loan amortization: A schedule that maps out how much principal and interest goes into each payment for the life of the loan – this only applies when your loan has a fixed interest rate and a known pay-off date. 
• Prepayment penalty: A penalty for paying off some or all of your loan before the end of the loan term. Be sure to ask your lender if your loan will have prepayment penalties so you know if you can pay it off early without incurring additional charges. 
• Prequalification/Preapproval: While often used interchangeably, these two terms do have different meanings. In general, prequalification and preapproval are assessments to determine if you’ll likely be approved for a new loan or credit card. These two words tend to have different meanings and processes depending on the lender and the type of loan. The prequalification process is typically less detailed and is generally not a guarantee for approval once an actual loan application is submitted. In comparison, the preapproval process includes a more comprehensive look at an applicant’s credit report and repayment ability, and while it’s still not a guarantee for approval, being preapproved for a loan often offers greater insight as to what loan terms a lender may be able to offer once an application is submitted and approved.  
• Principal: The amount of money you’re borrowing. 
• Repayment schedule: The timeline you'll follow to repay the loan. 
• Soft credit check: A quick check that has no impact on your credit score. This happens when you view your credit score or give a lender permission to check your score so you can get prequalified. 

Loan collateral and fees: a closer look 

Collateral 

Collateral is an asset that you pledge as security for a loan – when there’s collateral attached to your loan, it’s usually referred to as a secured loan. If you default on the loan, the lender can seize the collateral to recoup their losses. They can also charge you penalties and fees, which can add up quickly. There are a few things to keep in mind if you're using collateral to secure a loan: 

1. The value of the collateral must be equal to or greater than the amount of the loan. 
2. You'll usually be required to pay a higher interest rate if you're using collateral. 
3. If you default on the loan, you could lose your collateral. 

If you're considering taking out a secured loan, be sure to understand the concept of collateral and the risks involved. 

Fees

There are a variety of fees associated with taking out a loan. These fees can vary depending on the type of loan, the lender and the borrower's credit history. Some common loan fees include origination fees, application fees and closing costs. 

• Origination fees  are charged by the lender for processing the loan; they typically range from 0.5% to 1% of the total loan amount. 
• Application fees  are charged by the lender to cover the cost of running a credit check and other related expenses; they usually total a flat rate of up to $500 that can sometimes be negotiated. 
• Closing costs  are paid by the borrower at the time of closing and can include title insurance, appraisal fees and recording fees; they typically range from about 2% to 5% of the total loan amount. 

While loan fees can add up, remember that negotiation isn’t off the table. Don’t be afraid to ask your lender to explain fees you find confusing or excessive. 

Ask questions now - sign later

You’re not expected to become a loan expert overnight – especially if you’re borrowing from a reputable lender – but you can use this mini glossary to boost your confidence going into the loan process. Remember to take your time understanding all the details of your loan agreement, including your interest rate and the length of the loan term. Don’t be afraid to ask questions and speak up when you have concerns. You should only sign off on your loan when you’re completely confident you understand what you’re agreeing to.