Taking a personal loan solves many problems and fuels your aspirations. However, knowing the loan terminology before applying for one is a sign of a well-informed borrower. Also, it’s not like buying roses and lilies from the market, where you can negotiate for half the price.
One important thing to remember is to be aware of basic financial language, which can be helpful when finalising a lender and signing the agreement. Here are 25 common personal loan terms you should know to be financially sound.
Annual Percentage Rate (APR) is the borrower's annual cost to take out a personal loan. APR on a personal loan is the combination of the loan’s interest rate and the lender's respective fee, expressed as a percentage rate. It summarises the total annual cost the borrower will pay for the loan.
Application fee, also called a processing fee, is the one-time fee the bank or financial institution charges for processing a personal loan application. The charges for the application can vary across different lenders. It is advisable to compare the charges and fees of various potential financial institutions and banks to understand from an apple-to-apple view.
Put simply, amortisation is an accounting method that gradually reduces the book value of a loan or intangible asset over a specific timeframe. Amortisation is similar to depreciation for assets.
Through this method, a large chunk of payments will go towards interest during the early payoff via regular EMI payments for the tenure. As we continue to pay the amount, less interest is charged, and the amount that goes towards the principal increases. At the end of the amortisation loan, a small amount of interest is due, and only the principal payment is majorly left.
A borrower can be a person or an entity (such as a company) that receives money from the lender (a bank, person, or financial institution). The borrower is also called a primary borrower who must pay back the debt or credit received from the lender according to the loan agreement when applied and as signed.
In case a borrower decides to change lenders, they can transfer the outstanding balance to a new lender offering more favourable terms and benefits. While some financial institutions provide the option for balance transfer, not all lenders or NBFCs offer this facility.
Collateral basically means an asset that a borrower offers to a lender as security against the loan that he borrows. If the borrower fails to repay the loan amount, the lender has the right to seize the security.
A credit score is a three-digit number between 300 and 900 that is part of a credit report. The number varies from individual to individual based on their past credit history. A high credit score shows that the individual has a good history of repaying debts and is considered more creditworthy. This increases their chances of getting a loan with lower interest rates.
The lender first analyses the borrower's credit history and credit score to determine their potency to pay the loan within the stipulated time frame. Credit history can include bill payment history, outstanding history, outstanding debt, and the number of open credit card accounts, among other things.
A credit report has information about the entire credit history of an individual or entity. It provides information about a person's credit activity and present credit status. It includes loan payment history, the current status of every credit card account, and every loan and credit card you have or had in the past. It also tracks and includes records of on-time payments. This helps the potential lender better understand a potential borrower's profile.
A credit agency monitors and reviews the credit of potential loan applicants and borrowers and passes the information to lenders. They act as mediators between the borrowers and lenders, relying on crucial information that helps both parties navigate smoothly for their respective purposes.
The main job of the credit agency is to rely on the creditworthiness of the borrowers to the lenders. They compile and share information like the borrowers' borrowing history and repayment reports to the lenders, which helps the lenders choose the perfect pick by scrutinising and analysing precisely.
A cosigner is someone who jointly signs with a borrower on a loan and takes a contractual obligation to pay back the remaining balance of the loan if the borrower defaults to make the payments. A lender generally requires the borrower to add a cosigner to the application if the credit score and credit history do not suffice to meet the required expectations. Cosigners are usually someone with a stable credit history and good credit score.
Consolidating debt simplifies finances and reduces interest costs. By merging multiple credit card debts or loans into a single monthly payment, debt management becomes easier.
Moreover, personal loans often feature lower Annual Percentage Rates (APR) compared to credit cards, resulting in significant interest savings. Debt consolidation primarily benefits borrowers, as it consolidates the total balance of all debts into one substantial loan for the lender to receive.
Debt-to-income ratio (DTI) is the percentage of monthly total income that goes to paying debts. This helps lenders assess the borrower's capacity to pay regularly and monthly. A lower DTI is a good sign, as it indicates that the borrower is likely to be approved for a loan.
A fixed interest rate is a rate of interest that is fixed in nature and does not change due to the outside rise or fall in the market's interest rate. This gives the borrower stability in terms of repayment of the loan on a monthly basis. Also, personal loans usually come with a fixed interest rate.
A loan agreement is a written contract between a borrower and a lender that outlines the terms and conditions of a loan. It specifies essential details such as the loan amount, which is the total money being borrowed, and the interest rate, which represents the cost of borrowing.
The agreement also includes repayment terms detailing how and when the loan will be paid back and any collateral mentioned as security for the loan. Additionally, it covers default terms, explaining what happens if the borrower fails to repay the loan as agreed.
The origination fee is basically the compensation fee lenders charge for processing the personal loan application. Not all lenders charge origination fees; they vary from lender to lender, and hence, one should have clear communication with their respective lender regarding the same.
The principal amount refers to the actual amount the borrower needs and is sanctioned by the lender. This amount excludes any APR, interest rate, processing fee, etc. For example, if you want to take out a loan of ₹10,000, that is the principal amount you will receive from the lender.
The pre-qualification round is an examination the lender conducts to qualify potential borrowers for loans. They scrutinise and thoroughly review financial statements, soft credit checks, and income statements to determine whether you qualify for a loan. The pre-qualification round does not guarantee the borrower the loan's approval, but it weeds out borrowers who do not seem the right match for the loan.
It is a good sign to pay a loan on time, but sometimes, paying early before its due date can cause prepayment penalties, also called early payoff. Not all lenders take prepayment penalties, so confirming any penalty issue before agreeing regarding loans can be a good practice. These penalties help lenders receive money in some form for lost interest because of prepayment.
A secured loan refers to a loan with collateral attached, which can back the lender as security when the borrower cannot pay the remaining balance amount. The collateral can be any asset nearly equivalent to the borrowed amount.
A loan term indicates the duration for repaying the total amount borrowed, which can vary depending on the loan size. Typically, borrowers have 1 to 5 years to repay, but this period may extend to 10 years for larger sums.
The longer the term, the higher the monthly interest payments. Conversely, a shorter term may be more cost-effective in the long term, though it requires larger payments in the short run.
Underwriting involves the financial risk borne by a lender in exchange for a fee, typically seen in loans, insurance, and investments. It serves as a mechanism for lenders to assess the risk involved in a transaction. Various types of loans have distinct underwriting processes. For instance, in the case of personal loans, underwriting often entails evaluating a borrower's credit history and factoring in the potential risk of default in worst-case scenarios.
Many personal loans are unsecured, meaning no collateral is needed to borrow. Yet, certain lenders provide secured personal loans. It's recommended that individuals with low credit scores explore secured loan choices, as they may present more favourable options.
Variable Interest rate, also called a floating rate or adjustable rate, changes as per the larger financial market. If there are fluctuations in the market, if there is a rise or a downfall seen in the interest of Federal Reserves, then it directly affects the interest rates of variable interest rates.
We hope that this blog post on loan terminology will help you grasp the fundamental and crucial aspects of effectively navigating your personal loan options in the future. Always carefully review the terms and conditions before signing any associated documents when securing a personal loan.
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