When you decide to take out a loan, you might already be a little anxious about the situation. You hope you’re doing the right thing and taking out the right kind of loan. On top of that stress, you see the loan agreement and suddenly feel like you’re reading hieroglyphics. Don’t let crazy loan terminology freak you out into signing something you never meant to sign.
Understanding the commitment you’re about to make is extremely important. Without fully comprehending what you’re signing up for, you’ll be less likely to pay it all back on time and avoid debt. This glossary defines many common loan agreement terms so you can know what you’re getting yourself into.
ARM: This stands for “adjustable-rate mortgage” and refers to a loan with a changing interest rate based on a specified index. It usually involves a cap, but the interest rate will start low with the risk of changing in the future.
Additional Principal Payment: This is money given to the lender on top of the payment amount in order to make the loan span a shorter period of time. So if you have more money than you need to pay, you can hand it over and try to shorten the borrowing time period.
Annual Percentage Rate: Usually referred to as APR, this rate represents the cost of your loan yearly, including interest and other fees. It is always listed as a percentage.
Balloon Payment: The final sum payment made at the end of a balloon loan, which involves payments with low interest rates that don’t fully pay off what’s borrowed. You basically have to cover the rest of the money you never paid back via the previous payments.
Collateral: Something you pledge to guarantee you’ll pay back the loan. If you don’t, you risk losing this asset (whether it be money, property, etc.).
Finance Charge: This is the cost of actually borrowing the money throughout the entire life of the loan. For example, you know how much you’re borrowing, but because of interest rates and fees, you always end up paying more. This lets you know what that additional amount is, and then you can plan accordingly.
Interest: You’ve probably heard about the dreaded I-word, but just in case, interest is the charge for borrowing the money. It’s an amount you’ll have to pay back on top of the money originally borrowed.
Lock-in Period: This is the time period the lender guarantees a certain interest rate that won’t change.
Margin: Read “ARM” to make this definition easier. When an ARM loan is up for an interest rate adjustment, the margin is the number of percentage points the lender adds to the index rate in order to calculate the changes.
Point: A point equals 1% of the loan amount, usually in the case of mortgage loans. The lender uses points to cover loan costs like the expense of making the loan. Sometimes borrowers pay points to reduce the interest rate.
Prepayment Penalty: A charge you get if you pay off your loan before you’re scheduled to pay it off. Most standard lenders don’t implement this penalty, but make sure it’s not included in your agreement so you’re not caught off guard later.
Principal: This number strictly represents the amount of money you’ve borrowed (or the amount of money you owe) without including interest. So here’s the equation: Original loan – amount repaid – interest fees = principal.
Qualifying ratios: Lenders create this ratio in order to figure out what you can afford to borrow. It usually involves a comparison between your expenses and your income.
Settlement: The closing of a loan, usually a mortgage loan.
Total of Payments: This number is the amount you’ll have paid once you’ve made every payment scheduled. This terminology has been found on payday loan agreements.
Underwriter: The person who analyzes the risk involved in giving a borrower a loan. He or she usually considers your credit history, assets, and employment, and this process is generally related to mortgage loans.
When you read a bunch of text about balloons and principals and ratios, you may think it’s a description of an algebra classroom party, but this breakdown will help you identify what exactly it is you’re looking at and what it means for you.