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Loan Terminology to Know

By: Susan Verbeck, Chief Lending Officer

Posted on 11/9/2020 7:51:31 AM

A young man and woman is sitting at a table facing a woman. The couple is smiling and shaking hands with the woman. There is a piece of paper and pen on the table.

Loans have a lot of specific terms and jargon that can be confusing, even to experienced borrowers. In this list, we’re going to look at the most common loan terms so you can be informed, whether you’re looking to purchase a home or car or take out a personal loan.

We’ll start with the basics, then cover a longer list of terminology that’s often used when talking about payments. Finally, we’ll cover the basic loan vocabulary to be familiar with when filling out a loan application. This is a thorough list, so we recommend reading it through once and then bookmarking the link so you can quickly reference it.

Basic Loan Terminology

  • Borrower – The person borrowing money from the financial institution, who will be responsible for repayment of the loan.
  • Lender – The financial institution lending money to the borrower
  • Servicing – The act of managing and collecting payments on a loan. Sometimes this is performed by the lender, but other times it is performed by another institution.
  • Underwriting – The act of reviewing a loan application and assessing the financial risk of the borrower. This service is performed by an underwriter, not to be confused with a loan officer, who is your point of contact for your loan.
  • Secured Loan – A loan connected to a piece of collateral, such as a car. If the borrower doesn’t meet their financial obligation, the lender can take possession of the collateral. These types of loans are usually easier to get and have lower interest rates. 
  • Unsecured Loan – A loan that isn’t connected to any collateral. These types of loans usually have a higher interest rate because they represent more risk to the lender.
  • Collateral – Something owned by the borrower that can be taken away if they don’t pay their loan according to the terms. Loans like mortgages and auto loans use the object of the loan as collateral. For example, in an auto loan, your car can be repossessed if you don’t fulfill your payment terms.
  • Promissory Note – The promissory note is the legal document, signed by the lender and borrower, which details all the loan terms and binds both parties to those terms. It is also sometimes called a loan agreement.
  • Disbursement – In a nutshell, disbursement is simply the delivery of funds to an account. Regarding loans, this is usually relevant for student loans where the lender deposits an amount of money into the student’s financial account rather than directly paying the academic institution.
  • Refinancing – When you take out a new loan to pay off another loan in full. This is usually done when you can get a newer loan with better terms, such as a lower interest rate.
  • Equity – For loans, specifically mortgages and auto loans, equity refers to the difference between the value of the home vs. how much is owed. It can be negative or positive.

Loan Payment Terminology

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  • Installment – An agreed upon amount the borrower pays each month.
  • Loan Term – All the agreed upon details of the loan including how much the borrower pays each month, the interest rate, and how long the borrower has to pay back the loan.
  • Interest Rate – The amount the borrower has to pay for taking out the loan. It is usually expressed as a percentage of the total amount of the loan.
  • APR – Annual percentage rate, or APR, is the total amount the lender charges for the loaned money, which includes the interest rate and any fees or other charges.
  • Fixed Rate – An interest rate that does not fluctuate. It stays the same over the life of the loan. An adjustable rate or variable rate loan has an interest rate that will fluctuate, usually starting out below market value and increasing over the life of the loan.
  • Fixed Payment – The payment for a fixed rate loan that remains the same over the life of the loan.
  • Maximum Time to Repay – The maximum amount of time the borrower has to pay back the loan.
  • Minimum Payment – The minimum amount the borrower must pay each month.
  • Principal – The amount being borrowed, which does not include any interest or fees.
  • Origination Fee – A fee charged by a lender to cover the cost of processing the loan.
  • Guarantee Fee – Loans are usually backed by a different institution than the lender. This institution will charge the lender a fee to guarantee that payments will be made, even if the borrower does not live up to their end of the agreement. This fee can sometimes be passed on to the borrower.
  • Prepayment Fee – A fee that can be charged to the borrower when they pay off the entirety of the loan before the end of the loan term.
  • Down Payment – Money a borrower pays out-of-pocket towards the purchase price of the item being borrowed against. For example, if a car is $20,000, a borrower can make a $5,000 down payment, which will reduce the principal amount of the loan to $15,000.
  • Amortization – In simple terms, amortization is the process of paying off the principal and interest of a loan through installments. But amortization also refers to the process of front-loading interest payments so that the interest is paid first before the principal is fulfilled.
  • Payoff – To pay off a loan is to pay the remaining balance, including interest, principal and fees. Sometimes, loan terms indicate that you’ll be charged a prepayment fee.
  • Capitalization – This is additional interest added to a loan, often as a result of late payments or as a result of choosing to avoid upfront interest payments, usually in the case of a student loan. In simple terms, capitalization means paying interest on interest.
  • Default – This happens when the borrower has not met their agreed upon monthly payments for a period of time. The loan is then transferred to a collection agency and repossession can occur.
  • Deferment – An agreement between the borrower and lender to temporarily suspend monthly payments without accruing more interest.
  • Forbearance – An agreement between the borrower and lender to temporarily suspend monthly principal payments while interest continues to accrue, which, if not paid during forbearance, will be capitalized.
  • Charge-Off – After a loan has gone into default, but the collection agency has not been successful in collecting money, the account is closed. However, this is considered a serious derogatory mark on your credit report.

Loan Application Terminology

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  • Applicant – The person applying for the loan.
  • Co-Signer – An additional person who is not the borrower or applicant on the loan, but whose credit and income will be considered to help the applicant’s chance for approval. The co-signer will be responsible for payments not made by the borrower.
  • Application Fee – A fee that is sometimes charged to process an application and assess the applicant’s financial risk.
  • Prequalification – A lender reviews the application and gives the applicant an estimated amount that they could potentially borrow based on the initial review of their financial risk.
  • Preapproval – Unlike a prequalification, a preapproval is the actual amount the applicant will be able to borrow.
  • Net Income – Net income is the amount an applicant earns after all taxes and deductions are accounted for.
  • Credit Score – A credit score is a three-digit number that represents your financial risk, categorized on a scale of Poor to Excellent with lower numbers representing more risk.
  • Debt to Income Ratio – The number that results from dividing your debt by your income. Typically, this is calculated by looking at your monthly debt payments vs your gross monthly income (total income before taxes). Most lenders want your debt to be no more than 30%-43% of your total income.

Community First offers a number of different loans to help you finance your goals. Check out our loan options for more details or give us a call to find out which loan is right for you 904.354.8537.

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