Common and Important Loan Terms to Know

Imagine you’re applying for a payday loan to cover some unanticipated car repairs, feeling the urgency of your financial need. But, suddenly, you’re bombarded with confusing loan terms that leave you more anxious than relieved. It can be frustrating, even scary, to work your way through these unfamiliar waters. 

Understanding these loan terms is super important—not just for making smarter financial decisions but also for avoiding unexpected problems. This blog will serve as a glossary of some of the most common and important loan terms that you need to know.

Common Loan Terms to Add to Your Vocabulary

We all strive now and then to grow our financial literacy, and for good reason. We need to be in the know on how to manage our credit scores, how to keep our credit card and loan balances in check, staying on top of bill payments, and so much more. But sometimes, this can be overwhelming. Thankfully, understanding common loan terms isn’t all that complicated—you just need to know where to start.

Here are five loan terms to know and help you get started with improving your financial literacy.

Principal

The principal is the original amount of money you borrow when you take out a loan. For example, if you borrow $1,000, that $1,000 is your principal. Understanding the principal is important because it’s the base amount on which interest is calculated. Paying down the principal reduces the overall amount you owe.

Interest Rate

The interest rate is the cost of borrowing money, expressed as a percentage of the principal. There are two types of interest rates: fixed and variable. A fixed interest rate stays the same for the entire loan term, while a variable interest rate can change over time. Higher interest rates increase the total cost of the loan.

To help you understand the significance of an interest rate, the average interest rate for a personal loan is currently hovering around 12.35%. This rate assumes a high credit score and a respectable income-to-debt ratio. If your credit score is not as high as you would like it to be, it doesn’t prevent you from getting a loan, but you will typically pay a much higher interest rate.

Annual Percentage Rate (APR)

APR stands for Annual Percentage Rate. It includes the interest rate and any additional fees or costs associated with the loan, giving you a more complete picture of what you’re paying. The APR is useful for comparing different loan offers because it shows the true cost of borrowing.

Term

The term of a loan is the length of time you have to repay it. This can range from a few months to several years. The loan term affects your monthly payments and the total amount of interest you will pay. Longer terms usually mean lower monthly payments but more interest paid over time.

Amortization

Amortization is paying off a loan through regular payments over time. An amortization schedule shows how much of each payment goes toward the principal and how much goes toward interest. This helps you understand how your loan balance decreases with each payment.

Terms Around Fees + Costs of a Loan

When you start researching loan options, you need to pay attention to the overall fees and how much you will pay over the course of your loan. Unless you are able to obtain a rare 0% interest loan option, you will be responsible for paying back more than the amount you borrowed. Here are the key loan terms you need to know regarding the cost of borrowing.

Origination Fee

An origination fee is charged by the lender for processing your loan application. It is usually a percentage of the loan amount, often around 1% to 5%. This fee is deducted from the loan amount before you receive the funds, so it’s important to account for this cost when planning your loan.

Prepayment Penalty

A prepayment penalty is a fee that some lenders charge if you pay off your loan early. This penalty compensates the lender for the interest they lose out on when you pay the loan off ahead of schedule. Not all loans have prepayment penalties, so be sure to check your loan terms.

Late Payment Fee

Late payment fees are charged when you miss a loan payment or pay after the due date. These fees can add up quickly and negatively impact your credit score. It’s so important to make payments on time to avoid these extra costs and maintain a good credit standing. If your lender reports payment history to the credit bureaus (Experian, Equifax, and TransUnion), those late payments will really work against you. 

Closing Costs

Closing costs are fees associated with finalizing a loan, especially for mortgages. They include appraisal fees, title insurance, and attorney fees, among others. Closing costs can range from 2% to 5% of the loan amount, so it’s important to budget for these expenses when taking out a loan.

Legal and Financial Protection Terms for Loans

Last but certainly not least, you should be in the know about some important legal and protection-related loan terms. Being aware of these before you apply for a loan and sign on the dotted line can keep you from being unpleasantly surprised later.

Here are the terms you need to know.

Collateral

Collateral is an asset you pledge to the lender to secure a loan. If you fail to repay the loan, the lender can take the collateral to recover their money. Common collateral includes cars, homes, or savings accounts. Collateral makes loans less risky for lenders and can help you get better terms.

Co-signer

A co-signer is someone who agrees to repay the loan if you can’t. They share responsibility for the loan, and their credit is on the line just like yours. Having a co-signer can help you get approved for a loan or secure better terms, especially if you have a limited credit history.

Default

Defaulting on a loan means you have failed to make payments as agreed in the loan contract. Defaulting can lead to serious consequences, such as damage to your credit score, additional fees, and legal action. It can also result in losing any collateral you put up to secure the loan.

Debt-to-Income Ratio (DTI)

The Debt-to-Income Ratio (DTI) measures your monthly debt payments compared to your monthly income. Lenders use DTI to assess your ability to repay a loan. A lower DTI indicates better financial health and improves your chances of loan approval, while a higher DTI can signal risk to lenders. 

Ideally, you should target a debt-to-income ratio of 43% or lower, but many lenders look for a ratio closer to 35%. And if you have a low debt-to-income ratio, strive to keep it that way rather than assuming you can simply take on more debt. This can quickly become a runaway train.

In Need of Quick Cash to Pay for Emergency Expenses?

Generally speaking, even if your credit score is less than ideal and you don’t qualify for more traditional lending options, it is always best to do your homework on options that will allow you to pay off your debts on time. 

So, in the event of those emergency car repairs we shared above, it is better to take out a loan, borrow from a family member or friend, or put those expenses on your credit card than it is to default on the payment due. But, no matter what approach you take, make sure that you can fulfill any payback terms. 

Cash Loans Direct offers loans to help you stay on top of emergency expenses. Apply today.