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APR, origination fee, prime, subprime — if you’re in the dark about what those terms mean, you’re not alone.
A third of survey respondents ages 18 to 29 gave themselves a grade of “C” when it comes to financial literacy, according to a 2018 Equifax financial literacy survey. Ignorance is definitely not bliss when it comes to making financial decisions, like whether or not to get a loan, how to get a personal loan at the best rate for you, and which loan to choose.
Researching personal loans can be frustrating if you don’t understand the lender jargon you’ll encounter at each step of the process. Terms like “collateral,” “credit score,” “prepayment penalty” and “prime rate” could really throw you for a loop if you don’t know precisely what they mean. Here’s some personal loan lingo and simple definitions that could help.
Personal loans: The basics
A personal loan is a type of short-term installment loan that you can use for just about anything you need or want. Common uses include paying off high-interest debt like credit cards, consolidating multiple loans into one payment, making home improvements, paying medical bills, or financing a large one-time expense.
Unlike a credit card, a personal loan is for a specific amount of money and is repaid in fixed monthly payments, called installments, for a predetermined number of months. The repayment term varies, depending on the loan it could be as short as 12 months or as long as seven years. When you make the last payment to pay the loan in full, the loan ends and your account is closed. To borrow more money, you’d have to apply for another loan.
Personal loans can be secured or unsecured. For a secured loan, you must put up some personal property as collateral, such as a savings account or certificate of deposit. If you default on the loan, the lender typically has the right to seize your collateral as payment for the loan.
Unsecured personal loans aren’t backed by collateral. Instead, lenders look at your financial history to decide whether you qualify for the loan. Because they’re not secured, unsecured personal loans often come with a higher interest rate than you might get for a secured loan.
Personal loans are available from banks, credit unions, online lenders, and peer-to-peer lending platforms.
Before you apply
Before you apply for a personal loan, you should think about why you want it and evaluate other options. If you’re thinking about using a loan for something you want but don’t need, it’s probably better to save up for it instead of borrowing and paying interest.
If you want to use a personal loan to pay off debt, consider other options as well, like a balance transfer card with a 0% introductory rate. Paying the balance in full before the introductory rate ends means you won’t have to pay any interest on the transferred balance. But failing to pay in full by then could cause you to owe a lot in interest on any remaining balance. You’d have to keep your eye on the introductory time frame to make it worth your while.
When you apply for a personal loan, the lender will pull your credit. This could involve what’s known as a hard inquiry, which could stay on your credit reports for about two years, and could negatively affect your credit scores, depending on your situation.
Personal loan lingo: The definitions
Annual percentage rate (APR)
The amount of interest and other costs (such as fees) that you pay to borrow a sum of money, expressed as an annual rate. The APR represents the total cost of borrowing money.
An amount that’s deducted automatically from your bank account and paid to your lender as your loan payment. Some lenders offer a rate discount if you agree to set up automatic payments.
Property that you own and offer your lender to secure your loan. If you don’t repay the loan, the lender can typically claim the collateral to pay the loan.
Credit reports show information about your use of credit and credit history. The three major consumer credit bureaus — Equifax, Experian and TransUnion — each prepares a credit report that may be used by lenders. They generally include personal information like your payment history, how many credit accounts you have, how much credit you’re using and how long you’ve been using credit. Most reports include your name, social security number, current and former addresses and employer history.
Your credit scores are numerical representations of the information in your credit reports. Depending on the credit-scoring model used, scores typically range from 300 to 850. Lenders typically view credit scores and reports as an indication of how likely (or unlikely) you are to repay debt. Higher scores can indicate to lenders that you probably will make payments on time and repay the loan as agreed.
When you fail to repay a loan according to the terms of your loan agreement, the loan will be considered to be in default.
When you make late payments or miss payments, your credit account will be considered delinquent.
A service by which a sum of money is electronically deposited into a bank account (without a paper check). If you’re approved for a personal loan, your lender may offer to directly deposit the funds into your bank account.
Fixed interest rate
An interest rate that doesn’t change or adjust during part of the term or the entire term of the loan.
A loan for a fixed amount of money that requires fixed payments at specific intervals for a set period of time. Personal loans are a type of installment loan.
The amount you pay to borrow a sum of money, not including fees or additional charges. The interest rate is expressed as a percentage of the amount of money you borrowed. Interest rates are usually annualized.
A company, organization or individual that makes a loan to a borrower. Examples include banks, credit unions, online lenders and peer-to-peer lenders.
The amount that you’re required to pay to the lender by a specific date each month until your loan has been repaid in full.
Online loan application
A form that you’re required to complete via the internet to apply for a loan from a lender. Some lenders allow you to check if you prequalify online, which can give you an idea of whether you have a good chance of getting the loan, and submit loan applications online.
A fee that the lender charges the borrower for initiating your loan application and issuing your loan. An origination fee is usually calculated as a percentage of your loan amount.
A loan from individuals or investors to another person without the use of a traditional financial institution, such as a bank or credit union. Borrowers and lenders are typically matched through a peer-to-peer, or P2P, online lending service, sometimes called a “platform.”
A fee that some lenders charge if you pay off all or part of your loan early. The penalty compensates the lender for interest you didn’t pay because you made fewer payments than the lender expected to receive.
The lowest interest that a commercial bank typically charges its most-creditworthy borrowers. The Wall Street Journal publishes an average prime rate that’s an average of large commercial banks’ prime rates.
The amount of money you borrowed from your lender, excluding interest. As you pay off your loan, this amount will decrease.
The maximum amount of time you have to repay the loan in full.
A loan that is backed by collateral that your lender can typically collect if you fail to repay the loan.
A loan that is not backed by collateral.
Variable interest rate
An interest rate that can change after the loan terms are set. Your loan agreement should specify how this rate is determined and under what circumstances it can change. A variable interest rate usually changes with the prime rate, as published in the Wall Street Journal.
A personal loan can be a helpful financial tool when you need money for a big expense or to consolidate debt. But it’s important to understand exactly what you’re agreeing to when you take out a personal loan. And you need to have a solid plan for repaying the loan according to your agreement with the lender.
Learning common personal loan terms, and researching how personal loans work, can help you feel more confident that you’re making a good decision and getting a personal loan at the best possible rate.