May 16, 2024
Maybe you already know that a personal loan can be used to consolidate debt or pay for life’s big events. But have you ever wondered what “APR” stands for?
And do you know the difference between a secured loan and an unsecured loan? If you feel confused by financial terminology, you’re not alone. Loan agreements and the words they use are not things most people talk about every day.
That’s why we created this glossary of common words and phrases you might run into as you compare lenders and loan agreements.
Use this guide to get familiar with basic loan terminology. Then, as you consider your borrowing options, you will be able to understand your choices better and apply for the loan that’s best for you.
Amortization is the process of paying down your loan balance over time in equal monthly payments. Typically, a larger chunk of payments made early in the life of the loan will go toward interest. As you continue to pay down the loan, less interest is charged, and the amount of each payment that goes toward the principal increases. Toward the end of an amortized loan, most of the payment is principal while only a small amount of interest is charged.
When you see the acronym APR, it stands for Annual Percentage Rate. APR is a combination of a loan’s interest rate plus lender fees, and it is shown as a percentage of the total loan amount. APR is the percentage of interest and fees you can expect to pay in a single year.
Want to learn more? Read APR vs. Interest Rates: What’s the Difference?
A person or entity (such as a company) that receives money from a lender is a borrower. Also called a primary borrower, they are responsible for paying back the debt or credit received from a lender.
Collateral is an asset that secures a loan. For a mortgage, the house is the collateral. For an auto loan, the car serves as collateral. If a borrower defaults on a loan, the lender can claim the collateral to offset the cost of the defaulted loan.
A credit report contains information about a consumer’s credit history. It includes a record of on-time payments and the status of all your credit accounts, including every loan and credit card you have currently or have had in the past. The three main credit reporting agencies are Equifax, Experian, and TransUnion.
A credit score is part of a credit report. It’s a number from 300 to 850 assigned to a consumer based on their credit history, which can include bill payment history, outstanding debt, and the number of open credit card accounts, among other things. The higher your credit score, the more creditworthy lenders perceive you to be (that is, they believe that you are more likely to repay your loan on time). On the other hand, a lower score may make it harder for you to get a loan.
Debt consolidation is when you combine balances from other credit accounts into one fixed-rate loan. In some cases, it makes sense for borrowers to bundle higher-interest debt owed to multiple creditors into one loan with a lower rate or a different repayment term. Debt consolidation can be a great way to save money on interest and simplify your finances.
Learn more about debt consolidation.
Also known as DTI, your debt-to-income ratio is the percentage of your monthly total income that goes toward paying your debts. Lenders calculate this percentage to determine if you’ll be able to keep up with payments on any new debts. So, the lower your DTI, the more likely you are to be able to get approved for loans.
Interest rate is the percentage you pay each year to borrow money. As its name suggests, a fixed interest rate stays the same over the life of the loan, so your monthly payment will stay the same. The rate will not change even if interest rates rise or fall. Personal loans typically come with fixed interest rates.
Your gross income is the total amount you earn before any taxes or deductions are taken out. It includes wages, profits, and any other type of earnings.
An installment loan is any loan that is paid back with a regular monthly amount. Examples include a mortgage, a car loan, and a personal loan.
Interest is the money lenders charge for borrowing money. It is a percentage of the total amount borrowed. For example, if you get approved for an $18,000 loan at 12.99% APR for a term of 72 months, you'll pay just $361 per month.
An origination fee is a charge for setting up a loan. It compensates the lender for the time they spend processing the loan. Not all lenders charge origination and other fees. For example, Discover® Personal Loans doesn’t charge any fees as long as you pay on time.
Payment term or repayment term refer to how long you have to pay off a loan. The length of the payment term could affect the amount of interest you pay over the life of the loan and your monthly payment amount.
For example, if you pay off a loan as quickly as possible, you could lower your total interest paid. But that would increase your monthly payment. On the other hand, a longer repayment period could mean lower monthly payments, but more interest paid overall.
Sometimes a lender will charge a fee if a borrower pays off their loan before its final payment due date. Not all lenders charge prepayment penalties. Discover Personal Loans, for example, does not. Be sure to review your loan agreement to see if one applies. Prepayment penalties and other lender fees can increase the total cost of borrowing.
Principal means the amount of money being borrowed. It does not include any interest, APR, or fees. For example, if you take out a personal loan for $18,000, that is the principal.
Refinancing means applying for a new loan to pay off an existing loan. If you have improved your financial standing and have a good repayment history, you may have the opportunity to refinance with the same lender or a different bank. A new loan could result in lower payments, lower interest rates, or a shorter term, depending on your situation and the interest rate you qualify for.
Want to learn more? Check out our recommended reading: Can You Refinance a Personal Loan?
Revolving credit lets you borrow up to your credit limit. As you pay down your balance, you can borrow up to that limit again. The most common example of revolving credit is a credit card. Because the amount you owe and your interest rate can vary, monthly payments can change, and there is no set number of payments.
A secured loan requires the borrower to put up collateral, such as a house or a car. If the borrower defaults on the loan, the lender can take possession of that collateral.
Underwriting is the process a lender uses to decide if the risk of offering a loan to a borrower is acceptable. The underwriting process can differ depending on what type of loan you are applying for. With a personal loan, underwriting involves reviewing a borrower’s credit history and considering the risk of nonpayment. Underwriting for a mortgage is more involved: It includes an appraisal of the property and a review of the borrower’s personal finances, among other steps.
Want to learn more? Check out our recommended reading: What is Underwriting?
An unsecured loan does not require the borrower to provide collateral. Personal loans, credit cards, and student loans are unsecured loans. This is an important distinction to understand: A personal loan is not a secured loan and does not put your collateral at risk.
Read What’s the Difference Between Secured and Unsecured Loans? to learn more.
Sometimes called floating or adjustable rates, variable interest rates change along with what’s happening in the larger financial market. If the Federal Reserve raises interest rates, for example, a variable rate will also increase.
With this glossary of personal loans terminology, you should be better equipped to evaluate which loan is right for you.
And when you are ready to apply, be sure to read about what you’ll need to apply for a personal loan.
