Loans have long been around, and one way of looking at them is that they’re a stepping stone towards achieving your personal and financial goals. Whether it’s buying a home, financing a degree, or starting a business borrowing money can be a quick way of moving forward with your plans. In years gone by, loans were often established and settled with handshakes, but of course, in today’s world things are much more formal and complex. The paperwork needing to be completed when applying for a loan can be inches deep and quite often the terminology used in these documents can be confusing. Because Grow Financial Solutions’ motto is “making finance simple”, in this article we’ll help you understand some of the common loan terms, what they mean and what to look out for when considering applying for finance.
Basic Loan Terminology
Before taking a look at some of the more complex terminology associated with loans, it’s important to understand the basic terms that often arise in any type of borrowing agreement.
Principal: The amount borrowed from a lender.
Interest: The fee charged by the lender for borrowing money, and is usually calculated as a percentage of the principal amount.
Term: The length of time in which the borrower has to repay the loan.
Collateral: An asset used as security against the loan. In case the borrower fails to repay the loan, the lender can seize this.
When you sign a loan agreement, you’re entering into a contract with a lender to borrow a certain amount of money under specific conditions. These conditions, or loan terms, outline everything from how much you’ll pay each month, to the interest rate, to the consequences of missing a payment. Understanding the contract is crucial – not only to ensure you can meet your obligations – but also to know you’re getting a fair deal.
Key Loan Terms You Need to Know
Interest Rates: Fixed vs. Variable
Interest rates have a huge influence on the total amount you’ll pay back to the lender. Fixed rates remain the same throughout the life of the loan, offering predictability in your payments. Variable rates, however, can fluctuate based on changes in the market, affecting your monthly payments and the total interest paid over time.
How Interest Rates Affect Your Monthly Payments
Lower interest rates mean lower monthly payments and less money paid over the life of the loan. It’s important to shop around and compare rates from different lenders to ensure you’re getting the best deal.
Principal Amount: The Base of Your Loan
The principal is the amount you borrow and agree to pay back. As you make payments, a portion goes towards reducing this amount, while another portion covers the interest.
There are some things you can do to pay down your loan faster
- paying more than the minimum payment,
- making bi-weekly payments, or
- making one extra payment a year can reduce your principal faster and save you on interest.
APR (Annual Percentage Rate) Explained
The APR reflects the cost of borrowing on an annual basis, including interest and other fees. It’s a more comprehensive measure than the interest rate alone, providing a clearer picture of the true cost of the loan.
Comparing APR Across Different Loan Offers
When evaluating loan offers, comparing the APRs can help you understand which loan is more expensive in the long run, as it includes both the interest rate and fees.
Loan Term: How Long Do You Have to Pay?
The loan term is the duration over which you’ll repay the loan. Longer terms can lower your monthly payments but increase the total interest paid.
Short-term vs. Long-term Loans: Pros and Cons
Short-term loans typically have higher monthly payments but lower overall interest costs, while long-term loans spread payments out but accumulate more interest.
Monthly Payments: Calculating Your Financial Responsibility
Your monthly payment is determined by the loan amount, interest rate, and term. It’s crucial to ensure this amount is manageable within your budget to avoid financial strain. You can expect lenders to run a series of scenarios to assess whether a loan is manageable before you are approved. Meeting loan repayments in times of increasing intererst rates and the cost of living might require you to:
- create a budget,
- reduce unnecessary expenses, or
- refinance the loan for better terms
Fees and Penalties: Additional Costs to Consider
Be aware of any additional fees and penalties for late payments or prepayment. These can add up and significantly impact the cost of your loan, so ensure you understand all of the conditions that could trigger them in order to avoid paying them unkowingly.
Understanding Other Loan Terms
The terms of your loan agreement are crucial in determining how your loan experience will unfold. To be confident that you’re signing up for the best loan for you, check you understand everything thoroughly and also seek professional advice.
Collateral
Collateral is an asset you pledge as security for the loan. If you fail to repay, the lender can seize the collateral and sell it to recoup their funds. Assets like homes and cars are a couple of examples of what’s commonly used as collateral.
Make sure you understand the implications of secured vs. unsecured loans when assessing the risks involved with collateral.
Grace Period
A grace period is a set amount of time after your payment due date when you can make the payment without incurring any penalties. It’s important to know whether your loan includes a grace period and how long it is, as missing even one payment could lead to fees or defaulting on the loan.
Prepayment Penalties
Some lenders charge a prepayment penalty if you pay off your loan early. This is to compensate for the interest and fees they would have collected if the loan had continued for its full term. Before signing a loan agreement, ask if there are any penalties for paying off the loan early in case you want the option to do so down the track.
Amortisation
Amortisation refers to the process of paying off your loan through regular payments over a set period, though it changes over the time of your loan. In the early stages of repayment, a larger portion of your payment goes towards interest. Over time, more of your payment is applied to the principal.
What to Look Out For When Applying for a Loan
Before signing any loan agreement, it’s critical to read the fine print and understand all the terms and conditions. Asking questions and being aware of potential red flags can protect you from unfavourable terms and you should always seek a professional review of the loan document before signing on the dotted line.
- don’t hesitate to ask your lender about anything unclear in the agreement. Understanding every aspect of your loan is key to a positive borrowing experience.
- Be cautious of terms that seem too good to be true, vague language, or excessive fees. These could indicate you’re being presented with a less than ideal offer.
The Impact of Loan Terms on Your Long Term Financial Health
Choosing a loan with the most favourable terms you can negotiate will have a significant impact on your overall financial standing. And when it comes to home loans, with most having terms of at least 20 years, even seemingly small differences in loan terms can make a substantial difference over time.
So, it’s absolutely crucial to do your research and shop around for the best loan product before committing to any agreement.
Now while you can certainly do all the legwork yourself, working with us here at Grow Financial Solutions is a sure way to save you time and get the best loan option for your specific needs. We know the industry, the questions to ask and how to negotiate and secure the most favourable terms possible for our clients. Plus, we’re on hand to guide you through the entire process.
Don’t let confusing loan terms hold you back from getting the financial assistance you need. Contact us today to find out how we can help make the loan application process simple and straightforward.