Loan terminology does not come naturally to most people, but it is important to know some terms in order to be able to shop for installment loans wisely. Here are the most common terms you will encounter.
Principal: Principal is the amount of money that you initially borrow from your lender. After you take out a small dollar installment loan, the principal is the amount that you receive at the start of the loan. To complete your loan contract, you will need to pay back this principal along with interest and/or loan fees.
Interest Rate: The interest rate is expressed as a percentage. It is the percentage of the principal that the lender will charge you in exchange for lending you money. A simplified way to put it is that if your lender charges you 15 percent and you borrow 100 dollars, you would have to pay back 115 dollars at the end of the year. This is, of course, a simplification as interest rates are often compounded monthly and as you pay down principal, the interest paid decreases.
Annual Percentage Rate: While it is good to know the interest rate, the APR or Annual Percentage Rate is a much better tool to use when comparing loans. The APR is the effective interest rate when you add in the interest and all loan fees. By using this measurement, you can compare loans with different terms. The loan with the actual lowest interest rate, for example, might not be the one with the lowest APR because of higher loan fees.
Term: The term is the amount of time that you have to pay back the loan. Given the same dollar amount, the longer the term, the less each payment will be. Small dollar loans generally have short terms ranging from a few weeks to a few months. This will depend on the lender and the amount that you borrow.
Fees: Many lenders charge fees in addition to or instead of interest. Fees can vary but generally include origination fees, application fees and funding fees. There are also a number of potential fees such as prepayment penalties and late payment fees. Because of the variability of loan fees, it is important for you to thoroughly review your loan contract before you sign.
Collateral: This is an asset that a borrower will put up for loan security. If they default on a loan, the lender would then get to seize the asset. An example of collateral would be the car itself on an auto loan or a title loan. In general, small dollar loans do not have collateral requirements.
Credit Score: The credit score is a numerical representation of your credit worthiness. It is used by a lender to assess the risk involved in granting a loan. The higher your credit score, the greater your chances of approval are. In addition, higher credit scores equal lower interest rates. The opposite is also true.
Credit Report: This is a detailed record of an individual’s credit history. It will include both past and present borrowing history and payment history, among other things. Many lenders will use your credit report to decide whether not to extend credit to you and to determine your interest rate. Some lenders, such as payday loan lenders, may not use this report however.
Credit Check: During a credit check, your lender will pull your credit. Lenders often use a soft credit check to offer pre-approval. Soft checks do not have an effect on a credit score. Before a loan is finalized, a lender will then pull a hard credit check which can impact a credit score. A hard credit inquiry can temporarily lower your credit score by a few points.
Loan Default: A default occurs when a borrower fails to repay their loan according to the terms agreed upon. Defaulting on a loan can seriously impact your credit score and could result in legal actions from your lender.
Summing It Up
When it comes to finances, knowledge is power. While this list is certainly not a complete list of all vocabulary terms used in the loan industry, it can serve as your primer. Read it, learn it and then keep increasing your knowledge.