Personal loan terms: What you need to know

If you’re considering a personal loan, you'll need to understand several relevant words and phrases first. Knowing the lingo can help you understand exactly what you’re getting into and how a personal loan is designed. Read on to learn what you need to know to confidently navigate the process of applying and receiving your funds.

What are personal loan terms?

Personal loan definitions and terms are words and expressions used throughout the process of applying for, receiving, and paying back a personal loan. Knowing what these words and phrases are and what they mean will help you as you’re comparing lenders.

Anyone considering asking for a personal loan is called a borrower. A borrower is the person who applies for and receives the loan, agreeing to repay it over time. A co-borrower is someone who applies for a loan jointly with the primary borrower, sharing equal responsibility for repaying the loan. A co-borrower usually has access to the loan funds.

A co-signer is someone who agrees to take responsibility for the loan if the borrower cannot make payments, helping the borrower qualify for better terms with the lender. A lender is a financial institution or individual that provides a loan to the borrower and establishes the terms of repayment, including interest rates and fees.

A credit report is a detailed record of a person’s credit history, including their payment history, outstanding debts, and credit inquiries, used by lenders to evaluate loan applications. A credit score is a three-digit number that reflects a borrower’s creditworthiness based on their credit history and financial behavior.

Interest rate

Interest rates are usually expressed as a percentage, and they represent the amount of money that the lender is charging to lend you money. Most lenders will charge you a percentage of the amount borrowed to make up for the risk they’re taking by loaning you money. Interest rates are usually determined in part by external factors as well as personal ones like credit score, credit history and debt-to-income ratio.

Fees

Beyond interest, some lenders charge additional fees. Annual percentage rate or APR takes both interest rates and fees into account. APR is basically the total cost of borrowing money with a credit card or installment loan over a year, giving borrowers a clearer picture of what they will actually owe.

Funding time

After your initial application is submitted and approved, it takes some time for your money to be deposited. This difference in time is referred to as the funding time. Funds are typically dispersed within a few days, but the exact timeline can vary depending on the lender’s processes, the type of loan, and how quickly you provide any required documentation.

Origination fee

As its name suggests, an origination fee is charged by a lender to cover the costs of originating and processing the loan. The fee is usually calculated as a percentage of the loan amount. So on a $10,000 loan, a 1% origination fee will be $100.

Borrowers typically do not pay the origination fee separately. Instead, it is deducted from the loan amount before the funds are disbursed. For example, if you are approved for a $10,000 loan with a 1% origination fee, you would receive $9,900, as the $100 fee is deducted upfront.

Promissory note

A promissory note, or loan agreement, is the legally binding document that you will sign when closing your loan. The promissory note is the signed agreement that actually has the “terms” or details of the loan. This includes the interest rate, payment schedule, total repayment amount, and any fees. The promissory note also outlines the consequences of not paying, such as late fees, legal action or damage to your credit score.

Term length

Borrowers must decide how long the repayment period of your loan will last. The general rule is that the longer the personal loan term length, the higher the overall cost of the loan. Personal loans typically have a term between 12 and 60 months.

• Long-Term Personal Loans: There are different personal loan term lengths – some borrowers might need a longer term and lower monthly payments. One example of a long-term personal loan might be a debt consolidation loan.
• Short-Term Personal Loans: Short-term personal loans are typically emergency loans. Payday loans are an example of a short-term personal loan, though borrowers typically should try to avoid these because they can come with very high interest rates and fees.

Prequalification

Getting prequalified for a loan means taking the first step in the application process. A lender estimates how much you may be eligible to borrow based on your basic financial information, such as income, credit score, and debt. It’s a quick and informal process that doesn’t impact your credit score.

Late payment penalty

Just as with credit cards and most other types of financial transactions, making a late payment on a personal loan will generally come with a late payment penalty. This  penalty could include a fee, a negative mark on your credit, or both.

Prepayment penalty

Other terms that apply to personal loans

Here are some other terms that you should be aware of when applying for a personal loan.

Principal and interest

Principal is the amount of the loan that you borrow – the actual cash that you receive when the personal loan is funded. Interest is essentially the cost of getting the loan, paid to the lender. A portion of your monthly payment goes toward the principal, and another portion goes toward interest. Some personal loans may allow you to pay only the interest for a period of time. This lowers your monthly payment amount but increases the total amount of money you have to repay.

Loan amortization is the process of gradually paying off a loan through scheduled, equal payments. Each payment is divided into two parts: the principal, which is the original amount borrowed; and the interest, which is the cost of borrowing. In the early payments of the loan term, a larger portion of your payment goes toward interest. Understanding amortization can help you see how much of each payment goes toward reducing your debt.

Collateral

Collateral refers to any asset that backs the loan, protecting the lender. If the borrower fails to repay the loan, the lender can seize the collateral to recover its losses. For example, in a mortgage, the home itself is the collateral. In an auto loan, it’s the car. Many personal loans do not require collateral, which generally raises interest rates.

Secured vs. unsecured

A secured loan is backed by collateral. For example, if you fail to adhere to the terms of a home mortgage, you may forfeit your collateral, meaning you could lose your home. An unsecured loan is not backed by any collateral.

If you don’t pay off an unsecured loan, you will not lose any collateral, but your credit may be damaged and your lender could send your loan to a collection agency. Be sure to discuss with your lender the right loan for your situation.

Fixed interest vs. variable interest

With a fixed loan, your interest and monthly payments are the same throughout the loan term. In a 5-year fixed personal loan, you’ll pay the same amount in each of the 60 monthly payments. With a variable loan, the interest rate can change, through either external factors or how much of the loan you uaw. This means that your payment amounts may be different each month.

Installments vs. revolving credit

An installment loan is a fixed amount of borrowed money. Mortgages and many personal loans are examples of installment loans. With an installment loan, you receive all of the money at closing and then pay it back over the loan term.

With revolving credit, you have access to a particular amount called the “line”, but you don’t have to use all of your line at once. You can use however much you need, and you only pay interest based on the amount that you have actually borrowed. Home equity lines of credit (HELOCs) and credit cards are types of revolving credit.

Hard inquiry vs. soft inquiry

Learn the lingo of loans

Understanding these key terms will help you confidently navigate the personal loan process. Ready to get started? Apply for a personal loan with Rocket Loans^sm today.