While most modern financial institutions do their best to simplify the borrowing process, it can still be a little confusing. Your experience greatly hinges on your existing financial literacy.
You need some idea of how online loans work when you first start researching your options. But more importantly, this knowledge needs to follow you to the final negotiations, when you read your loan contract for the last time before you agree to the terms.
If you’re like most people, several terms stand out for the wrong reasons—you don’t know what they mean! Don’t sign a financial document and hope they don’t come up. Read this list of definitions first. It will provide a solid foundation of financial literacy as you search for online loans in the future.
Principal
No, this doesn’t refer to the head teachers who managed your old grade schools. Principal in a financial context refers to the amount you borrow. This is an important number to know, as it determines whether your loan provides enough funds to support your goals.
Interest Rate
Few lenders will only ever expect you to repay the principal on its own. Most apply interest, which is a percentage of your principal that compounds on a regular schedule, usually daily.
Interest rates are considered a normal cost of borrowing. However, they may vary drastically from lender to lender, loan to loan, and borrower to borrower. The higher your interest is, the more your loan will cost at the end of the day.
Annual Percentage Rate
The annual percentage rate, shortened conveniently to APR, is an important shortcut in calculating the cost of borrowing. That’s because it factors in more than just the interest rate when determining the cost. It also includes other finance charges, such as administrative or origination fees. Truncating all your charges into one percentage makes it easier to compare multiple loans at a time.
Amortization
This mouthful of a word is related to your term, or the timing of your loan. It refers specifically to the time it will take you to repay your full cost of borrowing. For example, a payday cash advance only gives you until your next payday to do this. The average installment loan, on the other hand, has an amortization period of weeks, months, or even years.
If your lender allows you to make additional or early payments, you can use this calculator to see how your extra payments affect what you owe.
Secured vs Unsecured
You can roughly chop personal loans into two distinct categories: one secured, the other unsecured. Secured financial products are backed by collateral, or a financial asset, that the lender may take as payment if you default. Unsecured financial products don’t require collateral, which means there’s more risk involved for lenders. As a result, you may notice unsecured loans are more expensive than secured alternatives.
Grace Period
Depending on the type of loan you take out, you might have a grace period. This is a set amount of time following your due date where your lender may accept payments without penalties. While each lender has unique rules, most grace periods last 30 days. After that, your lender may report your late payment to the credit bureaus.
These Terms Get You Off to a Good Start
While these form a core group of words you should understand inside and out, there may be more terms that cause some confusion. Before you sign your contract, always ask your lender to explain anything you don’t understand. This could help you avoid accepting financing you can’t afford.
