Financial terminology can be overwhelming and confusing, but it’s important to understand it before taking out a loan. We’re here to help make it simple for you.
Here are 11 common loan terms every borrower should know and understand before getting a loan. These terms will help you make informed decisions and avoid misunderstandings when talking with lenders. Understanding these terms will help you to navigate the loan process with more confidence.
APR (Annual Percentage Rate): The total annual cost of borrowing. This rate includes interest, fees and any additional costs associated with your loan. To ensure you’re evaluating the true annual cost of borrowing across lenders, it’s best to compare APRs.
Automated Clearing House (ACH): A network used for all kinds of fund transfer transactions, including direct deposit of paychecks and monthly debits for routine payments. For example, it can be used to make automatic loan payments between borrowers and lenders or service providers.
Basis Points (bps): One hundredth of one percent (one basis point = 0.01%). Changes to interest rates are often described in basis points. For example, if an interest rate went from 4.5% to 5%, it would be described as 50 basis points higher.
Debt Consolidation Loan: A loan used to replace one or more loans that have high interest, unfavorable terms, or both. Most commonly this takes place with credit card debt, but you can also consolidate other sorts of debt.
Debt-to-Income Ratio: The ratio used to determine the share of a borrower’s monthly income that goes towards paying debts. Lenders use the debt-to-income ratio as a factor in determining a borrower’s eligibility for a loan as well as how much money they may borrow.
Deferment: A set period of time during which the borrower may pause their loan payments.
FICO: The most widely used credit score model in the US. Your FICO score is used by prospective lenders to estimate your level of risk as a borrower. Your FICO score is calculated using a proprietary equation that evaluates information in your credit report. Scores can range from 300 to 850.
Interest Rate: The cost of borrowing money. You must pay interest in addition to the principal amount you borrow. Each of your monthly payments are part interest and part principal.
Prepayments: Payments made in excess of scheduled repayments. This can reduce future monthly payments and/or the loan term. Depending on the interest rate, it can make a lot of sense to make prepayments on your loan. But some lenders charge penalties or prohibit borrowers from prepaying, so be sure to check the fine print on any loan agreement you sign.
Principal: The total amount borrowed. In the most simple terms, this amount is multiplied by the interest rate to determine periodic repayments.
Underwriting: The process that a financial company uses to assess the eligibility of a potential borrower to receive a product (credit, insurance, mortgage, or equity). Traditional lenders use your credit report, credit score, and income information as their primary source of underwriting criteria. In addition to those, Upstart’s underwriting model evaluates potential borrowers based on their education¹ and work experience.
The bottom line on financial terms
It takes time to become fluent in financial terms, but it’s important to learn as much as you can about the borrowing process before you sign a loan agreement. Understanding financial language can help you make better financial decisions.
At Upstart, we understand that a credit score isn’t the only factor that defines a person’s creditworthiness. Our AI model looks at a variety of information when making loan decisions, not just credit score.
¹Neither Upstart nor its bank partners have a minimum educational attainment requirement in order to be eligible for a loan.