Financial lingo is weird. We didn’t invent it, but we’re here to help you figure it out. As Albert Einstein once said, “If you can’t explain it simply, you don’t understand it well enough.”
Here are simple definitions for 11 of the most common loan terms that every borrower should know.
APR (Annual Percentage Rate): The total annual cost of borrowing. This rate includes interest, fees and any additional costs associated with borrowing. To ensure you’re evaluating the true annual cost of borrowing, it is best to compare loans based on APRs.
Automated Clearing House (ACH): A network used to make automatic loan payments between borrowers and lenders or service providers.
Basis Points (bp): One hundredth of a percentage point (one basis point = 0.01%). Changes to an interest rate 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 Refinance And Consolidation: A loan used to replace one or more loans that have high interest or unfavorable terms. Debt consolidation is refinancing two or more sources of debt, most commonly credit card debt. When a loan is refinanced, the existing lender is paid in full using the money from a new loan that has better terms.
Debt To Income: The ratio used to determine what percent of a borrower’s monthly income goes towards paying debts. Lenders use this as a factor in determining a borrower’s eligibility and how much money they may borrow. Learn more about debt to income.
Deferment: A set period of time during which the borrower is not required to make loan payments, also known as a “grace period”.
FICO: The most widely used credit score model in the US and is used 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. Learn more about credit scores.
Interest Rate: The cost of borrowing money. This is the amount that you must pay in addition to the principal amount you borrowed. Interest rates are typically shown as a percent of the total amount borrowed.
Prepayment: Payments made in excess of scheduled repayments. This can reduce future monthly payments and/or the loan term. We love to see our borrower’s prepay, but some lenders charge penalties or prohibit borrowers from prepaying, so be sure to check the fine print.
Principal: The total amount borrowed. This amount is multiplied by the interest rate to determine 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 salary information as their primary source of underwriting criteria. In addition to those, we evaluate potential borrower’s based on their education and work experience (e.g. university attended, major, GPA, salary history, and SAT/ ACT).
photo: Reuben Ingber