Using a loan to finance an expense whether it’s for an automobile purchase or home improvement project can be a smart decision. However, if you’re not familiar with certain loan terminologies, you might be at a disadvantage when it comes to evaluating a loan or comparing loans from multiple lenders.

1. Amortization

The period of time on which the repayment of loan principal and interest is based.  Loans have different amortization schedules and terms.

There are three basic ways to repay a loan:

  1. In equal installments, each containing a blend of principal and interest.
  2. In varying but regular installments, each containing a blend of principal and interest.
  3. In irregular installments of principal or interest only with a large final payment.

2. Annual Percentage Rate (APR)

The annual percentage rate (APR) is the total yearly cost of taking out a loan. This rate includes the interest rate, along with any other finance charges. For example, when you take out a personal loan, you might have to pay loan origination fees. If you were to only look at the loan’s interest rate, it would be lower because the loan origination fee isn’t included.

Under the Truth in Lending Act, lenders must disclose the APR, so you have a complete understanding of how much it’ll cost to take out a loan.

3. Balloon Payment

The final payment of a loan with an amortization period that is longer than the loan term. For example, if the loan amortization period is 10 years but the loan term is 5 years the unpaid principal at year 5 is the Balloon Payment. This type of loan is awarded to borrowers who need a smaller or more affordable monthly loan payment but have the capacity to refinance at the end of their loan term.

4. Borrower Default

Defaulting on a loan occurs when a borrower doesn’t pay back the loan as promised. If you’re a couple of days late on your payment, the lender might be willing to work with you. However, if they try to reach out to you for months and you don’t respond, they may send your debt to a debt collector. The debt collector could report you to the credit bureaus, which would harm your credit.

When a debt is considered in default varies by the lender and type of debt. For example, federal student loans are not considered to be in default until they are nine months past due. To find out when your loan would be considered in default, reach out to your lender or read the terms of the loan.

5. Collateral

Collateral is an asset that you can pledge to a lender to back—or secure—a loan. Common types of collateral include real estate, vehicles, cash and investments. For example, when you take out an auto loan or mortgage, the car or house is the asset that secures the loan. If you fail to repay your loan, the lender can repossess your car or foreclose on your home. Collateral is required on secured loans; it’s not required on unsecured loans.

6. Credit Score

Before approving your loan, lenders will check your credit score to assess how risky of a borrower you are. Some will use your FICO credit score, which ranges from 300 to 850. Your score is calculated based on the following factors:

The best interest rates for loans usually go to borrowers who have well to excellent credit scores. Based on the FICO credit model, a good credit score is at least 670.

7. Default

Failure to pay a debt or meet an obligation

8. Equity

Represents the difference between an asset s current market value and the amount of debt or other liabilities. In terms of a child care equity that is provided through internal assets, savings, grants, individual donors, collaborative resources and other sources can be used to assist in funding some of the facilities development costs. It is best to use equity funding for the planning and predevelopment stages of developing child care facilities, while debt (loan financing) is more fitting for the real estate acquisition and construction costs incurred during the development stage.

9. Fees

Charges by a Lender for making the loan. Fees can include a range of costs. Such as a loan origination fee, service fee and monitoring fee.

10. Fixed Obligation to Income Ratio (FOIR)

FOIR (Fixed Obligations to Income Ratio) is a popular parameter which banks use to determine loan eligibility. In this case, a bank takes into account the instalments of all other loans already availed of by the applicant and still due, including the home loan applied for.

FOIR (Fixed Obligations to Income Ratio) takes into account all the fixed obligations that a borrower is supposed to meet regularly on a monthly basis. The fixed obligations do not include statutory deductions from the salary such as Provident Fund, professional tax and deductions for investments such as insurance or a recurring deposit.

As per bank’s eligibility criteria, the borrowers should restrict all their fixed obligations including the currently applying loan EMI to 50% of his monthly income. Or in other words, considering that 50% of your income is required for your living, banks would see that all your monthly loan obligations / liabilities should be only 50% of your monthly income.

For example, if your income is Rs.75,000 per month, and you have an auto loan running for which you are paying an emi of Rs.5000 and another personal loan of Rs.7500 per month. Considering that 50% of your income can be paid towards your loans,

We have,

50% of 75000 = Rs.37,500

Auto Loan Emi = Rs.5000

Personal Loan Emi= Rs.7500

So, your disposable income for this fresh loan is:

37,500-5000-7500 = Rs.25, 000

Thus, a backward calculation of the repayment capacity is made to find out the amount to be given as loan.

Loan Eligibility = Gross monthly income * FOIR% – all other obligations / per lakh EMI (EMI calculated on the basis of applied tenure and rate of interest).

FOIR ratio varies from bank to bank and from case to case, but on an average it would be with 40% to 55%. The lower this ratio, the better are your chances of getting your loan application approved. If a borrower’s FOIR is high, lenders or banks take this as a negative. This is because it means that your disposable income after paying EMIs will be low and this in turn means that the credit risk for the lender is higher.

11. Fixed Interest Rate

When a loan has a fixed interest rate, the interest rate remains the same for the duration of the loan. Since the interest rate remains the same, the monthly payment doesn’t change. The predictable monthly payments make it easier for you to budget your loan payments.

12. Guarantee

A promise by one party to pay a debt or perform an obligation contracted by another if the original party fails to pay or perform according to a contract. Loan guarantee or loan insurance programs are designed to make certain loans less risky for lenders, such as loans for community economic development projects and for small businesses like child care.

13. Installment Loan

An installment loan is a loan with a fixed repayment period listed in the loan agreement. For example, let’s say you take out a personal loan to refinance high-interest debt. Once you receive the lump sum payment, the lender will require you to make monthly payments or installments to repay the loan.

14. Interest

The cost of using loaned money, usually expressed as an annual percentage that a lender charges a borrower for the use of the principal over time.

15. Interest Rate

 The amount a Lender will charge for the use of its funds. Interest rates vary greatly from loan to loan and are frequently tied to industry measures such as Prime Rate. For example, if Prime Rate is 4.75%, then a Prime Plus Two Percent rate would mean a loan with a 6.75% interest rate

16. Loan Agreement

A loan agreement is a legal contract between you and the lender. In this agreement, you’ll find important information, such as:

Reading this agreement is important because some lenders include information on how you can use the funds. For example, when taking out a personal loan, most lenders prohibit you from using the funds for education expenses or investing.

17. Late Fee

If you make a past due payment on your loan, your lender may charge you a late fee. The amount of this late fee and when the lender charges it varies according to the lender. For example, some lenders might not charge you a late fee until your payment is 15 days late. This information can be found in your loan agreement.

18. Loan Deferment

When you encounter financial hardship, some lenders will allow you to do a loan deferment. During this time period, you won’t be responsible for repaying the loan. However, your loan may continue to accrue interest. The deferment extends the loan term, which can increase your overall cost of borrowing funds.

19. Loan Limit

The maximum amount a lender will loan you is your loan limit. A lender will allow you to borrow a certain amount of money based on your income, creditworthiness and DTI. Although a lender may allow you to borrow more than you can afford, it’s wise to consider your budget before borrowing the maximum amount of money.

20. Loan Terms

Your loan term is the amount of time you have to repay your loan. For example, if you take out a six-year auto loan, the loan term would be six years.

21. Secured Loan

A secured loan is one that has collateral attached to it. If you default on the loan, the lender can seize the asset. Some common examples of secured loans are home equity loans, auto loans and mortgages. To secure the best interest rate possible, it’s a good idea to prequalify with multiple lenders to compare rates.

22. Unsecured Loan

An unsecured loan is one that doesn’t have collateral attached to it. Some common examples of unsecured loans are credit cards, personal loans and student loans. When you take out an unsecured loan, the lender cannot seize your personal assets, unless they are awarded a judgment by a court.

23. Term

The agreed upon period of time for which a loan is made. A loan provided for 10 years has a 10 year term

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