Important Loan Terminology
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ike every other industry, the financial sector has its own set of terms. For those who are unfamiliar with them, these words and phrases can be confusing. To help ease some of the confusion this jargon can cause, we have defined some common financial terms you might encounter when applying for a loan.
- Adverse Credit - Being more than 90 days late on any debt or carrying Title IV debt (federal financial aid for students) which has in the past five years been subjected to bankruptcy discharge, default determination, repossession, foreclosure, tax lien, wage garnishment, or write-off.
- APR (Annual Percentage Rate) - The rate of interest you pay. It is the annual cost of credit which includes the actual interest, lender fees, discount points, and mortgage insurance (if applicable). The APR can be higher than the loan’s interest rate.
- Balloon Payment - At the end of a mortgage, amortized loan, or commercial loan, this oversized payment is due. This happens when the entire loan is not amortized (a debt paid off in regular installments on a fixed repayment schedule over a certain length of time). These balloon payments are often rolled into a new mortgage or a continuing mortgage at market rate, which can be either a fixed rate or adjustable mortgage. One final balloon payment is made when the mortgage matures.
- Bridge Loan (Bridging Loan) - Also known as a “swing loan,” this type of loan covers a borrower who is between transactions. For example, if a person is selling one home and buying another, the lender lends money using the current unsold home as collateral. This allows the individual to use that money to close on the home they are buying.
- Debt Consolidation - Taking a number of debts and packaging them into one new, single loan which might have more favorable interest rates and terms than the original loans. By taking on a new loan to pay off the other existing loans, debt consolidation may bring lower monthly payments, lower interest rates, or both. This process is frequently used for consumer debt, student loan debt, and other unsecured debts.
- Deferred Payment Loan - A loan agreement in which the buyer agrees to begin making payments on a specified future date before which no interest is accrued and no payments are made on the principal. In real estate, the borrower hands the title over to the lender with an agreement to pay off the loan in full when the property is sold.
- Down Payment - An amount of money which is not borrowed, but is paid from a buyer’s personal resources at the time of closing. This amount of money makes up the difference between the loan amount and the total purchase price.
- Early Repayment Penalty - A stipulation in a loan contract stating that if a borrower pays off a loan early, they must pay a penalty. This is usually equal to one or two month’s interest. The earlier you repay a loan with this type of stipulation, the higher the penalty.
- Home Improvement - Altering, adding to, improving upon, converting, modernizing, repairing, remodeling or replacing some part of a home or a structure or land adjacent to the home which is a part of the owner’s property.
- Interest-Only Payment Loan - A loan in which a borrower only pays interest for a certain amount of time. During this period, the monthly payments have no impact on the principal balance (the total amount that was borrowed). At the end of this specified time period, the borrower may have several options – continue an interest only mortgage, pay towards the principal, or convert the loan to a typical interest and principal mortgage.
- Loan Commitment - The commitment that a lender makes to lend a certain amount of money or to extend a certain amount of credit to a borrower. This commitment is typically made for a fixed amount of time at a specific interest rate for a certain type of purchase. It also lays out the terms and requirements of the loan. A commitment fee of 0.5 to 2.5 percent is typically charged for a written commitment.
- Loan Underwriting - The way a lender determines their risk in loaning money to a certain borrower. The ‘three C’s’ of underwriting determine this risk - credit, capacity and collateral. By looking at these factors, the lender decides how worthwhile it is to lend to a borrower and how much risk they take on.
- Prepaid Interest - When closing on a home, this is an amount charged to the borrower which covers interest on the loan between the closing date of the home and the end of the closing month.
- Refinancing - Financing a purchase with the proceeds from a second loan. With housing, a new mortgage is obtained on a property which often replaces the existing loan. This new loan typically has a lower interest rates, making it beneficial to the borrower.
- Simple Interest - Interest which is based only on the balance of the principal. Each payment goes towards paying the interest first, then the principal. Each month, the borrower pays that month’s interest in full. In contrast with compound interest, old interest does not accrue.
- Standard Rate - The rate by which the interest rates of adjustable rate mortgages (ARM) rates are adjusted. When your loan reaches the scheduled adjustment date, this is the reference rate which is used.
- Wraparound - Secondary financing which combines an existing loan with a new loan. This results in an interest rate between the old rate and the current going interest rate. Payments are made to the secondary lender who then pays the first lender after deducting any fees from the payment.