If you’re learning about personal loans, the technical terminology might make as much sense as Morse code.
All you want is to find a loan that will help you take care of your medical bills or pay off your credit card debt, but it’s difficult to feel confident in your research when you’re wading through technical loan terms like “APR,” “unsecured,” and “origination fee.”
Read on to learn the definitions of 14 loan terms you’re likely to come across—and what they mean for you.
Personal loan basics
First things first: what exactly is a personal loan? Unlike loans designed for specific purchases (like a car loan or mortgage), a personal loan is intended to be used for many different things, like consolidating your credit card debt or funding a large life expense such as moving to a new apartment.
You can get a personal loan from many banks and other financial services providers, all of which will offer different options. Once you apply for the loan that works best for you and are approved, you agree to pay back the full amount of the loan (in monthly installments), plus any interest, over a specific period of time.
You might have a lot of ideas for how you could use a personal loan, but before you apply for one, take some time to consider the purpose of borrowing that money. After all, you’re taking on debt, which always has a cost. Some things might be worth that cost (especially if they’re pressing needs, like repairing a car you need to get to work), while other things (like a new sofa or phone upgrade) might be a better savings goal.
Of course, you’ll also want to look at your current financial situation to decide how the loan payments will affect your monthly budget. A personal loan to consolidate credit card debt might help reduce the amount of money you spend on debt every month, while applying for a loan to get a new laptop will add another bill. Make sure you can afford the monthly payments before you apply for a loan.
With the purpose of your loan and how it will affect your budget in mind, it’s time to carefully consider the terms associated with finding and applying for the best loan for your needs.
Here are 14 common loan terms . . . and what they mean for you
There are dozens of personal loan vocabulary words out there. We chose 14 common terms that you’re likely to see during your hunt for the right personal loan for you. Understanding these terms will help you review personal loan offerings and apply for one with confidence.
Lender (aka, Creditor)
Definition: The bank, credit union, or financial institution from whom you borrow money
What this means for you: Different lenders provide different personal loan products—and they’re not all created equal. Research lenders carefully. Check their rates, fees, and if their loans can be taken out online.
Definition: The amount of money that you borrow (not including interest or fees)
What this means for you: Your principal amount is the actual amount of money you borrow. Financial institutions offer a variety of options, and how much you qualify for will depend on factors like your credit score and income. As you make payments every month, the principal amount you owe goes down (although your monthly payment also includes fees and interest, so the entire amount you pay every month isn’t deducted from the principal). While it may be tempting to borrow as much as you qualify for, remember that you’ll have to pay interest on the entire principal, so aim to borrow just the amount you need.
Definition: The exact amount of time you have to pay back the loan (usually between one and five years
What this means for you: Unlike credit cards, personal loans have a fixed term—you agree to pay the money back in a certain amount of time. Normally, the longer the term, the higher the interest rate (which means you’ll spend more money on interest overall). But the shorter the term, the higher your monthly payments will be. When choosing your term, you’ll need to decide what’s important to you: is saving interest or having a lower monthly payment. Choose a term that supports your personal preference and unique situation.
Fixed monthly payment
Definition: A monthly payment due to the lender that does not change throughout your loan term.
What this means for you: This amount is paid every month until your loan is paid in full. The payment consists of both principal and interest. Fixed monthly payments make budgeting straightforward, since the amount never changes. That said, if you have the means to occasionally pay back a bit extra on your principal, you can pay off your loan faster.
Annual percentage rate (APR)
Definition: The yearly rate (expressed as a percentage) that you’re charged for borrowing the money, including interest and finance charges.
What this means for you: Every loan has both an interest rate and an APR. The APR is different from the interest rate because it also includes all other charges and fees—it’s the total amount you will pay each year for borrowing the principal. The higher the APR, the more you’re paying for borrowing the money—and the lower the APR, the better deal you’re getting. APRs for personal loans ranged from 10% to 28% in 2019. Use the APR instead of the interest rate to shop around; every lender calculates and discloses the APR in the same way (by including all fees and finance charges in addition to interest), so you can really compare apples to apples.
Fixed interest rate
Definition: An interest rate that stays the same throughout the life of the loan
What this means for you: With fixed interest, you don’t have to worry about interest rates increasing and having to pay more interest later on. For example, if your fixed interest rate is 7%, it will be 7% for the entire term of the loan. A fixed rate also makes planning for the future and budgeting to pay off your debt easier—you can count on the same payment every month and know exactly when you’ll pay off your loan.
Definition: A fee that the lender charges for creating and processing the loan
What this means for you: Some lenders charge this fee just for processing your application and lending you the money. This fee is normally due as soon as you receive the loan money (or it’s deducted from the principal amount you get). For example, if you borrow $5,000 and have a 4% origination fee, you have to pay $200, on top of interest, just for borrowing the money. Origination fees range widely among lenders (and some lenders don’t charge an origination fee at all!), so research each loan carefully.
Definition: A loan that is not backed by collateral
What this means for you: When you borrow money with an unsecured loan, you simply receive the money and pay it back according to the loan’s terms; if you miss payments, the lender can’t take your property. That said, missing payments is never a good idea, as it will likely hurt your credit score and may incur late fees. Interest rates are normally a bit higher for an unsecured loan since the lender has no guarantee (like collateral) that they can get their money back if you don’t make your payments.
Definition: Any asset (e.g., a Certificate of Deposit, savings account, or personal property) that backs your loan. Collateral is used for secured loans
What this means for you: If you apply for a secured loan, you’ll need to offer something of value as collateral—this serves as a kind of assurance that you’ll pay back the loan. If you default on your loan, the lender can seize your collateral. Collateral only applies if you apply for a secured personal loan; unsecured loans do not require collateral.
Definition: A loan that must be backed with collateral
What this means for you: Financial institutions offer secured loans to reduce the risk of loaning money; if you don’t repay your loan, the lender can take the collateral instead. Secured loans are usually used for a specific purpose (like buying a car or house), though some lenders also offer secured personal loans you can use for other purposes. Because secured loans are backed with collateral, they may be easier to qualify for and tend to have lower interest rates compared to unsecured loans.
Definition: When a lender extends you an offer of credit because they’ve determined that you meet a set of criteria
What this means for you: Pre-screening (aka, pre-qualification or pre-approval), is a process in which financial institutions identify customers who they believe will qualify for a loan based on a set of specific criteria (note that each lender will have its own unique criteria for this purpose). Lenders might then extend such customers a “firm offer of credit”—an opportunity to apply for a loan based on their belief that, once they review and verify your official application, you will indeed meet the necessary criteria to qualify. If you receive a prescreened offer for a loan, it will have information about how to opt out of getting such notices in the future if you don’t want them. You can learn more details about pre-screening here.
Definition: A record showing your borrowing and repayment history
What this means for you: Lenders want to see how responsible you’ve been in the past with paying back debt, as well as paying bills such as utilities,rent, and loan obligations. They look at things like the number and types of credit accounts you have open, the amounts owed, and whether you’ve made payments on time. Your credit history can affect the amount you can borrow and your interest rate (as well as your ability to qualify for a personal loan in the first place).
Definition: A breakdown of your credit history (including things like your personal information, lines of credit, and financial details), which is prepared by a credit bureau
What this means for you: There are three main credit bureaus (Equifax, Experian, and TransUnion) that collect financial information such as the credit you’ve taken out, whether you’ve paid bills on time, and whether you’ve filed for bankruptcy in the past (get more details on what information credit bureaus collect here). Lenders use this information to determine if you qualify for credit.
Definition: A number determined by credit reporting bureaus that represents your creditworthiness based on your credit history
What this means for you: Your credit score is calculated based on information in your credit history and credit report. While there are a few different companies and credit bureaus that calculate credit scores, the most widely recognized is FICO (the Fair Issac Corporation). FICO credit scores normally range from 300–850; 300–629 is considered “poor,” 630–689 is considered “fair”, and 690–719 is considered “good.” A FICO score over 750 is considered “excellent.”
Ready to apply for a personal loan?
Arming yourself with this information can help you make a clear assessment of your personal loan options and how applying for a loan will affect your overall financial picture. Knowing these loan terms and how they apply to you will help you understand what you’re committing to when you accept a personal loan and make your choice with confidence.
Want more information on whether a personal loan is right for you? Check out our blog post on how personal loans work for a deeper dive.
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