Finding the loan that is right for you involves wading through all the details of any given offer. It is key to understand loan terminology if you want to be able to compare apples to apples when choosing between loan programs. Just comparing interest rates is not enough. There are many other factors that come into play when determining the financial feasiblility of borrowing money.

There are two main components to a loan. There is the principal, which is the amount of money you borrow. And there is the interest, which is the surcharge you pay back over and above the principal amount you borrowed.

The key document in any loan transaction is the promissory note. The promissory note is the contract between the borrower and the lender and explains in great detail all the terms and conditions of the loan. It provides the details of what is expected from both parties during the duration of the contract such as repayment terms, payment schedules, and payment delinquency penalties.

The following are some of the key terms found in the promissory note and other related loan documents:

Origination Fee

Processing the loan application and setting up the actual loan for disbursement to the borrower is called “originating” the loan.  Some lenders charge origination fees, especially when issuing mortgage loans.

Often, the origination fee is taken from the principal before it is given to the borrower. This means the borrower isn’t given all the money that’s borrowed, but must still repay the total amount as if he or she had been given all the money.

Application Fee

Although it is illegal to charge an application fee for a federal loan, lenders may charge an application fee for other types of loans. This is a fee charged to process the application. It is usually not taken from the principal of the loan and must be paid when you apply for the loan, regardless of the loan amount.

Interest Rate

This is a percentage of the loan amount that you’re charged for borrowing money. It is a re-occurring fee that you’re required to repay, in addition to the principal. The interest rate is always recorded in the promissory note.

Sometimes, the interest rate remains the same throughout the life of the loan until it is all repaid. Other times, the interest rate will change every year, quarter (three months), monthly, or weekly based on some financial variable such as the interest rate of Federal Treasury notes.

Capitalization

This is the process of adding interest that has accrued onto the loan principal. Subsequent interest then begins to accrue on the new principal. Capitalization is typically an action that is taken when a loan becomes severely delinquent and the lender has no ability to foreclose on the loan and collect on any security interest such as a house or other real property.

Disbursement

This when and how a borrower is to receive the funds that they have borrowed. The disbursement date can vary based on the type of loan and the state in which the loan was obtained.

Servicing

Servicing means taking care of the loan after the money is disbursed and until the loan is completely repaid. Many times servicing also means holding the records and associated documents of the loan even after it has been repaid. Servicing includes:

* Billing the borrower.
* Recording payments.
* Keeping track of the amount of money left to be repaid.

Sometimes the lender will change servicers or sell the borrower’s loan to someone else who uses a different servicer. This can be confusing to the borrower because payments will be sent to a different address. It’s usually easier for the borrower if the servicer remains the same throughout the life of the loan.

Minimum Payment

This is the least dollar amount of payment that will be acceptable to the lender on any given payment date. Even if the loan is small, the borrower must make the minimum payment each month until the loan has been fully repaid.

Term

This is the repayment period of the loan. Home loans typically have fixed terms of 15 or 30 years. Credit cards have open ended terms and are referred to as revolving accounts.

Default

Being in default is defined differently for different types of loans. Basically, it means being delinquent in repaying a loan more than a certain number of days (the grace period) or failure to comply with any of the other terms of the promissory note. Generally missing one payment does not mean the borrower is in default.  But it is important that you make all payments on time to avoid a ding to your credit.

Being in default subjects the borrower to a variety of extra expenses and penalties. Generally the remedy for a default is more than just bringing the payments up to date. Sometimes it means you must repay the entire loan immediately.

If you default on a federal or state loan, your lender and the government can take a number of actions to recover the money, including:

* Withholding your tax refunds.

* Withholding part of your salary if you work for the federal government.

* Suing and taking you to court.

* Informing credit bureaus which might affect your credit rating. As a result, you may have difficulty borrowing money for a car or a house.

* Requiring you to repay your debt under an income “contingent” or alternative repayment plan. You could end up repaying more than the original principal and interest on your loans!

Forebearance

A forebearance is an agreement between the lender and the borrower to reduce or postpone the borrower’s monthly loan repayment for a defined, limited period. This must be a documented agreement and will typically extend the term of the loan to account for the skipped or reduced payments.

These are just some of the terms you will come across when reviewing loan documents. Make sure you carefully review all terms and conditions before entering into any loan agreement.

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