If you’re getting your first student loan or credit card, you’re likely seeing some terms you don’t recognize. A key component of being an informed consumer is understanding all those financial terms. You’ve probably heard an announcer at the end of a TV commercial speed-reading through a bunch of legal terms. We’re going to slow it down and lay out the most important terms you need to know.
This is the act of interest accumulating on your principle balance.
Annual Percentage Rate (APR)
APR is a more accurate reflection of the total annual loan cost. It includes the actual interest rate, plus any other incurred charges or fees (such as upfront origination fees). You can find more information about interest rates and APRs on our website.
Capitalization means adding unpaid accrued interest to the principal balance of a loan. This increases the amount of your monthly payments and the total amount repaid over the life of the loan. You can choose to pay the interest as it accrues to reduce or completely avoid the cost of capitalization. The more frequently interest capitalizes, the more you wind up paying.
A cosigner or co-borrower is an individual who signs the loan promissory note with you. They are equally responsible for repaying the debt. Having a cosigner can often help you qualify for a better interest rate. This is especially true if you don’t have established credit or sufficient income. This article further outlines the potential benefits of having a cosigner.
Compound interest is interest calculated on the principal loan amount, plus any interest accrued during previous periods. For example, if interest is compounded monthly, you would then pay interest on the interest that accrued in the previous month, as well as the outstanding principal. Compound interest can drive up your total cost of paying off debt.
A credit bureau is an agency that collects personal and financial information from various sources about consumers. The agency retains information about the types and amounts of credit you have obtained as well as your timeliness in making payments. Your credit card companies and the various lenders which have made loans to you report this information to the agency.
A credit score is a number, generally between 300 and 850, provided in a credit report and used by a lender as a predictive indicator of your likelihood to repay a loan. The credit score may be used by the lender to determine eligibility and set the terms of a loan, such as the interest rate and fees. The higher the credit score, the better. Higher scores will generally allow you to receive better interest rates. Check out our article on understanding your credit report for more detailed information.
The failure of a borrower to repay a loan according to the terms of the promissory note is a default. For federal student loans, default occurs at 270 days delinquent and has a negative effect on your credit score.
Failure to make payments when they are due is referred to as delinquency. Delinquency begins with the first missed payment. Missed payments or delinquent payments will negatively impact your credit score, so make sure you stay current on all payments.
The total amount of interest that will be paid over the life of a loan when the loan is repaid according to the payment schedule is the finance charge.
Fixed Interest Rate
A fixed interest rate is an interest rate that remains the same for the duration of the loan or credit obligation.
This is an amount, calculated as a percentage of the principal loan amount, that lenders charge for borrowed money.
The interest rate is the rate at which interest is calculated on your loans or credit card balance.
Minimum Monthly Payment
The smallest monthly payment amount that can be made in order for a loan account to remain in a current repayment status is the minimum monthly payment. For a credit card bill, you’ll find that paying more than the minimum monthly payment will help you pay your balance faster and likely help you avoid potential rate increases on your credit card.
The fee you pay and deduct from the principal of a loan prior to disbursement is the origination fee. For federal loans, you pay this fee to the federal government to offset the cost of your interest subsidy. For private loan programs, you pay the origination fee to the lender to cover the cost of administering and insuring the program.
The promissory note is the binding legal document you sign for a loan, which lists the terms and conditions of the loan as well as your rights and responsibilities. For federal student loans, another name for the promissory note is the Master Promissory Note (MPN).
Simple interest is interest only calculated based on the principal amount of the loan.
Truth in Lending Disclosure
This disclosure is a statement lenders provide to you prior to or at the time of disbursement of a private loan that lists the lender name and contact information, amount financed, annual percentage rate (APR), finance charge, payment amount and schedule, and total repayment amount.
Variable Interest Rate
The rate of interest charged on a loan changes periodically (monthly, quarterly, or annually) and fluctuates with a stated base index (such as the Prime Rate or a LIBOR index) is a variable interest rate. The variable interest rate fluctuates as the base index changes. So, your monthly payment amounts will increase or decrease depending on if interest rates rise or fall.
Now you have a basic understanding of some of the common financial terms and how they impact you as a consumer. Remember, always make sure that you understand all of the terms and conditions when you take out student loans, open a new credit card account, or take on a new loan of any kind. Reputable companies will be happy to answer any questions you have so that you have a clear understanding of your financial obligations.