What Are Loan Terms?
“Loan terms” refers to the terms and conditions involved when borrowing money. This can include the loan’s repayment period, the interest rate and fees associated with the loan, penalty fees borrowers might be charged, and any other special conditions that may apply. Reviewing loan terms carefully is important for understanding your obligations when taking out a loan.
- “Loan terms” is a broad way to describe the various details of a loan, including the repayment period, monthly payments, and costs.
- When applying for a loan, the lender should specify what the loan terms are before finalizing any borrowing agreement.
- It’s important to review loan terms carefully to check for any hidden clauses or fees that could potentially cost you money.
Understanding Loan Terms
When lenders make loans to borrowers—whether it’s a mortgage loan, personal loan, car loan, or any other type of loan—it’s under certain conditions and guidelines. These guidelines for borrowing are spelled out in the loan terms, and they detail what’s expected of both the borrower and the lender. Loan terms are typically included in the final loan or credit agreement.
Reviewing loan terms before signing off on a loan is important for several reasons. First, you need to know what your obligations are with regard to making payments on the loan. If your loan payment is due on a specific date each month, for example, you would need to know that to avoid paying late and potentially damaging your credit score.
Understanding the loan terms can also help you to determine whether a loan is a good fit for you before you enter into a repayment agreement with the lender. If there’s something in the loan terms with which you don’t agree—such as a penalty fee or another condition—you could reject the loan offer.
Loan terms can vary considerably. What you agree to for a car loan, for instance, may be very different compared with the terms required for a personal loan or mortgage, and there may be terms included that are specific to the type of loan involved.
Types of Loan Terms
There are a number of important pieces of information to consider when reviewing loan terms. Reading through a loan agreement can take a little time, especially for a more complicated loan, such as a mortgage. If you aren’t able to read a loan agreement in full, here are the most important loan terms to keep in mind.
Loan Repayment Period
The first loan term to get familiar with is the loan repayment period. This means how long you’ll have to repay what you borrow. For example, if you’re getting a mortgage, your loan might have a 30-year term, meaning your payments are spread out over a 30-year period. A car loan, on the other hand, might have a five-year term, while federal student loans have a standard 10-year repayment term (except for consolidation loans, which can have terms from 10 to 30 years).
Loan repayment periods are typically broken down into an amortization schedule. This schedule shows you how your payments are applied to your loan balance over time. Typically, this will detail:
- How much of each payment goes to principal
- How much of each payment goes to the interest
- How your principal balance decreases over time
- The total amount of interest paid over time
The longer your loan repayment period, the lower your monthly payment may be, but a longer loan repayment period can also translate to more interest paid in total over the life of the loan. For this reason, it might be wise to first use a personal loan calculator to determine how a shorter term will affect the overall cost of the loan.
Interest Rate and Fees
After the loan repayment period, the next loan terms to focus on are the interest rate and fees. The interest rate is the rate of interest you’ll pay for the loan; the fees are what the lender can charge you to obtain the loan. Your annual percentage rate (APR) reflects the total cost of repaying the loan annualized over the course of a year.
In terms of fees, there are several important ones to look out for in your loan terms and conditions, including:
- Origination fees
- Closing costs (in the case of a mortgage or home refinance loan)
- Prepayment penalties
- Late payment penalties
- Application fees
- Annual fees
Lenders can decide which fees to charge and when to apply them. For example, some lenders charge an origination fee, which is used to cover the cost of processing the loan, while others don’t. Some lenders may charge a prepayment penalty if you decide to pay your mortgage off early. These fees can be a flat dollar amount or a percentage of the loan amount.
Again, each of these fees should be included in your loan agreement. In the case of a mortgage loan, they should appear in your loan estimate and closing disclosure. These must be presented to you before you close on a mortgage, so you know exactly what you’re paying.
Other Loan Terms and Conditions
While the loan repayment period and costs may be your most important concerns, there are some other loan terms of which to be aware. For example, one big thing to watch out for is anything that mentions balloon payments.
Balloon payments are one-time payments that are due at the end of a loan to pay it off. While loans with balloon payments are less common, it’s important to be aware of whether any loan you agree to has one. If it does and you’re not prepared for it, you may find it difficult to come up with the money to make the final payment on time.
You should also review loan terms and conditions for any wording relating to default. Specifically, your loan agreement may specify when you would be considered in default on the loan due to missed payments and what recovery strategies are available to the lender for recovering the money that’s owed.
Defaulting on a loan can open the door to serious consequences, including credit score damage as well as collection efforts, including a civil lawsuit.
Finally, be sure to check for any wording relating to a personal guarantee, especially in the case of a business loan. Personal guarantees mean that you agree to be held personally responsible for the debt. If you take out a business loan and default, the lender could come after you personally, which may be damaging to your credit score and finances.
Negotiating a Loan
When taking out a loan, keep in mind that it may be possible to negotiate the terms and conditions with the lender. For instance, some of the things you may be able to negotiate include the loan repayment period, the APR, fees, and the monthly payment. Working with the lender can help you secure the best deal possible on a loan.
For example, say you want to buy a car with a sticker price of $20,000. You’re initially approved for the full loan amount at 6.5% and a seven-year term. If you have a high-value trade-in and a solid credit score, you may be able to negotiate the price down to $18,500 and get the lender to restructure your loan terms to a 4.5% rate with a five-year term. Negotiating even small differences in a loan amount, an APR, or fees could translate to big savings over the life of the loan.