Personal loans themselves are fairly straightforward financial products, but they often contain plenty of technical personal loan terms that can be confusing if you’re not familiar with them.
Personal loans work differently from credit cards, which offer unsecured revolving lines of credit, up to a specific limit. You make a purchase and have a fixed time to repay the money owed in full, or pay a minimum plus interest.
A personal loan allows you to borrow a specific amount of money, usually from a financial institution, and then repay the debt with interest in equal payments over an agreed time period. Plenty of personal loans also let you make extra repayments, so every dollar you pay above the required repayment will shorten the life of the loan and its overall cost.
10 Personal Loan Terms Explained (And Why They Matter)
1. Principal amount
The amount of money that you borrow, not including interest or fees. The principal amount you owe goes down as you pay it off. Remember, though, that your monthly payment will also include fees and interest, so the entire amount you pay every month isn’t deducted from the principal. Always aim to just borrow the amount of money you need and no more. And if you have the means to occasionally pay back a bit extra on your principal, you’ll pay off your loan faster.
The term is the exact amount of time you have to pay back the loan, and it’s usually between one and five years. Generally, the longer the term, the higher the interest rate. The shorter the term, the more your monthly payments will be. So, you have to decide what you want: a lower monthly payment, or to save on interest.
3. Fixed monthly payment
Your fixed monthly payment is your payment due to your lender that doesn’t change throughout your loan term. It’s paid every month until your loan is paid off completely. The fixed monthly payment is made up of both principal and interest amounts.
4. Comparison rate
Some personal loan lenders will display a comparison rate, which shows the true cost of the loan. It includes the interest rate, payments, and most ongoing and upfront fees and charges, in one single figure that reflects the total annual cost of the loan.
5. Credit score
This is an assessment of your credit-worthiness, based on your borrowing and repayment history. Your credit score is calculated from a deeper analysis known as a credit report, which is undertaken by a New Zealand credit rating bureau.
6. Upfront fee
When you apply for a personal loan, you may be charged an upfront fee. If you find a personal loan with a high upfront fee, ensure that the interest rate and features are competitive enough to outweigh this cost.
7. Draw down
The funds are “drawn down” into your account, so they are accessible by you to use for the purpose of the loan.
8. Late payment fee
Keep up your regular repayments, otherwise you may face a late payment fee. This is usually a flat fee, and not based on the loan amount. You could set up an automatic payment for your loan using online banking to avoid paying this penalty.
9. Secured loans
Secured loans use an asset, such as a car, to secure a loan. The asset is then used as security against the debt. The money borrowed can generally be used for any legal purposes. This can include debt consolidation, home renovations, school fees, paying for a holiday or buying a car. But always check with the lender first. If you’re unable to repay the loan, the lender may be able to sell your security item.
10. Unsecured personal loans
The lender requires no security for the debt. The loan is still subject to your ability to repay it, and if you can’t, the lender may take you to court. The interest rates on unsecured loans are higher, on average, than on secured personal loans. This reflects the higher risk of losing money for the lender.
Ready to apply for a personal loan?
Arming yourself with information like this is key to helping make an assessment of your personal loan options and how applying for a loan will affect your overall financial health. A personal loan is, as the name suggests, a personal decision, and one that should be made only after thoroughly going through your finances.
And before you make any decision, compare the different loans and lenders in the market to ensure you get the best deal. To help with your homework, Canstar rates and compares all the best loans and lenders. And we reward the best with our Outstanding Value awards. For more information on our winners and awards for 2020, just click on the big button below.
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