“If you are sure you understand everything that is going on, you are hopelessly confused” -Walter Mondale
Credit can be confusing, especially with all the different legal terms. It’s always helpful to have a clear understanding of what these different credit terms mean so that you can always make the most informed choice. Here are several common terms broken down into more easy-to-digest words:
Asset
An asset is a personal belonging of yours you either already own or are purchasing with the new loan you are applying for. Two examples: Bail Bonds usually require collateral to get a bail loan, and a new home or car purchase usually requires the home or vehicle listed as collateral.
Collateral
When you buy a home, for example, your home is collateral for getting your loan. Basically if you fail/refuse to pay your mortgage the loan provider can take your house to pay for part or all of the loan amount still remaining.
Secured Debt/Loan
When you have to offer a personal belonging to get a loan this is called a secured loan or secured debt. many credit cards, by contrast, offer unsecured loans meaning you don’t have to offer an asset to get the card or spending limit.
Annual Percentage Rate (APR)
The annual percentage rate (or APR) is the amount of interest on your total loan amount that you’ll pay annually.
Interest Rate
An interest rate is the cost of borrowing money. It is basically a percentage of the principal balance charged by a loan or credit provider for lending money. Some of the factors that can influence a borrower’s interest rate include the length of the loan, the risk of default, as determined by underwriting, and inflation rates. Also, interest can be charged by day, week, month, year, etc.
Billing Cycle
The billing cycle for a credit or loan account refers to the number of days between statements. Billing cycles can vary per credit or loan provider but generally last between 20-45 days. Once a billing cycle ends, the provider will send a statement to the borrower based on the activity during that cycle.
Principal Balance
The principal balance refers to the unpaid portion of a loan or credit account excluding interest and other fees. The amount of a payment that goes toward principal and interest or other fees will be defined in your agreement. In order to pay a loan in full, the principal balance must be $0. The higher the interest rate is on your loan, the more your payments will go towards paying off interest and less towards your principle balance.
Minimum Amount Due
The minimum amount due is a monthly payment that a borrower needs to pay to keep their account current and avoid late fees. The amount of this payment could be a fixed installment or a percentage of the outstanding balance on the account. Keep in mind that some lenders have early payoff penalties which could cost you extra money if you want to pay off your balance at a more expedited rate than required. Steer clear of loans with these types of provisions.
Payoff Amount
A payoff amount is the total dollar amount that must be paid to close a debt. The payoff amount could be more than the principal balance because it may include unpaid interest, late charges and fees. Often times, to receive an accurate payoff amount, the borrower may need to request a quote from their lender or credit provider. Always follow up to make sure the account is paid in full. You would not believe how many people have had their credit damaged when they thought an account was paid off yet a small balance remained that became delinquent.
Refinance
Refinancing is the process of moving one or more debts to a new loan or changing the terms of an existing loan. The reasons for refinancing may vary per borrower but some potential advantages include a lower interest rate or an extended loan term. However, there are some possible drawbacks such as additional fees that can reduce the overall benefit for the borrower. You should consider the overall cost of refinancing. Common forms of debt that are refinanced include car loans, student loans and mortgages.
Down Payment
Down payments are a one-time cash payment that is submitted early in the loan application process. The amount of the down payment is usually a percentage of the item’s full purchase price. For example, the down payment for a mortgage could range from 5-20% of the home’s total value. In addition to improving the odds of getting a loan approved, a down payment can often lower the monthly payment and reduce the interest rate.When applying for a mortgage or vehicle loan, a down payment is almost always required by the bank or lending institution.
Cosigner
A cosigner is a person, other than the primary borrower, who signs a credit or loan application with the primary borrower. Adding a cosigner to a loan application can potentially strengthen the odds of approval if the cosigner has a higher income or credit score than the primary borrower. If the application gets approved, the cosigner will be equally responsible for repaying the debt and assume legal liability to pay the debt in full if the primary borrower defaults.
Debt-To-Income Ratio
When you apply for a line of credit or a loan the lender wants to make sure you are in a position to repay the loan before they issue you the loan or line of credit. One way they do this is by looking at your current income (they might require past income documentation as well) and they might want to know what loans or lines of credit you currently have. Even if you don’t owe any money on a credit card the credit limit can affect your ability to get a loan or another card. Basically the new lender takes into consideration what if scenarios: What if this customer suddenly spends half of their credit limit, will they be able to make their monthly payment on this new loan? What if they ‘max out’ their credit card/s?
These are a handful of very common terms you will likely encounter, though there are many more! Please feel free to comment or write us with questions and we will help to unravel some of the other confusing terms you might come across.