Credit can be complex and confusing. When you’re applying for a loan or credit card, the process can be intimidating — especially when unfamiliar terms start getting thrown around. While some terms are self-explanatory, others can be a bit more ambiguous.
Getting familiar with some of the terms you will encounter in the loan or credit card application process can be beneficial in getting the best loan terms and ensuring you are entering into credit agreements that are favorable for you. Depending on your credit score, of course, you will be eligible for more favorable loan terms and lower interest rates.
Let’s take a look at 11 common credit terms you’re likely to encounter in the process of a credit application scenario.
An interest rate is a percentage of the principal balance your lending institution charges you for borrowing the money. Many factors go into determining a borrower’s interest rate, including credit score, the risk of default and inflation, as well as the length of the loan.
Annual Percentage Rate (APR)
APR is an annual rate that accounts for the interest and other fees paid on a loan or credit card balance. This percentage varies based on the bank or lending institution.
A billing cycle is essentially the number of days between statements on a credit card or loan account. The length of this cycle is typically between 20 and 45 days and is at the discretion of the credit or loan provider. The credit card company or loan institution provides the borrower with a statement once the billing cycle ends. Some lenders will allow the consumer to request a different billing cycle than what is offered.
Minimum amount/payment due
Minimum amount due is the monthly payment a borrower must pay to keep their account current and in good standing, avoiding late fees. The amount of this payment can be fixed or variable based on the outstanding balance on the account. The former is more common on installment loans, and the latter is more common on revolving credit accounts. It’s important to remember, especially with credit cards, that making only the minimum payment won’t yield fast results in paying off a balance, and the longer you carry any balance on a card, the more interest you’ll be paying.
A payoff amount is the total dollar amount that has to be paid to satisfy a debt. Payoff amounts are often more than the principal balance because they include any unpaid interest, late charges or fees. If you are ready to pay off a loan, it’s important to contact the lender to get the correct payoff amount, because interest compounds daily, so that figure is always changing.
Mortgage insurance is completely separate from the insurance borrowers are required to carry on a home in order to secure a loan against it. Mortgage insurance is designed specifically to protect the lender in the event that a borrower defaults on the loan. Mortgage insurance is required in all states for borrowers who have less than a 20-percent equity stake in their home.
Down payments are an initial one-time cash payment that is put towards a loan at the beginning of the application process. For mortgages and auto loans, a down payment is typically a percentage of the full loan amount. While auto loans don’t always require a down payment, mortgages nearly always do. The smallest down payment options are attached to FHA and VA loans, which require between 3 percent and 5 percent down, with special programs available to make down payments as low as 1 percent available to qualified buyers. Conventional loans require 20 percent down in order to avoid mortgage insurance.
The principal balance is the unpaid portion of a loan or credit account excluding interest and fees. Your loan agreement should clearly define the amount of your monthly payment that goes toward principal and what goes toward interest and other fees.
Refinancing allows you to move debt to a new loan and/or change the terms of an existing loan. For example, many consumers refinance their mortgage loans, using their equity to pay off other loans such as credit cards, and/or to secure a lower interest rate or shorten the term of the new loan. It’s important to calculate the associated fees to ensure that the overall benefit warrants refinancing. In addition to mortgages, consumers can often yield benefits from refinancing student loans and car loans. This is often especially beneficial after credit repair efforts have raised a previously low credit score.
A cosigner is someone other than the primary borrower who assumes risk for a loan along with the primary borrower. Adding a cosigner to a loan is a way to increase the odds of approval, particularly if the primary borrower doesn’t have substantial income or a high enough credit score to qualify on his or her own. Cosigners are equally responsible for repaying the debt on which they’ve signed and are therefore putting their own credit score at risk if the primary borrower makes late payments or defaults on the loan.
Collateral is the asset or property used to secure loan repayment. Collateral value must be equal to or greater than the loan amount. The asset or property is then at risk of seizure (or repossession in the case of a mortgage or auto loan) by the lender in the event that the borrower defaults on payments.
Understanding these credit terms can remove some of the anxiety associated with the credit application process and help you manage your credit more effectively. If you’re struggling to qualify for any type of loan and wondering how to fix your credit you may benefit from working with a credit repair professional. Lexington Law offers a free credit report summary and consultation. Contact us today to get started.