Choosing a personal loan is a major financial decision that can impact your budget for years. Many Americans turn to personal loans for everything from debt consolidation to emergency expenses, but not everyone fully understands the terms involved. Knowing what to look for in a loan agreement can help you avoid hidden fees and unfavorable conditions.
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Personal loans are usually unsecured, meaning you do not have to put up collateral, but that does not mean all loans are the same. Lenders set their own requirements and fees, so it is important to compare offers carefully before signing anything. Learning the most important terms will enable you to make a more informed choice and protect your financial future.
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Annual Percentage Rate (APR)
The annual percentage rate, or APR, is the yearly cost of borrowing money, including both interest and mandatory fees. According to Bank of America, lenders must disclose the APR to help Americans compare loans on an equal basis, as required by the Federal Truth in Lending Act.
A borrower can use the APR when comparing personal loans to decide which is best for them. A lower APR means the loan will cost less overall, so always check this number before committing.
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Interest Rate
The interest rate on a personal loan is the percentage charged on the principal amount borrowed. Unlike an APR, an interest rate doesn’t include fees.
The interest rate can be either fixed or variable. A fixed rate stays the same for the entire loan term, while a variable rate can change during the loan term.
Knowing your interest rate can help you estimate your monthly payments and the total cost of your loan.
Loan Term
The loan term, or tenure, is the length of time you have to repay the loan, and it’s usually measured in months or years. Shorter terms mean higher monthly payments but less total interest, while longer terms lower your monthly payment but increase the total interest paid.
Always choose a loan term that fits your budget and financial goals.
Origination Fee
An origination fee is charged by a personal loan lender when the loan is taken out. It’s the cost of processing the loan application, and it is usually a percentage of the loan amount. According to LendingTree, it is typically between 1% and 10%. Some lenders deduct this fee from the loan proceeds, so you’ll receive less money than you borrow.
Always ask about the origination fee before accepting a loan offer.
Prepayment Penalty
A prepayment penalty is a fee charged if you pay off your loan early, which some lenders include in the agreement. This penalty can reduce the savings you might get from paying off your loan ahead of schedule, so make sure to check for any prepayment penalties before signing your loan agreement.
Collateral
Collateral is an asset of the borrower’s that can be used to secure a loan. These can include a car or savings account. Most personal loans are unsecured and do not require collateral, but secured loans may offer lower rates if you have valuable assets.
However, if you default on a secured loan, the lender can take your collateral to recover their money.
Amortization
Amortization involves spreading out loan payments over a period of time, showing how each payment reduces principal and pays interest. According to the Consumer Finance Protection Bureau, early in the loan term, more of each monthly payment goes toward interest, while later payments reduce the principal faster.
Reviewing your amortization schedule can help you understand how your loan balance will decrease over time.
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This article originally appeared on GOBankingRates.com: 7 Terms You Should Look For When Considering a Personal Loan
