I’m a Financial Expert: 9 Key Terms To Consider When Taking Out a Personal Loan

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A personal loan can be a great way to pay for things like big-ticket items, unexpected bills or even small business expenses. Some lenders offer loans of only around a few hundred or thousand dollars, but others can go up to $100,000 or even more. Any personal loan is a commitment, but the more you borrow, the more you’re responsible for paying back.

Before you take out a personal loan, there are certain key terms you should know. These are some of the most important ones, according to financial experts Kyle Enright, president of Achieve Lending, and Trevor Smith, corporate branch manager at Wasatch Peaks Credit Union.

Also see 10 key questions to ask before taking out a personal loan.

APR or Interest Rate

Personal loans come with an interest rate, which is usually based on factors like your credit score and income. The higher the interest rate, the more you’ll end up paying the lender to borrow money — especially if you have a longer repayment term.

You should also consider the loan’s APR. “Borrowers need to know the interest rate on the loan, but APR (annual percentage rate) provides a better figure for comparison and evaluation purposes,” Enright said. “APR is the total annual cost of borrowing, including the interest rate and any fees.”

Enright noted that interest rates — not APRs — are generally between 8% and 36%. Some loans may have a higher rate.

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Debt-to-Income Ratio

Your debt-to-income (DTI) ratio calculates how much of your monthly income goes toward your debt payments. It’s expressed as a percentage. Lenders use it to determine how well you manage your debts and may base the loan amount on it.

“Higher ratios are associated with greater risk of missing or late payments on the loan,” Enright said. “At Achieve, we look for a debt-to-income ratio of 45% or lower, but again, every lender is different.”

You can get your DTI by dividing your total monthly debt payment amount by your monthly income. Include things like your mortgage or rent, other loans, credit cards, alimony, and child support in your total monthly debts.

Credit Score

Your credit score is a three-digit number that lenders use to determine whether to approve you for a loan — and at what rates and terms. The better your score is, the better your approval odds.

“In most cases, applicants with higher credit scores will receive the lowest rates,” Enright said. “At Achieve Lending, for example, borrowers should have a minimum credit score of 620, but many lenders will lend to consumers with lower scores; they will just be offered a higher interest rate.”

On the FICO scoring model, which many major lenders use, your credit score ranges from 300 to 850. A score of 670 or higher is generally considered “good” credit.

Fixed Rate vs. Variable Rate

Interest rates can be either fixed or variable. The one you get can make a difference in how much you pay each month and the total cost of your loan.

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Take a fixed rate, for example. “This means that the interest rate on the loan cannot change at any time throughout the term,” Smith said.

A variable rate can change. This means you could pay more in interest during one month and less the following.

Origination Fee

Personal loans often come with origination fees, which exist to cover any administrative costs that come with processing and funding loans. According to Enright, they usually range from 2% to 7% of the loan amount.

“Most lenders will deduct the amount of the origination fee from the loan proceeds. So if you’re looking for a loan of a specific amount, you may need to request a higher loan amount,” Enright said. “If a lender does NOT charge an origination fee, they are likely including the cost in the interest rate. So be sure and check the overall costs of the loan over its life.”

Be sure to ask any lender about the origination fees in advance. That way, you won’t be blindsided by a higher interest rate or end up with a smaller-than-expected amount.

Prepayment Penalty

If you’ve ever taken out a loan before, you might have come across the term “prepayment penalty.”

“This is a cost the lender charges if a borrower chooses to pay off the loan early,” Enright said. “Some lenders impose one, and some don’t.”

You might find prepayment penalties on other types of loans, like mortgage loans. In the case of mortgages, you may face a prepayment penalty only if you pay off or refinance your home within a set period of time — like three to five years.

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Other Fees

Some personal loans come with additional fees, like late fees.

“Be sure to know your monthly payment due date, and then if there are late fees,” Enright said. “If so, understand how much and when they are assessed.”

Some lenders will charge a fixed amount when you miss the payment due date. This can be either a dollar amount or a percentage of the owed amount.

Collateral 

Smith noted that it’s also good to understand whether or not your loan requires collateral.

“This is anything with a title, that can be used to take a loan out,” Smith said. “Using collateral may lower interest rates.”

Some lenders may also be more willing to lend you money if you have collateral. Failure to repay the loan could mean losing the collateral, thus lowering the risk of defaulting on the loan.

Co-Borrower

Certain personal loan lenders allow for co-borrowers. If you have spotty credit history or issues with your income, having a co-borrower could help you get a loan — provided the co-borrower meets the lender’s criteria.

“A co-borrower’s name appears on the loan, and therefore is expected to make payments,” Enright said. “A co-borrower also has access to the funds.”

If you don’t repay the loan, the co-borrower is expected to. This makes them responsible for the loan too.

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