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The lender considers your risk as well as market conditions to decide what interest and fees to charge you for the loan. If the lender approves your application, you’ll receive written, formal loan approval. You’ll also submit proof of income and other documents.īased on the information in your application and a check of your credit report, the lender may approve your loan as requested, approve with different terms, deny your application, or request more information. You’ll provide information about your income, debts, assets, addresses and employment. You submit an application stating the amount you want to borrow and what you want it for. With all that terminology out of the way, here are the step-by-step basics of how a loan works: The higher your credit score, the more likely you are to get a loan and the lower the interest rate is likely to be. Lenders pull your credit report and apply a formula to it – a FICO or VantageScore – to generate a credit score. This is a score that indicates your creditworthiness. Credit scores are compiled by three large credit reporting agencies (CRAs)” TransUnion, Experian, and Equifax.Ĭredit score. This is a history of how you’ve used credit in the past, including any late payments and bad debts. Because it lacks that security, unsecured loans have higher interest rates than unsecured loans.Ĭredit report. Mortgages and car loans are common examples of secured loans. Collateral means an asset that you pledge to the lender if you don’t repay your loan, the lender can take and sell your collateral. Note that the servicer may be different from the lender, so it’s important to know where to direct payments and inquiries. This is the organization that processes your loan payments and handles any issues with your payments. Lenders can be banks, credit unions, specialty lending companies, credit card companies, and peer-to-peer intermediaries. This is the individual or organization making the loan. It sometimes comes with coupons that you can attach you your checks, and then it’s called a “payment book.” This is the schedule of how much you’ll owe every month and when each payment is due. This is an important tool for understanding how quickly you’ll pay your principal will be paid down and how much interest you’ll pay. It shows each month’s payment, how that payment breaks down into principal and interest, and how the amount you owe declines with each payment. This is a table that shows how repayment will progress month by month over the life of the loan. Check your loan agreement for fees before you sign it because they can significantly increase the cost of a loan.Īmortization schedule. There can be many types including application and processing fees, origination fees, late charges, and prepayment penalties.

In addition to interest, some lenders charge fees. It’s simple – if your loan has a ten-year term, for instance, you repay it over ten years (120 months). This is the period over which you have to repay the loan. Typically, the interest rate is tied to a published financial index and moves up and down as the index changes. In contrast to a fixed-rate loan, an adjustable-rate loan’s interest rate may change at specific times during the loan’s life according to formulas that are spelled out in loan documents. In this context “fixed” means that the interest rate stays the same throughout the life of the loan.Īdjustable interest rate. Interest is usually computed as a percentage of the amount you owe.įixed interest rate. This is what you pay lenders for tying up their money. When your principal balance hits zero, you’ve paid off your loan. It starts out as the amount you borrow and falls as you pay the low down.

Most of the concepts are actually pretty simple if you look at them one by one. Don’t be intimidated - it’s not as complicated as it seems. There’s a lot of jargon associated with loans. This guide can help prepare you to borrow money successfully, and act as a reference any time you have questions about loans. This guide covers the essentials, including In order to borrow successfully, it’s important to understand how loans work. However, borrowing mistakes can make your life miserable for years to come. Borrowing money can help you achieve the lifestyle you want.