10 key personal loan terms every first-time borrower should know

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Applying for a personal loan can feel overwhelming, especially if it’s your first time. Of course, getting your documents in place and having all the approvals on time is important, but equally important is understanding certain words or terms that lenders typically use. If you don’t want to be at sea during this process, it’s best to learn some basic vocabulary of personal loans so that you are be better equipped to compare offers, negotiate effectively, and avoid making costly mistakes.

1. Principal
This is the actual amount of money that you borrow from the lender. All interest and charges are calculated in relation to this base figure.

2. Interest rate
This is the cost of borrowing, expressed as a percentage of the principal. It may be fixed (does not change over the length of the loan) or floating (changes with the market).

3. Annual percentage rate (APR)
The APR is the loan cost, both interest and other fees, spread over a period of one year. It is a better indicator than using the interest rate by itself.

4. Tenure
Tenure is how long you are to repay the loan. The tenures of personal loans vary from one year to five years. The longer the tenure, the smaller the monthly installment but more the total interest.

5. Equated monthly installment (EMI)
An EMI is the monthly amount you pay to the lender, interest and part of the principal. EMIs make repayment easier but must be made on time to avoid paying fines.

6. Credit score
Your credit score shows how creditworthy you are and how well you've repaid previously. The better your credit score, the higher the chances of getting your loan sanctioned and paying less interest.

7. Processing fee
Borrowers also pay a single processing charge to cover administrative expenses. It is deducted from the amount disbursed or added to the loan price.

8. Prepayment and foreclosure
Prepayment is paying some of your loan before it is due, and foreclosure is paying the full outstanding sum in advance. Certain lenders penalize this, so conditions need to be examined with diligence.

9. Collateral
The majority of loans are individual and are not secured, i.e., no collateral is required. Where security is required, collateral refers to the property given as security to the lender, which in default of payment can be repossessed.

10. Debt-to-income ratio
This is a calculation of your monthly debt obligations in comparison to your monthly income. The lenders use this when considering whether you will be able to comfortably service the new loan as well as any other existing obligations.

Why these terms matter
Loan documents are replete with jargon that may bewilder new borrowers. Familiarity with these terminologies helps you shop around, bargain better, and be prepared for the surprises that lie ahead. Financial literacy not only makes you borrow smart but repay smart as well.

FAQs
Q1. Is APR always higher than the interest rate?
Yes, because APR does not simply reflect the interest rate but includes charges and fees
associated with the loan.

Q2. Can I reduce my EMI after taking the loan?
You can potentially reduce EMIs by extending the repayment period or by refinancing at a
different institution, but at the expense of higher total interest outgo.

Q3. Does multiple loan application adversely affect my credit score?
Yes. Every loan application causes a credit inquiry, and too many inquiries in a short time
frame will reduce your score.