There are many phrases that sound extremely similar but have nuanced meanings. The phrase âloan termsâ can cause some confusion because itâs often used to refer to multiple aspects of your mortgage.
If youâre feeling overwhelmed, thereâs no need to worry. A loan term can easily be understood with the right guidance and definition. Letâs break it all down.
Taking out a loan is a big financial decision that requires careful consideration of the terms and conditions set by lenders. As a borrower, it is critical that you have a clear understanding of what loan terms are before signing any loan agreement. In this comprehensive guide, we will explain what loan terms are, the different types of terms, how they impact your borrowing costs, and tips for negotiating better terms.
What Are Loan Terms?
Loan terms refer to the provisions and requirements of a loan agreed upon by the lender and borrower. These terms are outlined in the loan contract and govern the loan until it is fully repaid. The loan terms specify key factors like:
- Loan amount
- Interest rate
- Loan term or length of the loan
- Payment amount and due dates
- Fees and closing costs
- Prepayment and late payment penalties
- Events that would trigger default
By clearly establishing the rules and expectations for both parties, loan terms provide a framework for the lending agreement. Reviewing and understanding loan terms before committing to a loan ensures you know what you are getting into.
Key Types of Loan Terms
While specific loan terms can vary, there are some universal terms that appear in most loan contracts. Being aware of these key terms will help you compare offers and make an informed borrowing decision.
Loan Amount
The loan amount is the amount of money you are borrowing. The lender will determine the maximum amount you qualify to borrow based on factors like your income, existing debt obligations, and credit history.
Interest Rate
The interest rate is the cost of borrowing money, expressed as an annual percentage of the loan amount. For example, a 5% interest rate on a $20,000 loan means you will pay $1,000 in interest charges annually The rate can be fixed for the full term, or variable/adjustable meaning it changes over time
Loan Term Length
The loan term is the amount of time you have to repay the loan. Common term lengths are 6 months, 1-5 years for personal loans, and 15-30 years for mortgages. Longer terms mean lower monthly payments but higher total interest costs over the life of the loan.
Monthly Payment Amount
Your monthly payment is the regular installment you pay each month towards the loan. It is calculated based on factors like the loan amount, interest rate, and term length. Your payment stays the same for fixed-rate loans but can change for adjustable-rate loans.
Fees and Closing Costs
Common fees charged by lenders include origination fees, application fees, processing fees, and prepayment penalties for paying off a loan early. Closing costs like appraisal and attorney fees are also standard for real estate purchase loans.
Prepayment and Late Payment Penalties
If your loan has a prepayment penalty, you will be charged a fee for paying off your loan faster than the repayment schedule, usually only applies in the first few years. Late fees are charged if you miss or are late on a monthly payment. Be aware if there is a grace period before late fees kick in.
Default Clause
The default clause outlines the events that would allow the lender to demand full repayment of the outstanding loan balance. Common default triggers are failure to make payments, filing for bankruptcy, or breaking other terms of the loan. Default can lead to foreclosure, loan acceleration, collection lawsuits, and credit damage.
How Loan Terms Impact Costs
The loan terms you accept directly affect how much you end up paying in interest charges and fees over the life of the loan. To get the best deal, you need to understand how key terms like interest rate, fees, and term length influence the total costs of borrowing money.
Interest Rate – The higher the interest rate, the more interest you pay over time. Just a 1% higher rate on a $200,000, 30-year mortgage results in $73,000 more in interest.
Fees – Upfront fees like origination and processing fees get added to the loan balance, increasing your total repayment amount. They factor into the annual percentage rate (APR).
Term Length – Longer terms reduce your monthly payment, but because you pay interest for more years, your total interest expense is higher.
Prepayment Penalties – These limit your ability to pay off debt faster and incur less interest by penalizing you for extra payments.
Paying attention to how loan terms drive overall costs, and negotiating more favorable terms when possible, is key to reducing what you pay to borrow money.
Tips for Negotiating Better Loan Terms
You may be able to negotiate with lenders to improve certain terms and get a better deal. Here are some tips for negotiating your loan:
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Shop around – Compare offers from multiple lenders to give you negotiating leverage.
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Highlight strong qualifications – Emphasize a high credit score or significant down payment when asking for a lower rate.
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Request fee waivers – Ask for origination or application fees to be waived if you have an existing relationship with the lender.
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Adjust term length – Opt for a shorter term if the lender won’t reduce rates, to at least reduce your total interest costs.
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Make a deal – Offer to use the lender for multiple needs in exchange for better terms, like combining your mortgage and auto loan.
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Pay points for a lower rate – Points are fees paid upfront to reduce your ongoing interest rate, resulting in interest savings that offset the points over time.
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Avoid prepayment penalties – Make sure the lender agrees to remove any prepayment penalties so you retain flexibility.
Being informed on loan terms, costs, and negotiation strategies will help you secure favorable lending terms. Don’t be afraid to speak up and ask questions to ensure you fully understand the loan agreement.
Common Loan Terms FAQs
Here are answers to some frequently asked questions about loan terms:
How long are loan terms usually?
- Personal loans: 2 to 7 years
- Auto loans: 4 to 6 years
- Mortgages: 15 to 30 years
What is the difference between interest rate and APR?
The interest rate reflects just the cost of borrowing money. APR shows the total yearly costs including interest and fees. APR is always higher than the rate.
Can loan terms be changed once the agreement is signed?
Generally loan terms cannot be altered after signing without refinancing the loan. Exception is adjustable-rate loans, where the interest rate changes per the contract.
What happens if I break the loan terms?
Breaking material terms like failure to repay usually triggers default. Default can lead to penalties, loan acceleration, and negative credit impacts.
Do all lenders charge origination and prepayment fees?
No, many lenders, especially online lenders, do not charge these fees. Shop around to find a lender that does not charge them.
The Bottom Line
The terms of your loan dictate everything from how much you will repay each month to the total interest costs you incur. It is critical to read and understand all loan terms before entering any lending agreement. Be sure to evaluate how factors like interest rates, fees, and term length influence the overall costs of borrowing money. Where possible, negotiate with lenders for more favorable terms that reduce your costs. Going through the loan terms in detail will ensure the loan product you choose provides the best financial outcome for your borrowing needs and budget.
What Is A Loan Term?
Before we get too deep into loan terms, itâs important to understand what exactly a loan term is. A loan term is defined as the length of the loan, or the length of time it takes for a loan to be paid off completely when the borrower is making regularly scheduled payments.
These loans can either be short-term or long-term, and the time it takes to pay off debt from the loan can be referred to as that loanâs term. All the most common loans will include a term, including student loans, personal loans, auto loans and different types of mortgage loans.
The fact that the phrase âloan termsâ is often used as umbrella language to describe different mortgage-related words is the primary reason why so much confusion exists around this topic. âLoan termâ is just the lingo used to describe the broad aspects of your mortgage. Therefore, depending on the context, it may refer to the lifespan of your loan, or the terms and conditions involved in borrowing funds.
If youâre ever uncertain about anything regarding your mortgage, itâs best to ask your lender to clarify.
To better understand what a loan term is, letâs look at an example. Letâs say you have a 15-year fixed-rate mortgage. The loan term will then be 15 years. During this time, the loan must be paid off or refinanced during the term. Your loan can last for any length of time â it just needs to be agreed upon by the lender and you as the borrower.
Why Is The Length Of The Loan Important?
The length of the loan term, or how much time the borrower has to repay the loan, has a huge impact on a mortgageâs affordability. The term determines not only how long the borrower will be in debt, but also how high the borrowerâs monthly loan payments and overall loan costs will be.
In general, shorter terms translate into higher monthly mortgage payments. But longer terms lead to higher costs over the life of the loan.
A borrower who chooses a 15-year fixed-rate mortgage may have to spend more money to pay off their principal and interest each month. However, by the time their loan matures, theyâll ultimately have spent less on interest.
On the other hand, a borrower who obtains a 30-year fixed-rate mortgage may have access to more spending money since their monthly payments are lower. Over time, they end up paying more for the privilege of borrowing funds.
Letâs take a closer look at how the term a borrower chooses affects both their monthly mortgage payments and their total interest costs.
|
Term |
Monthly Mortgage Payment |
Total Interest Costs |
|---|---|---|
|
15-Year |
$3,698.44 |
$165,719.13 |
|
20-Year |
$3,029.90 |
$227,176.40 |
|
25-Year |
$2,639.18 |
$291,755.26 |
|
30-Year |
$2,387.08 |
$359,347.53 |
Note: The information on this chart is based on a conventional fixed-rate mortgage for a $500,000 loan with an interest rate of 4%.
Although youâd save $1,311.36 a month by selecting a 30-year mortgage instead of a 15-year, youâd still be paying an extra $193,628.40 more in interest over the course of the loan.
Itâs important when choosing the loan amount and the term of your loan that you decide if you want to make smaller monthly payments or spend less on your mortgage over the long run. As you make the decision, you should be sure to compare both the interest rate and APR for each term youâre considering. Comparing these rates will help you gain a better understanding of the true cost of your loan options.