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If you’ve ever applied for a loan and been baffled by the papers you had to sign, you’re not alone. Those documents were created by lawyers working for big banks and lenders, and they’re stuffed with confusing, unfamiliar language – especially if you’re a first-time borrower.
These contracts spell out exactly what you and your lender have agreed to, including:
Loans affect your current and future finances, so it’s really important to read and understand every word before you sign anything. I know they’re long and frustrating – kind of like the user agreements that we all just scroll to the bottom of.
But take the time, ask questions, and make sure you 100% know what you’re agreeing to.
Because once you sign the contract, you’re legally responsible for everything it includes, even if you didn’t realize it.
How Loans Work: The Basics
When you borrow money, you make a commitment to pay that money back plus some extra (interest).The loan officially starts when you sign your agreement and get the money.
Most loans are installment loans, where you borrow a set amount of money for a specific time period (usually 3 to 30 years). You make equal payments over the life of the loan until you’ve paid back the full amount you borrowed. The first payment usually starts about a month after you get the money. You’ll usually have a few options for making your payments:
Some – but not most – lenders may also allow you to make loan payments with a credit card. But then you’re just really swapping one loan for another, not paying down your debt.
Credit cards count as revolving loans, where you can borrow the same money over and over as long as you make regular payments.
As you make payments, you’ll see your loan balance decrease. In the beginning, a bigger portion of your payment will go toward interest – so it may seem like you’re not making a lot of pay-down progress. But with every new payment, the interest portion will decrease so more of your money will go toward the pay-off.
Different Kinds of Loan Agreements
Loan contracts can be super simple or mind-numbingly complicated. What your agreement looks like depends on who you’re borrowing money from (or lending money to). And they can range from quick and easy to “need a drink to get through this.” You can see samples of some basic different loan agreements here.
A really simple agreement can be just a few words that describe the agreement between the borrower and the lender. For example, “Mac owes Jenny $50” written on a napkin and signed by both of you – that counts as a loan agreement. That kind of contract is called a promissory note, and it basically serves as proof that one person owes money to someone else. This is what you’d use if you loaned money to a friend or family member and wanted some kind of agreement in place (which is definitely a good idea).
Most loans involve more specifics than that, and usually come with phrases like:
When you borrow money from a big company – like a bank or a mortgage lender – the agreement will be much more involved. The most complicated contracts can be as fat as notebooks, with dozens of pages devoted to each feature of the loan. These are the ones you really need to slog through, especially if you’re unfamiliar with the lender or the loan involves collateral (property of yours that the lender can take if you don’t pay).
You’ve Gotta Understand the Terms and Conditions
Standard loan agreements use a lot of financial and legal terms, and that combo can be confusing when you don’t speak the language fluently. Even some terms that sound familiar (like interest and principal) can come with unexpected twists in a loan contract. Lenders throw these terms around during the process and expect you to understand them.
So here’s your guide to some common loan language that you need to know:
APR and interest rate seem like the same thing, but they’re not. APR includes the total borrowing costs—interest and fees—that you’d pay over one year on the original loan amount, expressed as an annual percentage. Interest rate includes only that, the percentage you’ll pay periodically based on the outstanding loan balance.
You may come across other unfamiliar words (or words that don’t mean quite what you thought they did) in your loan agreements. Before you sign, ask the lender to explain them to you so you know exactly what you’re agreeing to. If you they brush you off or don’t answer in a way that makes sense to you, ask again or ask someone else (feel free to contact me with questions).
Want to learn more about loans and how you can use them to your advantage? Check out my book Debt 101.