Applying for a loan–whether it’s for a new car, a new house, or to finance your trip to a new country–can sometimes be confusing or overwhelming. But it doesn’t have to be. Just like a baby learning to talk for the first time, the first thing you have to do is learn the language. You’ll find out that when you know the terms, you’ll feel more comfortable once you finally apply for a loan.

Sometimes terms used by the financial industry can leave you scratching your head, so here’s a quick (and expanding!) guide on specific terms you may encounter on your way to getting the loan you need.

(NOTE: We’ll constantly be updating this page to include more terms in the future)

SECURED LOAN

This is the type of loan that is secured by a collateral. The more well-known examples of secured consumer loans are car loans and housing loans. Less common are jewelry loans and home equity loans secured by property or real estate. All of the loans are ‘secured’ by a collateral–which gives assurances to the bank or lender that should you be unable to repay your loan, they have other means to recover the amount you borrowed from them

When a bank evaluates a loan application, they closely look at the means by which the borrower will pay the loan.

For a loan applicant who is employed, they will look at the employment of the borrower, his salary and how much of his monthly salary is available to settle the monthly payment due on the loan.

For a person who is self-employed, the bank will look at their business, its revenues, expenses, net income and how much of the business’ monthly cash flow is available to settle the monthly payment due on the loan.

Beyond the borrower’s means of payment, the bank has to think of how to ‘protect the loan’ in case the borrower, employed or self-employed, is not able to regularly settle the payment due on the loan by the due date.

Aside from applying collection efforts and other collection strategies, the bank protects the loan by having a fallback. In case of a secured loan, the bank’s fallback is the collateral that secures the loan. For a car loan, the collateral is the car that will be purchased or financed. For a housing loan, the collateral is the house or property that will be purchased or constructed. The collateral will be used to settle the outstanding balance of the loan in case the borrower is not able to settle payment according to the terms of the loan.

UNSECURED LOAN

An Unsecured Loan is a loan where the lender is primarily relying on the means by which the borrower will pay the loan.

For a loan applicant who is employed, they will look at the employment of the borrower, his salary and how much of his monthly salary is available to settle the monthly payment due on the loan.

For a person who is self-employed, the bank will look at their business, its revenues, expenses, net income and how much of the business’ monthly cash flow is available to settle the monthly payment due on the loan.

Common examples of an unsecured loan are salary loans and credit cards.

CAPACITY TO PAY

When a bank evaluates a loan application, they closely look at the means by which the borrower will pay the loan.

For a loan applicant who is employed, they will look at the employment of the borrower, his salary and how much of his monthly salary is available to settle the monthly payment due on the loan.

For a person who is self-employed, the bank will look at their business, its revenues, expenses, net income and how much of the business’ monthly cash flow is available to settle the monthly payment due on the loan.

The amount available every month to pay the loan is the borrower’s capacity to pay.

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COLLATERAL

Aside from taking a look at a borrower’s capacity to pay and credit history, lenders see the need for a fallback in case the borrower is not able to repay his loan, especially for big-ticket items such as cars and houses.

One of the ways they can get that reassurance is through a collateral, or items which the bank can liquidate (convert to cash) and use the proceeds to settle the outstanding balance of your loan. A collateral is common for relatively big amounts that are to be paid over a longer period of time; in essence, the higher the risk, the greater the need for collateral. Bigger loan amounts and longer payment periods increase the risk. Such is the case for car loans and housing loans, for example.

LOAN PERIOD OR LOAN TERM

The length of period for repayment of the loan depends on several factors. One of them is the ‘life’ of the collateral. A loan term does not usually exceed the ‘life’ of the collateral. Another factor is the borrower’s capacity to pay. The shorter the loan period, the higher the ‘amortization’ (insert amortization link). Another consideration is the borrower’s age – the loan period does not usually go beyond the expected retirement age of the borrower.

For a car loan, the loan period ranges from 1 year to a maximum of 5 years. For a housing loan, the loan period can go up to 30 years.

AMORTIZATION

To amortize a loan means to pay off a debt with a fixed repayment schedule in regular installments over a period of time. The amount is fixed over a period of time and the amount is called ‘amortization’.

The amortization is computed to match the borrower’s cash inflow in terms of amount and timing. The most common payment schedule is monthly so you’ll often hear the term ‘monthly amortization’. For a borrower who is an employee, the amortization is matched against his monthly salary in terms of amount and timing. For a borrower who is self-employed, his business’ cash inflow is matched in amount and timing against the loan amortization.

The regularity of the amount and the payment period helps the borrower manage their loan. In this way,, they know both the amount for which they have to prepare and the date when the funds should be ready. The borrower needs to work the payment amount and the timing around his cash inflow and outflow for other expenses and payables.

The payments have already been pre-computed to pay off both the principal loan amount and the interest costs during the specified time period. Car loans and housing loans are almost always amortized.

PRINCIPAL

The principal is the amount you want to borrow from a bank or a financial institution. This is the amount to which the interest rate will be applied.

INTEREST RATE

Borrowing money from financial institutions obviously isn’t free. Just like any commodity, loan products come with a cost. The cost is called “interest” and it is expressed as a percentage.

Interest rates differ for secured and unsecured loans. As you can imagine, the interest rate for unsecured loans is higher than secured loans because it is riskier–meaning the lender doesn’t have as high an assurance that you will be able to repay your loan as with secured loans that involve collaterals..

Interest is also computed differently for different loan types. Regardless of the way they are computed, all loans have an Effective Interest Rate (EIR) – the EIR is usually expressed as an annual rate and reflects the true cost of the loan. You can compare loans based on their EIR.

The interest rate in the Philippines is market-driven. Banks and lending institutions compete with each in terms of interest rate and other features. Certainly one of the most important things you should confirm about any loan is the interest rate.

MORTGAGE word written on wood block, golden coins and chart.

MORTGAGE

At the time that the loan is granted, the lender requires the borrower to mortgage the property to secure the loan. By mortgaging the property, the borrower conditionally transfers ownership over his property to the lender so that in case that he is not able to settle his loan according to the terms of the loan, the lender can take possession.

When the property to be mortgaged is a house or property, the mortgage is a real estate mortgage. When the property to be mortgaged is personal like a car or jewelry or an appliance, the mortgage is a chattel mortgage.

There are fees associated with a mortgage because these are recorded on public documents relating to the properties to be mortgaged.

FORECLOSURE

Foreclosure is the process by which a bank or the lender will take possession of the mortgaged property so that it can be liquidated into cash and used to pay the outstanding balance of the loan. This is a process that protects the rights of both the lender and the borrower.

A lender will exhaust all means to collect payment on the loan before foreclosing on the mortgage or taking possession of the mortgaged property. The reason for a lender’s reluctance to foreclose is that the foreclosure proceedings take a long period of time and does not necessarily mean that the outstanding balance of the loan is settled. The lender’s capital is tied up in the foreclosure; in the case of a real estate mortgage, the minimum amount of time for the actual foreclosure proceedings is one calendar year.

Borrowers who can already see that they will have difficulty in meeting the loan payment terms should approach and ask the lender for a new payment schedule – this should be done earlier than later, certainly way before the time that foreclosure will be initiated by the lender.

This way, the lender can provide the borrower with options on a new payment schedule that will ease the payment burden of the borrower and increase the probability that the borrower will successfully pay off the entire loan–the ultimate goal of any lender. On the side of the borrower, he will be able to keep his property and maintain his good credit record. Foreclosure on the mortgaged property should be the last resort of the lender and borrower.

Now that you understand these terms about loans, it’s time to apply for one. Sign up with Lendr to know more!