Term of the loan explained

Writer and editor - Bryan Robinson | Updated on 2023-02-22

Loan Basics

A loan is a debt provided by an entity (financial institution, individual, etc.) to another entity at an agreed-upon interest rate and repayment schedule. A loan is a borrowed sum of money that is expected to be paid back in full, usually with interest. Loans are often used to finance the purchase of large assets such as real estate or vehicles. In this article, we’ll explain the basics of loans so you can make informed decisions about borrowing money. They may also be used for other purposes, such as consolidating debt or paying for education.

How do loans work?

Loans are a common part of modern life. Many people take out loans to buy cars or houses. Some loans are for large sums of money, and others are for small amounts. The terms of a loan (how long it will last) can also vary greatly.

The payments on a loan are typically made monthly, though some loans require payments to be made weekly, biweekly, etc. The borrower repays some of the loan principal (the original amount borrowed) plus interest each month. As the borrower repays the loan, the amount of money they owe decreases.

Interest is the cost of borrowing money and is typically expressed as a percentage rate. The interest rate on a loan is used to calculate the monthly payment amount. The higher the interest rate, the higher the monthly payment will be.

Types of loans

There are two types of loans: secured and unsecured. A secured loan is when the borrower offers the lender a piece of collateral to back the loan. The most common type of secured loan is a mortgage. An unsecured loan does not have collateral backing it. The most common type of unsecured loan is a credit card.

Secured loan

A secured loan is a loan in which the borrower pledges some asset (e.g. a car or house) as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan. The debt is thus secured against the collateral, and if the borrower defaults, the creditor can attempt to recover the debt by seizing and selling the asset used as collateral.

If you are a homeowner, you may be able to use your home as collateral for a loan. This is called a home equity loan or home equity line of credit (HELOC). The advantage of this type of loan is that you can typically get a lower interest rate than with other types of loans because your home equity serves as collateral. The disadvantage is that if you default on your payments, you could lose your home.

Unsecured loan

An unsecured loan is a loan that is not backed by any type of collateral. This means if you default on the loan, the lender does not have the right to seize any of your assets. The advantage of an unsecured loan is you do not have to put any of your assets at risk. The downside is unsecured loans usually have higher interest rates than secured loans because they are more risky for the lender.

Examples of unsecured loans include credit cards, student loans, and personal loans.

Home equity loan

A home equity loan is a type of second mortgage.Your ‘first mortgage’ is the one you used to purchase your home, but you can place additional loans against the property as well — secured by the equity in your home. Home equity loans are commonly used to finance major expenses such as home repairs, medical bills, or college education.

A home equity loan is a lump-sum loan, which means you get all of the money at once and repay with equal monthly payments over the life of the loan (typically five to 15 years). In most cases, lenders will approve a loan if it’s worth up to 85% of your home’s appraised value (minus any existing mortgages or outstanding home equity loans).

Loan Terms

The term of a loan is the length of time that you have to repay it. The average loan term is about 5-7 years, but some lenders will offer terms of up to 25 years. The longer the term, the lower your monthly payments will be, but the more interest you will pay over the life of the loan.

Define term of the loan

A loan’s term can refer to the length of time that you have to repay the loan. For example, a 30-year fixed-rate mortgage has a term of 30 years. Auto loans often have 5- or 6-year terms, although you can find 4-year auto loans as well.

The term of a loan also refers to each payment made on an installment loan. For example, if you take out a $1,000 loan with a 12% annual interest rate and you make monthly payments, your first payment would include all of the interest accrued from the date of disbursement until the end of that month as well as 1/12 of the principal. The term would be one month long. Your second payment would include 11/12 of the principal plus all of the interest accrued since your last payment. The term would again be one month long.

How does the term of the loan affect payments?

The term is the length of the loan, and it affects the monthly payment as well as the total interest you’ll pay. A loan with a shorter term has higher monthly payments, but you’ll pay less in interest overall because you’re borrowing the money for a shorter period of time. A loan with a longer term will have lower monthly payments, but you could end up paying more in interest over time.

Loan Payments

Since you will be making payments on your loan each month be sure to budget for this additional monthly expense. Your monthly payment will be the same each month, but the amount you pay toward the principal and the amount you pay in interest will change each month.

Define how loan payments are made

Loan payments are typically made on a monthly basis, and these payments are used to pay off both the principal (the amount you borrowed) and the interest (the cost of borrowing money). Your monthly payment will remain the same for the life of the loan, making it easy to budget for your repayment costs.

The principal is the amount of money you borrowed, and the interest is the cost of borrowing that money. Your monthly payment goes toward both the principal and the interest. The amount that goes toward the principal will depend on your interest rate. The lower your interest rate, the more of your monthly payment will go toward the principal.

The term of your loan will also affect how much you pay each month. A shorter loan term means you’ll have a higher monthly payment, but you’ll pay less in interest over the life of the loan. A longer loan term means you’ll have a lower monthly payment, but you’ll pay more in interest over the life of the loan.

What is a loan grace period?

A loan grace period in the case of student loans is the time during which a borrower is not required to make payments on their loan. This time period begins when the borrower finishes school, or when they leave school and enter a grace period. For federal student loans, the grace period is six months. For private student loans, the grace period can be shorter or longer, and may not exist at all.

Borrowers who are still in school and enrolled at least half-time can defer their loans, which means that they do not have to make any payments while they are in school. Interest will still accrue during this time, but it can be capitalized (added to the principal balance of the loan) so borrowers do not have to pay it until after they leave school.

For Direct PLUS Loans first disbursed before July 1, 2008, the grace period is nine months. For Direct PLUS Loans first disbursed on or after July 1, 2008, there is no grace period; repayment begins 60 days after the last disbursement was made.

Private student loans do not have a statutory grace period. However, many lenders provide a deferment or forbearance option for a limited time when you are unable to make payments. You should contact your loan servicer to find out if these options are available and what conditions apply.

There could be grace periods on other types of loans as well, like mortgage loans. It all depends on the terms of the loan.

The purpose of the grace period is to give borrowers time to find a job and get on their feet before they have to start repaying their loans. During the grace period, interest will accrue on the loan, but borrowers will not be required to make any payments.

Bryan Robinson

Bryan Robinson
Writer and editor

Bryan Robinson is a finance writer with expertise in lending and their interest rates, fees, contracts and more.
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