Loan documents are full of jargon that can be confusing. But understanding what you are signing up for is essential - it is a legal commitment that could last for years.
This guide explains the most common loan terms in plain English, so you know exactly what you are agreeing to.
Interest Rate vs Comparison Rate
The interest rate is what the lender charges you for borrowing money. But it is not the whole picture.
The comparison rate includes most fees and charges, giving you a more accurate picture of the true cost of the loan. Always compare loans using the comparison rate, not just the headline interest rate.
Fixed vs Variable
Fixed rates stay the same for a set period. Variable rates can change with the market - they might go up or down.
Fees You Might Pay
Loans often come with various fees beyond the interest rate.
- Establishment fee - One-off fee to set up the loan
- Monthly or annual fee - Ongoing account keeping fee
- Early termination fee - Charged if you pay off the loan early
- Late payment fee - Charged when you miss a payment
- Variation fee - Charged for changes to your loan
- Discharge fee - Charged when the loan ends
Secured vs Unsecured
A secured loan is backed by an asset - usually the thing you are buying. For car loans, the car is the security. If you cannot pay, the lender can repossess the car.
Unsecured loans have no security, so they typically have higher interest rates to compensate for the higher risk to the lender.
Loan Term
The loan term is how long you have to repay the loan. Longer terms mean lower monthly payments, but you pay more interest overall. Shorter terms mean higher payments but less total interest.
Car loan terms typically range from 2 to 7 years. Consider what you can afford each month, but also the total cost over the life of the loan.
Balloon Payments
Some car loans include a balloon payment - a large lump sum due at the end of the loan. This reduces your regular payments but leaves a big bill at the end.
You will need to pay this balloon amount, refinance it, or trade in the car. Make sure you understand and plan for this if your loan has one.
Default and Consequences
Defaulting means failing to meet your loan obligations - usually missing payments. The consequences can be serious.
- Late fees and penalty interest
- Negative marks on your credit report
- Possible repossession of the secured asset
- Legal action and debt collection
- Difficulty getting credit in the future
Key Takeaways
- Compare loans using the comparison rate, not just interest rate
- Understand all the fees before signing
- Secured loans use your asset as guarantee
- Longer terms cost more in total interest
- Understand balloon payments if your loan has one