Your Retirement Center

The Substance of a Loan

When you borrow, you want to know how much, for how long, and at what price.

Whether you need a loan only occasionally or borrow on a more regular basis, you'll be concerned with the same basic subjects:

  • The amount you'll be able to borrow
  • How long you'll have to repay
  • What the finance charge will be
Contrary to popular belief, an IOU is not a binding promise to repay a loan. Only an official loan agreement is. American legal interpretation considers an IOU merely an acknowledgement that money is owed.
Some loans have built-in limits. For example, if you borrow money to buy a car, the maximum you're eligible for is determined by the price of the car. If you borrow to pay tuition, there is often a per-year or four-year total that you can finance. Home equity loans are generally capped at 80% of your equity, and loans in excess of $50,000 may be more difficult to arrange. Other loans have built-in terms, or time frames. Car loans rarely last for more than five years, in part so that the vehicle hasn't outlived its usefulness before it's paid off. But what limits the interest rate you pay is the competition. If lenders want your business, they offer rates similar to or lower than what other lenders are quoting.


When you take a loan, you're committing yourself not only to repay, but to repay on a specific schedule. Those details are spelled out in the loan agreement, or loan note, a detailed document the lender provides. When you sign it, you've agreed to its terms and conditions. The fine print may be off-putting, but you should read it carefully. It explains exactly what you're getting — and getting into. Some lenders have rewritten their loan agreements in recent years to make them more easily understandable. And the loan officer you work with should be willing to answer your questions before you sign. You should never hesitate to ask for clear explanations.


Usually you request a specific loan amount. The lender can approve it, reject it, or offer you a smaller amount. Sometimes you need to apply to more than one lender to find one who will approve your request. You may have to pay an application fee each time.

The amount financed, or the principal, is what you borrow. However, you may not actually get the entire amount that is approved. That's because the lender will usually subtract any application fees, credit-check fees, or other costs of the loan before writing you a check or crediting money to your account. In addition, the lender may require you to use part of the loan amount to pay off another loan or urge you to purchase insurance to cover the loan if you should die before repaying the full balance due.


The cost of a loan is determined by the annual percentage rate (APR) that the lender offers, and the length of time you take to repay. However, you may be able to find a loan at a better rate if you investigate what various lenders are charging before you apply. Sometimes lenders are eager to lend, and offer lower rates or waive the fees. While you probably can't time your need to borrow to coincide with those occasions, some borrowers apply for home equity lines of credit when lenders promote those loans at a reduced upfront cost. Then the money is available if it's needed, but there's no charge unless the line is used.

You may also be able to get a preferred customer rate, or a small discount on the interest rate, if you maintain a savings or investment account with the lender.


The terms of repayment are part of your loan agreement. In most cases, you pay interest and some of the principal on a regular schedule, usually once a month. In some cases, including some college loans, you may pay only interest for a specific period and then begin to repay the principal. In others, you pay only interest for the term of the loan and then repay the entire principal in a lump sum. Most lenders allow you to prepay a loan at any time. Some charge a prepayment penalty, usually about 2% of the amount borrowed, although many states prohibit this practice.

IT ALL BEGINS WITH THE APPLICATION Loan applications may vary, but they all ask for the same basic information:
Employment Someone at work may be asked to verify your employment, and you may be asked to provide one or two recent paystubs.
Accounts You may be asked for your credit card account numbers and balances, for your banks' and securities firms' names, account numbers and balances, and for recent tax returns.
References You may need business and personal associates to supply references.


In many cases, you may have to pay a late fee if your payment arrives after the payment due date, and you should expect to be penalized if you send a payment check that bounces, or is returned unpaid by your bank because you don't have enough in your account to cover the check. Failing to live up to the agreement is called defaulting on the loan. The lender may have the right to repossess, or take back, and sell the property you put up as security. Lenders may also impose a stiff penalty if you default. And, if they hire a collection agency or lawyer, you'll have to pay for those services, too. Another way lenders can collect if you default is by setting off, or taking the amount you owe from any checking or savings account you have with the lender.

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