Loan Terminology

There are two main parts of a loan:

• The principal -- the money that you borrow.
• The interest -- this is like paying rent on the money you borrow.

You must also sign a promissory note in order to borrow any money. The promissory note is a contract between you and the lender that explains in detail what is expected from you and the lender. ALWAYS READ THE PROMISSORY NOTE CAREFULLY.

The following are some key characteristics and terminology concerning educational loans:

1. Application Fee

2. Capitalization

3. Co-signer

4. Default

5. Deferment

6. Disbursement

7. Forbearance

8. Guarantee Fee

9. Interest Rate

10. Loan Consolidation

11. Maximum Time to Repay

12. Minimum Payment

13. Origination Fee

14. Payment Consolidation

15. Servicing

1. Application Fee

Some lenders may charge an application fee for their alternative loans. This is a fee charged to process the application. It is usually not taken from the principal of the loan and must be paid when you apply for the loan, regardless of the loan amount.

2. Capitalization

Adding interest that has accrued onto the loan principal. Subsequent interest then begins to accrue on the new principal.

3. Co-signer

This is a person who signs the promissory note with the borrower and promises to repay the loan if the borrower does not. Both the co-signer and the borrower are responsible to repay the loan. Some loans require a co-signer and some don't.

4. Default

Being in default is defined differently for different loans. Basically, it means being delinquent in repaying a student loan more than a certain number of days or failure to comply with any of the other terms of the promissory note. Generally missing one payment does not mean the borrower is in default. IT IS IMPORTANT NOT TO DEFAULT ON YOUR LOAN.

Being in default subjects the borrower and co-signer to a variety of extra expenses and penalties. Generally the remedy for a default is more than just bringing the payments up to date. Sometimes it means you must repay the entire loan immediately.

If you default on a federal or state loan, your lender and the government can take a number of actions to recover the money, including:

• Withholding your tax refunds.


• Withholding part of your salary if you work for the federal government.


• Suing and taking you to court.


• Informing credit bureaus which might affect your credit rating. As a result, you may have difficulty borrowing money for a car or a house.


• Requiring you to repay your debt under an income "contingent" or alternative repayment plan. You could end up repaying more than the original principal and interest on your loans!


• Preventing you from obtaining additional state or federal student aid until you make satisfactory payment arrangements.

5. Deferment

This means that the payments on the principal of the loan will be delayed for a specified time. However, the interest must be paid or it is added to the principal. This means the loan will cost the borrower more in the long run, but it may make the loan easier for the borrower to repay.

6. Disbursement

This is when and how you get the money that you've borrowed. Generally the money is sent to the college and then given to you. Some colleges can transfer the money directly into the student's bank account.

If your educational program is short or if there is a short time remaining in the academic year, you might get all the money in one disbursement. If you will be in college for the whole academic year, the money is given to you in two or more parts.

7. Forbearance

An arrangement to postpone or reduce a borrower's monthly payment amount for a limited and specified amount of time, or to extend the repayment period. The borrower is charged interest during the forbearance.

8. Guarantee Fee

These fees are used to guarantee that lenders are repaid even if the lender can't collect on the loan due to default, death, or disability.

The guarantee fee is often taken from the principal before it is given to the borrower. This means the borrower will not be given all the money that is borrowed, but must still repay the total amount as if he or she had been given all the money.

9. Interest Rate

This is a percentage of the loan amount that you're charged for borrowing money. It is a re-occurring fee that you're required to repay, in addition to the principal. The interest rate is always recorded in the promissory note.

Sometimes, the interest rate remains the same throughout the life of the loan until it is all repaid. Other times, the interest rate will change every year, quarter (three months), monthly, or weekly based on some financial variable such as the interest rate of Federal Treasury notes.

Some lenders will lower the interest rate when the borrower makes a certain number of payments on time, has a co-signer for the loan, and so forth.

10. Loan Consolidation

Several loans are combined into one larger loan. The payment pattern and interest rate may change on the consolidated loans. The total payment may be smaller and the length of time for making repayments may be increased. This means the loan will cost the borrower more in the long run, but it may make the loan easier for the borrower to repay on a monthly basis.

11. Maximum Time to Repay

The promissory note will state the maximum time that the borrower can take to repay the entire loan. Read the promissory note carefully. The maximum loan repayment can be tied to:

• When the student leaves college
• When the money was borrowed

12. Minimum Payment

This is the smallest amount of payment that will be acceptable to the lender. Even if the loan is small, the borrower must make the minimum payment each month until the loan has been fully repaid.

13. Origination Fee

Processing the loan application and setting up the actual loan for disbursement to the borrower is called "originating" the loan. Some lenders may charge origination fees.

Often, the origination fee is taken from the principal before it is given to the borrower. This means the borrower isn't given all the money that's borrowed, but must still repay the total amount as if he or she had been given all the money.

14. Payment Consolidation

The monthly payments for several loans are combined into a single monthly payment or bill. The loans are still separate, but the payments are divided between the loans. The monthly payments are the total of all the separate payments. Check with your servicer or lender to see if this option is available.

15. Servicing

Servicing means taking care of the loan after the money is disbursed and until the loan is completely repaid. Many times servicing also means holding the record of the loan even after it has been repaid. Servicing includes:

• Billing the borrower.
• Recording payments.
• Keeping track of the amount of money left to be repaid.

Sometimes the lender will change servicers or sell the borrower's loan to someone else who uses a different servicer.