Loan Jargon

Loan jargon can be puzzling, but understanding these common terms in business banking and financial management can make navigating loans easier:

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Loan jargon

Amortization: A schedule showing how each loan payment is divided between principal and interest over the loan’s lifespan. Commercial real estate loans typically amortize over 20 to 30 years, while non-real estate loans usually amortize over 3 to 10 years.

Annual Debt Service: The total principal and interest paid annually on a commercial loan.

Basis Point: Equal to 1/100 of one percent, used to express the interest rate on a commercial real estate loan. For instance, 350 basis points equals 3.50%. Basis points also quantify origination fees.

Borrower: The individual or business applying for and receiving loan funds, responsible for adhering to the loan terms and repayment.

Bridge Loan: A short-term loan, typically lasting from six months to three years, providing temporary financing until permanent financing is secured. Common during property renovations or while seeking long-term commercial tenants.

Closing Costs: Fees and expenses related to loan closing, such as origination and documentation fees. For real estate loans, these costs are additional to the property price and include title searches, attorney fees, survey charges, and deed filing fees.

Collateral: Assets like real estate, vehicles, cash, or investments pledged to a lender to secure a loan. If the loan isn’t repaid, the lender can claim the collateral.

Commercial Loan: A loan intended for business purposes.

Construction Loan: A short-term interim loan for financing construction costs, with funds advanced periodically by the lender as work progresses. Payments are often on an interest-only basis.

Construction-to-Permanent Loan: Similar to a construction loan but written for a longer term, initially interest-only then converted to an amortizing (permanent) loan.

Contingency Reserve: Additional funds set aside in the construction loan budget to cover cost overruns during construction or renovation.

Cost Basis: The total property cost, including purchase price, hard and soft costs, minus depreciation. Upon asset sale, capital gains are calculated as the sales price minus the cost basis.

Debt Service: Periodic payments of principal and interest on a loan.

Default: Failure to repay a loan according to the promissory note terms. The default timing can vary by lender and debt type, specified in the loan agreement.

Delinquency: Failure to make an installment payment when due or to meet other terms of the promissory note.

Demand Loan: A loan written without a specific term, with the principal balance due upon demand by the lender.

Guarantor: An individual or entity that is contractually obligated to make repayment on the loan in addition to the borrower.

Hard Costs: Actual expenses for construction and building improvements such as grading, excavation, concrete, framing, electrical work, carpentry, roofing, and landscaping.

Interest: The sum paid for borrowing money, covering the lender’s cost of doing business.

Interest Rate: The percentage charged for borrowing money.

Late Fee: A fee that may be charged by the lender when a payment is not made on time. The amount and conditions for charging the late fee are outlined in the loan agreement.

Lender: A person or entity, such as a bank, that loans money to the borrower.

Loan Agreement: A legal contract between the borrower and the lender, containing information about the loan amount, payment schedules, interest rate, late charges, default consequences, and other essential details.

Loan Origination Fee: A charge collected by the lender, deducted from the loan amount to cover expenses related to the loan, such as underwriting, processing, and administration costs.

Loan Term: The period until the loan matures. Occasionally, it can be shorter than the amortization period.

Loan-to-Cost Ratio (LTC): The construction loan amount compared to the cost of building the project. Used in underwriting to assess project risk; a lower LTC indicates lower risk for the bank.

Loan-to-Value Ratio (LTV): The full borrowed amount relative to the property value when completed. Used in commercial loan underwriting.

Line of Credit: A revolving loan often used for business working capital needs, available either on demand or for a specified term.

Maturity Date: The date by which the outstanding loan principal, interest, and fees must be paid in full.

Origination Date: The date when a loan takes effect and is funded or disbursed.

Prime Rate refers to the interest rate at which banks lend money to their most creditworthy clients. In the United States, the Prime Rate, as reported by The Wall Street Journal, is derived from the prime rates of the ten largest banks in the nation.

Principal denotes the initial amount borrowed, which diminishes as the loan is repaid.

A Promissory Note constitutes a legally binding contract signed by both the lender and borrower, outlining the terms under which the borrower agrees to repay the loan.

A Secured Loan is backed by collateral such as property or real estate. In the event of default, the lender reserves the right to seize the asset linked to the loan.

Soft Costs encompass various expenses associated with construction, including architect’s fees, engineering reports and charges, appraisal fees, municipal government fees, as well as financial costs like construction period interest and loan fees.

Underwriting is the process of evaluating whether a loan should be granted, considering factors such as property cash flow, creditworthiness, and other pertinent criteria.

An Unsecured Loan is a loan extended without the requirement of collateral.

Variable Interest Rate refers to a loan structure wherein the interest rate can fluctuate based on a specified benchmark. Payments on such loans may increase or decrease over time in response to changes in the underlying interest rate. The loan agreement specifies the benchmark rate and the frequency of rate adjustments.