December 28, 2020
What are the Important Terminologies Related to Loans?
By : Ellie Brown
There are many situations in one’s life when they feel the need to borrow money for financing their purchases. It could be a loan taken while buying a home or purchasing your dream car. Millennials’ in the UK are known to spend freely using their credit card, which is a particular type of loan in itself.
People and businesses also take loans for a variety of reasons in the UK, including their personal expenditures or business expansion. There are specific terms in the credit or loans lexicon which many perplex borrowers and thus they are afraid of approaching a lender. This blog will explain some of these terms in detail for a better understanding.
Fortunately, there are direct lenders in the UK present online offering very bad credit loans with no guarantor and no broker needed. These are loans specifically designed for bad credit borrowers who are usually not entertained by established commercial banks.
These are unsecured loans for which you will not have to pledge any asset as collateral. There is an instant decision on these loans, which means the approval/rejection decision on loan in a few hours and the loan amount is transferred to your bank account minutes after it is approved.
Let’s look at some of the loan related jargons which are floated around but have several connotations to it. Here it goes:
- Floating Interest Rate Loan
You must have heard telling you that a particular loan comes with a floating interest rate; it means the interest rate on your loan can change during its course. It could move up or go down depending on the central bank rates and macroeconomic scenario.
Thus, your instalment amount will be adjusted accordingly based on the direction of the movement of interest rates.
- Monthly Instalments
Financial institutions in the UK mostly use instalments for the regular payment towards the loan during its repayment. However, there is another term for it which are used by some of the banks, it is monthly instalment, which is an acronym for Equated Monthly Instalment. It is same as the recurring instalment which you are bound to pay on pre-defined intervals.
This instalment amount consists of both the principal portion of the loan and the interest component based on the interest rate on loan.
You must have heard your relationship banker saying that this loan is secured for which you have to give a collateral. This collateral is nothing but the security or an asset which you own. You have to transfer the possession of this asset to the bank.
Bank will safely keep this asset with itself until you repay the entire loan amount. Banks demand these collaterals as a security measure to reduce the risk involved in lending to a retail or a corporate customer.
Collateral is usually computed as a percentage of the loan amount, and this percentage varies from customer to customer. Direct lenders offering very bad credit loans mostly do not ask for collateral from their customers.
You might have read about the Central Government in many countries are announcing a moratorium on loans soon after Coronavirus was declared as a global pandemic.
This moratorium is nothing but an instalment holiday or a monthly instalment holiday wherein the borrower does not have to pay instalment during the tenor of the moratorium. This does not even exacerbate your credit score as you are allowed not to pay the instalment if you want. It is a voluntary option offered by banks on orders of the Central Bank or the Central Government.
Additionally, when you take an education loan, you won’t have to repay anything until the academic course ends, this period is also the moratorium period as you are allowed not to pay the loan instalment.
- Credit Score
Big banks often reject loan applications citing substandard credit score; let’s get to know what exactly is this credit score. It is a score out of 1000 and is computed by authorized credit rating agencies. These credit rating agencies in the UK are Equifax, Experian, and Noddle or Call Credit.
A score in the range of 720 to 880 is considered a decent score, and anything above 880 to 1000 is an excellent score. However, a score below 700 is substandard, and it is these borrowers whose credit scores fall in this zone are not entertained by established commercial banks. This score is of utmost importance to be able to get loans at lucrative interest rates.
If you have a bad credit score then either your loan application will get rejected, or you will be charged a very high-interest rate on the loan if approved. Timely repayment of loans or your credit card bills will maintain your credit score but any default on these obligations will take your credit score down.
Lien is another important concept in the context of the UK. It can be defined as a kind of fee or charge set by financial institutions on a time deposit (recurring deposit or fixed deposit). This charge is created when a loan is granted to a borrower against that term deposit being used as collateral against that loan.
This customer deposit is now under the possession of bank until the duration of the lien on that deposit. The date on which lien will cease to exist is also mentioned on the receipt given to the customer.
- Loan to Value Ratio
Short for LTV, this is a metric which is often used these days by banks to reduce the risk involved in giving a loan. This ratio is computed by dividing the total value of the property to be purchased with this loan to the loan amount. The latter is at the numerator while the former goes in the denominator.
For instance: If the loan to value ratio is 70% then to purchase a property of 10 million pounds, you will only get a loan of 7 million pounds.
- Credit Risk
Banks take several measures like LTV ratio, taking collateral, putting covenants on loan, charging a higher rate of interest etc. All this is done to reduce Credit Risk, which is nothing but the default risk involved in lending to a borrower. It computes the probability of default on loan repayment by a retail or a corporate borrower.
There are several statistical credit risk assessment models used by banks to assess the credit risk while lending to a specific borrower or a business.