Key Concepts

Regardless of the source of your loan or what you will use the loan money for, there are several key concepts of borrowing you should be sure you understand.

First, when you take out a loan, you should know that you will owe your lender the initial amount of money you borrowed – the principal – as well as compensation for lending you the money, which is called interest. The interest rate is the percentage of the principal you owe for borrowing over a certain time period, usually a year.

Interest payments are calculated with either simple interest, which is a flat percentage of the principal, or compound interest, which is a percentage of the initial principal plus the interest payments that have already accumulated over time.

With compound-interest loans, which are the more common kind, it might seem tricky to calculate what you’ll ultimately pay over the term of a loan. For instance, a $10,000 loan with an annual compound interest of 9 percent means you’ll owe $15,386.24 after five years. Use a compound interest calculator to help you find out what your loan will ultimately require you to pay back over time.

If you miss a loan payment, your lender will charge you a late fee and the interest rate could increase. What you ultimately owe will not only be more than you borrowed but it will be more than you originally agreed to pay to borrow. A missed payment can also adversely affect your long-term ability to borrow. (You’ll learn more about that in the Credit Scores lesson.) If you default on certain loans (each loan has its own default terms), your lender could turn your loan over to a collections agency and seize your wages or property. If you don’t resolve the issue, you could be forced to declare bankruptcy.