Business Loan terminology you need to know
By: Anshul Gupta
Tags: Loans, Knowledge, Money, Productivity, Business

Amortization

Amortization is simply the allocation of payments designed in a way to pay off the loan within a stated repayment term or period. Amortization schedules are structured and used in such a way that most of the money is utilized in early payments towards paying down the interest and later, larger portions of these payments go on to repay the principal amount.

Balloon Payment

At the end of the loan term, the lump sum payment that is due is usually called a balloon payment. It typically implies that monthly payments are not enough to pay off the loan amount in full, and hence an additional balloon payment is required to close off the loan.

Principal and Interest (P&I)

The principal is the money that the borrower borrows from the lending institution, typically a bank. Interest is the amount of money that the lender charges on the loan amount. So, P&I typically refers to a monthly payment amount that includes a portion for principal repayment and a portion for interest.

Collateral

Any asset that you pledge to a lender to help secure a loan is referred to as collateral. Some examples of collateral include real estate, accounts receivable, inventory, equipment — basically anything that the lender can liquidate in case you default. Should you fail to comply with your end of the contractual terms, collateral helps minimize the risk to the lender.

Annual Percentage Rate (APR)

An APR is basically the annual cost of your loan and is quoted as a percentage, just like the interest rate. However, it provides a more holistic view of what the loan will cost you as in addition to the interest payments, it also includes any origination fees, documentation fees, or closing fees, etc. Based on your history as a borrower and the type of loan product you’re seeking, the APR offer you receive will typically vary from lender to lender.

Line of Credit

This provides a borrower with revolving credit, allowing them to borrow and payback that borrowed sum over and over again while staying within a maximum limit, as is normally the case with credit cards as well. Unlike a typical loan, this allows the borrower the capital needed as required, and they only pay interest or what they’ve withdrawn.

Covenant

A covenant is a formal agreement — a promise incidental to a deed or a contract. Guiding most covenants are the following functional objectives — full disclosure of information, maintenance of asset quality and adequate cash flow, control of growth and management, assurance of legal existence, provision of lender profit, or other program goals.

Delinquency

Delinquency describes something or someone who fails to accomplish what is required by law or a contractual agreement and occurs as soon as the borrower misses a payment on a loan. A default, in contrast, happens when the borrower fails to repay the loan as mentioned in the original contract. Most creditors typically allow a loan to be delinquent before considering that to be in default.

Recourse

In a general agreement, a recourse refers to a right to demand payment from a person who is taking on an obligation. A full recourse refers to the right of a lender to acquire assets of the borrower in case repayment is not made, while a limited recourse only allows a lender to take assets named in the loan agreement. A non-recourse loan is common in home mortgages and other real estate loans and helps limits the lender's rights to a particular asset being financed.

Working Capital

It typically means current assets and current liabilities and is the difference between the current assets (includes cash, accounts receivables, inventories of raw materials, and finished goods) and its current liabilities (accounts payable). Working capital is usually a good indicator of a company’s liquidity.

Write-off

When a loan becomes seriously delinquent and is determined to be uncollectible due to the borrower default, the lender in that case may choose to charge the outstanding investment amount as an expense or a loss.

Liquidation

Liquidation is a process of bringing a business to an end and thus distributing the assets of the business to its claimants. Once the liquidation is complete, the business no longer exists anymore. Another form of liquidation can occur when a business’ assets are sold at steep discounts.