Loan terminology can sometimes feel confusing. Here are some of the most common terms used in this area of business banking and financial management.
Amortization – schedule showing how much of each loan payment goes to principal and to interest throughout the life of the loan. Commercial real estate loans generally amortize over a 20- to 30-year period while non-real estate loans tend to amortize over a shorter 3- to 10-year period.
Annual Debt Service – total principal and interest paid each year on a commercial loan.
Basis Point – equals 1/100 of one percent and is used to describe the interest rate on a commercial real estate loan. For example, 350 basis points in interest is the same as 3.50%. Basis points are also used to quantify origination fees on the loan.
Borrower – person (or business) that applies for a loan and receives funds. The borrower is responsible for repaying the loan according to the agreed upon loan terms.
Bridge Loan – short-term loan, usually for six months to three years, that allows a borrower time or temporary financing until obtaining permanent financing. Bridge loans are sometimes used during property renovation or while seeking a long-term commercial tenant.
Closing Costs— fees and expenses associated with the closing of a loan such as origination and documentation fees. For real estate loans, these are fees over and above the price of the property, incurred by the buyer and/or the seller in the property ownership transfer. Closing costs may include title searches, attorney’s fees, survey charges, and deed filing fees.
Collateral – an asset, such as real estate, vehicles, cash, and investments, that can be pledged to a lender to secure a loan. If the loan is not repaid, the lender can take possession of the collateral.
Commercial Loan – a loan made for business purposes.
Construction Loan – short-term, interim loan used to finance the cost of construction. The loan funds are advanced by the lender to the builder in periodic intervals as the work progresses. Payments are billed on an interest only basis.
Construction-to-Permanent Loan – the same as a construction loan but written for a longer term. Initially written on an interest-only basis then converted to an amortizing (permanent) loan.
Contingency Reserve – additional funds set aside in the construction loan budget to be used in the event of cost overruns during a construction or renovation project.
Cost Basis – the total cost of a property including purchase price, hard and soft costs and less depreciation. Upon sale of the asset, the amount due in capital gains is equivalent to the sales price less the cost basis.
Debt Service – periodic payments of principal and interest made on a loan.
Default – failure to repay a loan as promised in accordance with the terms of the promissory note. The point in time that a debt is considered to be in default can vary by the lender and the type of debt and is specified in the loan agreement.
Delinquent – 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, carpentry, roofing, and landscaping.
Interest – sum paid for borrowing money, which covers the lenders’ cost of doing business.
Interest Rate – the sum charged for borrowing money expressed as a percentage.
Late Fee – a fee that may be charged by the lender when a payment is not made on time. The amount of the late fee and when it will be charged is included in the loan agreement.
Lender – person or entity such as a bank that is loaning money to the borrower.
Loan Agreement – legal contract between the borrower and the lender which includes information about the loan amount, payment schedules, interest rate, late charges, what happens in case of default, and other important information.
Loan Origination Fee – a charge that may be collected by the lender and deducted from the loan amount to cover expenses related to the loan. Expenses could include the costs of underwriting, processing, and administering the loan.
Loan Term – the period of time to maturity of the loan. Can, on occasion, be shorter than the amortization period.
Loan-to-Cost Ratio (LTC) – the construction loan amount in relation to the cost of building the project. The LTC ratio is used in underwriting to help lenders assess the risk associated with a project before offering a construction loan on the project. The lower the LTC, the safer the loan is for the bank.
Loan-to-Value Ratio (LTV) – the full amount of money borrowed for the project in relation to the value of the property when completed. The LTV ratio is used in commercial loan underwriting.
Line of Credit – a revolving loan most typically provided for business working capital purposes. Can be written on a demand basis or for a specified term.
Maturity Date – date that the outstanding loan principal, interest, and fees must be paid in full.
Origination Date – date a loan takes effect and is funded or disbursed.
Prime Rate – the interest rate that banks charge their best customers when lending them money. The U.S. Prime Rate, as published by The Wall Street Journal, is based on a survey of the prime rates of the 10 largest banks in the United States.
Principal – the amount of money that was borrowed, which decreases as the loan is repaid.
Promissory Note – legal and binding signed contract between the lender and the borrower which states that the borrower will repay the loan as agreed upon in the terms of the contract.
Secured loan – has collateral such as property or real estate pledged to it. If the loan enters default, the lender can seize the asset that was attached to the loan.
Soft Costs – construction-related costs such as architect's fees, engineering reports and fees, appraisal fees, municipal government fees, and financial costs such as construction period interest and loan fees.
Underwriting – process of determining if a loan should be made, based on property cash flow, credit, and other factors.
Unsecured Loan – a loan written without a pledge of collateral.
Variable Interest Rate – a financing option where the interest rate on the loan can vary (“adjust”) based on a benchmark rate. The payments on a loan with variable interest rates can increase or decrease over time based on changes in the underlying interest rate. The benchmark rate and frequency of the loan’s rate changes will be specified in the loan agreement.