How Loans Work

All loans have certain things in common, including the fact that they must be repaid.

The amount you borrow is called the principal.

The amount of time the loan lasts is the term.

The charges you will have to pay to use the principal are determined by the interest rate the lender charges, the principal, and the term. The higher the rate and the longer the term, the more borrowing costs. That's why you should always choose the shortest repayment term you can afford.

Here's more you should know about interest rates:

  • Sometimes the interest rate is fixed and stays the same for the term. Then you know from the start what borrowing will cost you.
  • Sometimes the interest rate is variable, which means it changes on a fixed schedule, such as once a year. It may be higher or lower each time it changes, based on the changes in the index the lender uses. For example, on certain federal education loans with variable rates, the rate changes on July 1 each year.
  • The annual percentage rate (APR) tells you the cost of borrowing for one year.

All loans are alike in some ways, but there's more to learn about some of the most common types of loans.
The more quickly you repay a loan, the less interest you'll owe. It's smart to start repaying when an education loan is disbursed or as soon as you graduate or leave school even if you have a grace period. Waiting only increases what you owe.