A personal loan can be a helpful financial tool when someone needs to borrow money to pay for things like home repairs, a wedding, or medical expenses, for example. The principal amount of a loan refers to how much money is borrowed and has to be paid back, aside from interest.
Keep reading for more insight into what the principal of a loan is and how it affects repayment.
Loan Principal Meaning
What is the principal of a loan? When someone takes out a loan, they are borrowing an amount of money, which is called “principal.” The principal on a loan represents the amount of money they borrowed and agreed to pay back. The interest on the loan is what they’ll pay in exchange for borrowing that money.
Does a Personal Loan Have a Principal Amount?
Yes, a personal loan does come with a principal amount. Whenever a borrower makes a personal loan payment, the loan’s principal decreases incrementally until it is fully paid off.
The loan principal is different from interest. The principal represents the amount of money that was borrowed and must be paid back. The lender will charge interest in exchange for lending the borrower money. Payments made by the borrower are applied to both the principal and interest.
Along with the interest rate, a lender may also disclose the annual percentage rate (APR) charged on the loan, which includes any fees the lender might charge, such as an origination fee, and the interest. As the borrower makes more payments and makes progress paying off their loan principal amount, less of their payments will go towards interest and more will apply to the principal balance. This principal is referred to as amortization.
Loan Principal and Taxes
Personal loans aren’t considered to be a form of income so the amount borrowed is not subject to taxes like investment earnings or wages are. The borrower won’t be required to report a personal loan on their income tax return, no matter who lent the money to them (bank, credit card, peer-to-peer lender, etc.).
As tempting as it can be to pay off a loan as quickly as possible to save money on interest payments, some lenders charge borrowers a prepayment penalty if they pay their personal loan off early. Not all charge a prepayment penalty. When shopping for a personal loan, it’s important to inquire about extra fees like this to have a true idea of what borrowing that money may cost.
The borrower’s personal loan agreement will state if they will need to pay a prepayment penalty for paying off their loan early. If a borrower finds that they are subject to a prepayment penalty, it can help to calculate if paying that fee would cost less than continuing to pay interest for the personal loan’s originally planned term.
How Can You Pay Down the Loan Principal Faster?
It’s understandable why some borrowers may want to pay down their loan principal faster than originally planned as it can save the borrower money on interest and lighten their monthly budget. Here are a few ways borrowers can pay down their loan principal faster.
Interest Payments
When a borrower pays down the principal on a loan, they reduce how much interest they need to pay. That means that each month as they make a new payment, they reduce their principal and the interest they’ll owe in the future. As previously noted, paying down the principal faster can help the borrower pay less interest.
Personal loan lenders allow borrowers to make extra payments or to make a larger monthly payment than planned. When doing this, it’s important that borrowers confirm that their extra payments are going towards the principal balance and not the interest. That way, their extra payments work towards paying down the principal and lowering the amount of interest they owe.
Shorten Loan Term
Refinancing a loan and choosing a shorter loan time can also make it easier to pay down a personal loan faster. Not to mention, if the borrower has a better credit score than when they applied for the original personal loan, they may be able to qualify for a lower interest rate, which can make it easier to pay down their debt faster. Having a shorter loan term typically increases the monthly payment amount but can result in paying less interest over the life of the loan and paying off the debt faster.
Cheaper Payments
Refinancing to a new loan with a lower interest rate may reduce monthly loan payments, depending on the term of the new loan. With lower monthly scheduled payments, they may opt to pay extra toward the principal and possibly pay the loan in full before the end of the term.
Other Important Information on the Personal Loan Agreement
A personal loan agreement includes a lot of helpful information about the loan, such as the principal amount and how long the borrower has to pay their debt. The more information the borrower has about the loan, the more strategically they can plan to pay it off. Here’s a closer look at the information typically included in a personal loan agreement.
Loan Amount
An important thing to note on a personal loan agreement is the total amount the borrower is responsible for repaying.
Loan Maturity Date
A personal loan’s maturity date is the day the final loan payment is due.
The monthly loan payment amount will be listed on the personal loan agreement. Knowing how much they need to pay each month can make it easier for the borrower to budget accordingly.
The Takeaway
Understanding how a personal loan works can make it easier to pay one-off. To recap: What is the principal amount of a loan? The principal on a loan is the amount the consumer borrowed and needs to pay back.
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FAQ
What is the principal balance of a loan?
The principal balance of a loan is the amount originally borrowed that the borrower agrees to pay back.
Does the principal of the loan change?
The original loan principal does not change. The principal amount included in each monthly payment will change as the amortization period progresses. On an amortized loan, less principal than interest is paid in each monthly payment at the beginning of the loan and incrementally increases over the life of the loan.
How does loan principal work?
The loan principal represents the amount borrowed. Usually, this is done in monthly payments until the loan principal is fully repaid.
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Many people aspire to live a “debt-free” life. And for good reason: Getting out of debt means that your take-home pay is completely your own (since you won’t be sharing any of it with creditors). Having more money to work with can help you achieve your goals, whether it’s building an emergency fund, sending your kids to college, or being able to retire some day. Knocking down debt can also improve your day-to-day life by relieving stress and boosting your mental health.
The question is, how do you get there? If you’re currently living under a mountain of student loans, credit card debt, medical debt, and/or other types of debt, it can be hard to see a way out or, frankly, even a ray of sunlight. But don’t give up. We’ve got six ideas that can help you whittle down your debt and get on the road to financial independence and freedom.
Key Points
• Living debt-free enhances financial stability and mental health by freeing up income and reducing stress.
• A realistic budget is crucial for managing expenses and allocating funds towards debt repayment.
• Extra income should be directed towards paying off debts, accelerating financial freedom.
• Debt repayment strategies like the snowball or avalanche methods help focus efforts and clear debts efficiently.
• Consolidating debts can simplify payments and potentially reduce interest rates, aiding quicker debt resolution.
What Does It Mean to Live a Debt-Free Life?
Living “debt-free” can mean different things to different people. In the purest sense, being debt-free means having absolutely zero debt — including no credit card debt, no car or student loans, and no mortgage.
However, some people subscribe to a looser definition of “debt-free,” where you’re free of so-called “bad debt,” such as high-interest credit cards and payday loans, but recognize that some debt is “good.”
A low-interest mortgage or student loan, for example, can be considered good debt, since it can help you increase your net worth or generate future income. This looser definition may work to your advantage because it allows you to achieve milestone goals like owning a home without high-interest debt burdening your monthly finances.
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Benefits of Living Debt-Free
However you define debt-free living, knocking down your debt comes with a wide range of benefits — some expected and some, perhaps, surprising.
• More money to spend: Interest charges eat away at your income, giving you less money for other things. Once you pay off your debts (particularly those with high interest rates), you’ll have a lot more money in your pocket.
• Financial stability: By freeing up cash, you’ll have money available to build your emergency fund (your best defense against running up costly debt in the future). You’ll also be able to put money towards other goals and investments.
• Less stress and anxiety: Dealing with debt isn’t just a financial challenge — it also impacts mental health. In a recent Forbes Advisor survey, 54% of adults said they often or always feel stressed by their debt circumstances; another 32% said they sometimes feel stressed because of their debt.
• A happier marriage: In the Forbes survey, 60% of respondents said financial stress has led to disagreements in their relationships. Money fights are a common cause of divorce.
• Increased self-esteem: Eliminating debt isn’t easy — it takes hard work, discipline, and determination. Reaching your debt payoff goals can give you a huge sense of accomplishment that leads to greater self-confidence.
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6 Ways to Climb Out of Debt
Having a lot of debt can feel overwhelming. The key to gaining control over the situation is to approach it one step at a time. Here are six strategies that can help.
1. Creating a Workable Budget
A smart debt-payoff plan begins with a realistic budget. Having a basic budget will help you live within your means (so you don’t get into more debt) and free up extra cash to put towards your debts each month.
The first step in creating a budget is understanding your monthly expenses. This includes everything from rent or mortgage payments, utility bills, groceries, and transportation costs to smaller expenses like subscriptions, leisure activities, and dining out. By assessing your expenses over the last several months, you may be surprised by how much you are spending in certain categories. You may also immediately find some places to cut back, such as canceling membership to a gym you rarely use and/or giving up streaming services you rarely watch.
If the idea of tracking every penny has been a barrier to budgeting, or if you’ve tried and failed in the past, try keeping things simple. The 50/30/20 rule is a simplified budgeting strategy that’s gained traction because it limits the number of spending categories you need to establish and track.
With this approach, you divide your take-home pay (what’s left after paying taxes) into three buckets:
• 50% goes to needs, including minimum debt payments
• 30% goes to wants
• 20% goes to savings and debt payments beyond the minimum
Keep in mind that these percentages are just a guideline, and can be tweaked to fit your situation. The key to becoming debt-free is to make a budget that’s strict but still doable.
2. Making More Money
Yes, this is easier said than done. But before rolling your eyes and moving on, consider the possibilities. Is it time for a pay raise? If a bump is overdue, it might be time to have a talk with the boss.
Consider any potential ways to make extra income from home. Do you always have nights or weekends off? Maybe a friend does catering, landscaping, house painting, or some other work and could use an extra hand from time to time.
If you have a marketable skill, like website design or creating social media content, you may be able to pick up freelance work. If you’re crafty, you might look into selling your wares online or at craft fairs and flea markets. If you love animals, you might want to offer dog walking or cat sitting services.
If you could earn an extra $500 per month, in 12 months, you’d be able to pay off an additional $6,000 of debt.
Even selling things you no longer need can bring in a nice lump sum of cash that you can use to knock down debt.
3. Applying Extra Money Towards Debt
If you get an unexpected windfall (such as a bonus at work, cash gift, tax refund, or inheritance), instead of living it up while the money lasts, consider using it to pay down some debt.
You might not think a few hundred dollars will make much of a dent, but every dollar you pay over the minimum can help reduce the interest you owe on a credit card or loan.
To get some idea of how paying even a little extra toward a bill can help, consider playing around with the numbers using a credit card interest calculator. It can be scary to see how much money you’ll pay in interest if you continue to pay only the monthly minimum, but it can also motivate you to divert as much extra money as you can toward getting that debt paid off once and for all.
4. Focusing on One Debt at a Time
Seeing progress can be inspiring. Think about how good you feel when you lose a little weight from changing your diet or gain some muscle from working out. Even small wins can be motivating.
How does that apply to downsizing your debt?
Two of the commonly recommended approaches to debt repayment are the snowball and avalanche methods. These strategies focus on making extra payments towards one balance at a time instead of trying to put a little extra money toward all your balances at once.
The Snowball Debt Payoff Method
The snowball method directs any excess free cash you might have to the debt with the smallest outstanding balance. Here’s how it works:
• List all of your outstanding debts based on how much you owe, from the smallest balance to the largest. (Disregard interest rates.)
• Pay as much as possible toward the debt with the smallest balance, while making the minimum payment on all other debts.
• After you pay off the smallest debt, turn your attention to the next-lowest balance. Keep going until you are debt-free.
The Avalanche Debt Payoff Method
The avalanche method focuses on paying off debts based on interest rate. It can take longer to get a win with this approach but, ultimately, it will save you more money than the snowball method. How it works:
• List your debts in order of interest rate, from highest to lowest. (Disregard balance amounts.)
• Pay as much as you can each month towards the debt with the highest interest rate, making the minimum payments on all other debts.
• Once you’ve paid off the highest-interest debt, focus on the debt with the next-highest rate, and so on, until you’re debt free.
Though the methods are different, both plans provide focus, and as each balance disappears, momentum grows.
A newer approach, the fireball method, may be a better fit for modern-day debt, which could include a large amount of low-interest student loan debt.
The Fireball Debt Payoff Method
The fireball method takes a hybrid approach to the traditional snowball and avalanche strategies. It’s called “fireball” because it can help blaze through bad debt faster by making it a priority. How it works:
• Categorize all debts as either “good” or “bad.” “Good” debt generally refers to things that can increase your net worth, such as student loans or mortgages. (Interest rates under 6% could be considered good debt.)
• List “bad” debts from smallest to largest based on each bill’s outstanding balance.
• Funnel any extra cash each month toward the smallest balance on the “bad” debt list, while making the minimum monthly payment on all other debts. Once that balance is paid in full, move on to the next-smallest balance on that list. Keep blazing until all “bad” debt is repaid.
• Pay off “good” debt on the normal schedule while investing for the future. Apply everything you were paying toward “bad” debt to investing in a financial goal.
The fireball approach can help you save money because it gets rid of your more expensive debt first, but it also provides motivation by giving you wins early in the process. These combined elements could provide an extra boost to your efforts.
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5. Consolidating Debts
If your credit is strong, a debt consolidation loan could potentially help you repay your debts at a lower interest rate, saving you money over time. It also simplifies repayment by merging multiple payments into one. With this approach, you take out a personal loan and use it to pay off multiple high-interest debts. The key is to find a lender that is willing to give you a lower annual percentage rate (APR) than what you’re currently paying. Keep in mind that the shorter your loan term, the lower your APR may be.
Another way to consolidate credit card debt is to move it to a balance transfer credit card. This can be a smart move if you can qualify for a 0% intro credit card. This way, you can avoid paying interest for the first several months and all the money you pay towards the card goes to knocking down debt. Keep in mind, though, that you may have to pay a fee when utilizing a balance transfer credit card. And, once the 0% intro period is over, you’ll have to start paying interest on the remaining balance.
6. Negotiating With Your Creditors
If your debt has become too much to handle and you’re delinquent on payments, you may want to reach out to your creditors, explain your financial situation, and see if they may be able to work with you. They might be willing to set you up on a payment plan, reduce your monthly payments, or settle your debt for less than what’s owed.
If you go this route, be sure to take notes on your conversation with the customer service rep (including the name of the person you spoke with, when you called, and what they said) and get the proposed repayment or debt settlement plan in writing before you make any payments.
Also keep in mind that debt settlement can negatively impact your credit, so this option is generally considered a last resort.
When it comes to debt, the deeper the hole you’re in, the longer it may take to climb out. But having the right plan in place before can help stick to a budget and methodically reduce your debt in a way that keeps you motivated and saves you money.
Becoming entirely (or nearly) debt-free comes with a substantial payoff: The money you were once spending on debt repayment each month can now go towards savings — and an opportunity to earn, rather than pay, interest.
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Accrued interest represents the interest that accumulates in between payments on a financial product. Accrued interest can apply to both lending and investment products, ranging from home loans and credit cards to bonds or savings accounts.
Accrued interest is different from regular interest, and it’s an important concept to understand.
What Is Accrued Interest?
When you are investing and earning interest, you’ll probably encounter accrued interest. And in the opposite situation, if you borrow money and owe interest payments, you’ll also deal with accrued interest.
This type of interest accrues in between payments. For instance, if you have a credit card balance of $1,000, and you make a partial payment on the 30th of the month, the remaining balance and any new charges will begin to accrue interest. It will be due on the 30th of the following month.
Think of accrued interest as interest that is building up, bit by bit, until that payment is made. In the case of an investment like bonds, in which you’re essentially loaning money to an entity like the government or a company, the accrued interest is interest earned on the money you invested that is eventually paid to you.
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How Does Accrued Interest Work?
It’s possible to owe accrued interest on a variety of lending products, like credit cards and loans. It’s also possible to earn accrued interest on certain investing products and savings accounts.
Whenever an individual borrows money, they owe interest. They are paying to use that money. On the flip side, when they are investing and giving a financial institution, government agency, or company money to borrow for an investment, such as a bond, then the individual is owed interest.
Accrued Interest When Borrowing Money
When you borrow money, with an installment loan, for instance, interest typically accrues daily. At the end of the month, the accrued interest is added to the total monthly payment amount.
With credit cards, unless you pay your balance in full every month, the same daily accrual happens after the cardholder makes a charge with their card. The interest is building up as the month goes on. How much interest accrues depends on the balance and the interest rate.
Accrued Interest When Saving
Accounts that earn interest, such as certificates of deposits (CDs) and high-yield savings accounts, also often accrue interest daily. The amount of interest accrued is based on the account’s average daily balance. An exception to that is bonds, which generate a fixed interest payment on a quarterly, semiannual, or annual basis.
How to Calculate Accrued Interest
How interest accrues varies by the lender and product that’s generating the interest, which could be a loan, a line of credit, an investment product, or a bank account such as a savings account.
Example of Accrued Interest When Borrowing
To calculate how much interest will accrue daily with a credit card, for example, an individual needs to divide their APR (annual percentage rate) by 365 (for the number of days in a year). Then, they would multiply their current credit card balance by their daily rate. So if a credit card has an APR of 24.37% with a balance of $500, the calculation for how much interest accrues daily looks like this:
24.37 / 365 = 0.067%
$500 x 0.00067 = $0.34 interest that accrues daily
To calculate the monthly interest charge, multiply the daily rate by the number of days in the credit card billing cycle. So if there are 30 days in the billing cycle the calculation would look like this:
$0.34 x 30 = $10.20 in interest
Although credit card interest accrues daily, the total amount accrued is typically not added to your balance until the end of the billing cycle. So if you pay your balance in full by the due date, you can avoid paying accrued interest.
Example of Accrued Interest When Saving
To calculate accrued interest on a savings account, for example, take your yearly interest rate, which banks generally list as an APY, or the percentage of total interest you can earn on your account per year. To find the monthly interest rate, divide the APY by 12 (for the number of months in the year). So, if the APY is 5%, the calculation would look like this:
5 / 12 = 0.416% monthly interest rate
Next, to calculate how much interest you will actually earn on your money, you need to know if the interest is simple interest vs. compound interest. Most savings accounts use compound interest, and it is calculated depending on how often it compounds, such as monthly.
To determine how much annual interest you’ll earn on a balance of $1,000 in your savings account, the formula is:
P(1 + R / N)˄NT
P is the principal amount (the $1,000), R is your APY (calculated in decimal form), N is the frequency of compounding, which is monthly, and T is the amount of time, which in this case is 1 for one year. It would look like this:
1,000(1+ 0.05 / 12)˄12 x 1 = $1,250
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Accrued Interest vs Regular Interest
Accrued interest is different from regular interest. Accrued interest typically indicates interest charges that have accumulated but not yet been paid. Perhaps you have heard the term in this context with student loans: The interest may start accruing (adding up) when the loan is disbursed, but it could only become due at your studies’ completion. You may not be paying the interest just yet, but you can know the interest will be assessed.
Regular interest refers to the interest earned on, say, a home loan. Your payment plus interest is due on a certain date and is not accruing day after day or varying. The “regular interest” involves a known principal and interest rate, as well as a constant monthly payment that is due every month.
Why Is Accrued Interest Important?
Accrued interest shows how interest that an individual owes or is owed adds up. For example, with bonds, it may help you understand the interest that’s accruing so you can make sure you are earning the right amount. Or, if you have borrowed money, you can look at how the accruing interest could add to the amount you owe, which might, in turn, help you manage your money.
In the case of a credit card, if an individual sees how long it will take to pay off a credit card balance over a year or two, they could crunch the numbers on how much interest they will accrue during that time. They may find that paying the debt sooner could save them a lot of money, and then work to create a budget to help them pay down what they owe.
Understanding how that interest builds up is a valuable tool. By better comprehending how much you owe or are owed, you can manage your money and work to enhance your financial health.
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FAQ
Is accrued interest good or bad?
Accrued interest isn’t necessarily a bad or good thing. If someone borrows money, they may not enjoy paying accrued interest, but it is a part of their lending agreement. On the other hand, if someone earns accrued interest on investments or savings, they’ll probably consider it a good thing.
Why do I have to pay accrued interest?
Paying accrued interest is more often than not necessary when someone borrows money. Those payments are required by lenders in exchange for lending money to consumers.
What is the difference between interest and accrued interest?
Regular interest represents the payment made in exchange for borrowing money or as a form of income earned from an investment. Accrued interest represents the amount of interest that builds up in between payments.
How do you avoid accrued interest?
When an individual enters a borrowing agreement, they need to pay any interest they accrue. That said, there are ways to avoid paying accrued interest altogether or to minimize accrued interest payments. For instance, pay your credit cards in full. When you pay the balance in full, you won’t have to pay any accrued interest.
Also, to minimize how much accrued interest you owe on a loan, you can make additional payments. Paying down the principal faster will lower how much interest accrues on a monthly basis. You may even be able to pay off the loan early, which also helps avoid more interest accruing.
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4.30% APY
SoFi members with direct deposit activity can earn 4.30% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate. SoFi members with direct deposit are eligible for other SoFi Plus benefits.
As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 4.30% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.
SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.30% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.
SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.
Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.
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Getting a personal loan? It’s not as simple as walking into a bank and asking for a check — there’s some paperwork involved.
Your personal loan agreement is the document that contains everything you need to know about the deal you’re making with your lender, including your rights and responsibilities as well as theirs. It’s a fairly long and complex form, but breaking it down can make it easier to understand.
Here, take a closer look at personal loan agreements.
What Is a Private Personal Loan Agreement?
A personal loan agreement, as mentioned above, is a document that details exactly what is being agreed to on both sides of a personal loan — lender and borrower. At the very least, it will state how much money is being loaned and the terms and conditions of the borrower’s repayment responsibilities.
But what about a personal loan that is not with a traditional lender? Private lenders can be individuals or organizations that make loans to individuals, sometimes without the qualification requirements of traditional lending institutions. A private personal loan agreement, specifically, is drafted as part of a private personal loan — one made between a private lender and a borrower.
Any personal loan agreement is a legally binding document, so it’s important to understand it in full before you apply your signature.
💡 Quick Tip: Before choosing a personal loan, ask about the lender’s fees: origination, prepayment, late fees, etc. One question can save you many dollars.
Why Is a Loan Agreement Needed?
A personal loan agreement is essentially a protective document. It protects both the lender and the borrower by laying out, in clear terms, exactly what is being agreed to. If either party fails to uphold the agreement, action can be taken — such as the lender seizing any assets offered as collateral or sending the account to collections — both of which, obviously, would be bad for the borrower.
But the document works both ways. Lenders, too, are subject to lender liability and can be taken to court if they fail to uphold their end of the loan agreement. Although these cases are far less common than borrower default, the loan agreement is a document that can be used for the borrower’s protection as well.
How to Write a Personal Loan Agreement
Here are the usual steps to writing a personal loan agreement.
Decide Whether to DIY It or Hire a Lawyer
Depending on the specifics of your loan and situation, you could write up a simple agreement by hand or draft it on your computer and then print it out for signing. Or you might download a template from a reputable site, which can be a popular option. These are often free or are sometimes available for a small fee.
However, if the loan is complicated or you don’t want to handle the agreement yourself, you could look into hiring a lawyer to draw up the paperwork. Either way, a personal loan agreement will be a legally binding arrangement. Hiring a lawyer will likely be a costlier proposition.
Gather the Necessary Personal Details
You will need the legal names and addresses of both parties. This ensures the lender can’t ask you for anything beyond the borrowed principal (plus interest, which will also be listed).
Agree to and Spell Out the Loan Terms
The loan agreement should list the payments that will be expected each month and the expected date of the conclusion of the loan term.
The interest rate for the personal loan should also be on the personal loan agreement, likely expressed as an APR, which shows what percentage of the loan principal you’ll end up paying back in the course of one year including interest and any additional fees that may be packaged into the loan.
The interest rate will vary based on your credit score and other financial factors. If you have decent credit, you’ll likely be able to qualify for a personal loan. But generally speaking, the higher your score, the lower your rate.
A personal loan agreement should also include the following:
• The loan agreement may list which types of payment are acceptable, such as check, bank transfer, or credit card.
• The personal loan contract should also list specific repayment conditions, including when payment is due and whether or not additional principal can be applied without penalty.
• A complete personal loan agreement should include details on how any disputes will be handled between the parties involved.
• Some personal loan documents may include the option to change your loan’s term (the period over which the loan is repaid).
• Personal loan contracts in the United States should stipulate which state’s laws will be used to govern and interpret the agreement if the borrower lives in a different state than the lender is headquartered.
• Severability is a clause that states that even if one part of a contract is found to be unenforceable or otherwise rendered null and void, the remainder of the agreement will still hold.
• Penalties associated with the personal loan, such as any late fees that may be assessed, at what point the loan will go into arrears or default, or other scenarios, should be listed in the contract as well.
Sign the Document
Finally, the contract for loaning money must be signed by the borrower and the lender in order to be made legally binding.
💡 Quick Tip: Swap high-interest debt for a lower-interest loan, and save money on your monthly payments. Find out why credit card consolidation loans are so popular.
Does a Personal Loan Agreement Need to Be Notarized?
Personal loans are a type of contract, and contracts do not need to be notarized to be legally binding. All it needs is your signature. Be sure to read all the fine print in detail before you uncap that pen.
Your driver’s license or some equivalent form of photo ID will likely be necessary in order to verify your identity.
Income Verification
Lenders will consider your income when qualifying you for a loan — after all, they have good reason to be interested in whether or not you’ll be able to repay the debt. Along with asking you to list your annual income, verifying documents such as tax returns may also be required.
Proof of Address
In order to prove your residence, and therefore eligibility for any type of personal loan, you may need to provide utility statements, bank statements, or other official documents.
Getting a Personal Loan
Taking out a personal loan is a big financial responsibility, but it can also be a smart money move if you need to handle large, unexpected expenses at the last minute, or to consolidate existing debt. For someone who has bad credit, a small personal loan responsibly managed can be one way to bolster their credit score.
Just remember that all loans come at a price — interest charged — and considering the total amount you’ll pay back to the lender over time is important in order to have a full understanding of the cost of the loan.
For example, if you take out a $10,000 personal loan at a 7% interest rate to be repaid over a term of five years, you’ll pay back a total of $11,880.72, or an additional $1,880.72 in interest. That’s not including any origination fees, late fees, or prepayment penalties a lender might charge.
The Takeaway
If you’re considering a personal loan, reading the loan agreement in depth is a good way to understand for sure what you’re agreeing to. That loan agreement will contain many details about funds borrowed and how they will be repaid.
Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. Checking your rate takes just a minute.
SoFi’s Personal Loan was named NerdWallet’s 2024 winner for Best Personal Loan overall.
FAQ
Does a personal loan agreement need to be notarized?
No, a personal loan agreement does not need to be notarized to be legally binding — it simply needs to be signed by each party to the agreement.
What is a private personal loan agreement?
A private personal loan agreement is the binding legal contract between a borrower and a private lender for a personal loan.
Why do you need a loan agreement?
The personal loan agreement serves to outline the specific terms of the loan and protect both parties in case either fails to uphold the agreement.
Photo credit: iStock/Chaay_Tee
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SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.
Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
This article is not intended to be legal advice. Please consult an attorney for advice.
If you’re thinking about refinancing your home loan or paying off your mortgage early, you might request a mortgage payoff statement. The amount due on this document is likely to be different from your current balance because it includes interest owed until the payoff date and any fees due.
Read on to learn more about what a mortgage payoff statement or letter is and when you might need one.
• A mortgage payoff statement details the total amount needed to fully pay off a loan as of a specific date.
• This statement includes the principal balance, accrued interest, and any applicable fees.
• Homeowners often request this document when considering refinancing or paying off their mortgage early.
• The statement is provided by the mortgage servicer and can be requested at any time.
• Accurate payoff information is crucial for managing financial decisions related to property ownership.
What Is a Mortgage Payoff Statement?
Starting with mortgage basics, a mortgage is a loan used to purchase different types of real estate, including a primary home. A bank or other lender agrees to lend money, which the borrower commits to pay back monthly for a set period of time and with interest.
There are jumbo loans, which exceed the dollar limits set by the Federal Housing Finance Agency, and home equity loans.
Say you have a mortgage and want to know exactly how much you’d need to pay to satisfy the loan. A mortgage payoff letter will tell you that magic number. Unlike your current balance, the payoff amount includes interest owed up to the day you intend to pay off the loan. It may also include fees that you’re on the hook for and haven’t paid yet.
Your monthly mortgage statement, on the other hand, only shows your loan balance and the amount due for your next monthly payment.
💡 Quick Tip: You’ve found an award-winning home. Enjoy an award-winning mortgage experience, too. SoFi has knowledgeable Mortgage Loan Officers to guide you through the process.
First-time homebuyers can
prequalify for a SoFi mortgage loan,
with as little as 3% down.
How Does a Mortgage Payoff Statement Work?
You can request a payoff statement from your loan servicer at any time. Note: Your mortgage servicer may be different from your lender. The company that manages your loan handles billing, accepts loan payments, keeps track of your principal and interest, and fields questions from borrowers.
You may request a payoff statement for any type of loan, including mortgages, student loans, personal loans, and auto loans. However, if you need your mortgage payoff statement, go to your mortgage servicer directly. The name and contact information of your mortgage servicer is included in your monthly statements.
When you make the request from the company that handles your mortgage servicing, you’ll need to provide the following details:
• Your name
• Address
• Phone number
• Your loan number
• The date you want your payoff to be effective if you’re seeking to pay off your mortgage early.
Asking for a payoff statement does not necessarily mean that you intend to pay off your loan immediately. You may simply be determining whether or not paying off your mortgage early is feasible, for example. The request itself does not initiate the prepayment process.
Traditional lenders, such as brick-and-mortar banks, may mail you a paper mortgage payoff statement. Online lenders may send a payoff statement online.
What Information Do Mortgage Payoff Letters Contain?
All mortgage payoff letters tend to contain similar information, including:
• Payoff amount: The amount of money that would satisfy the loan.
• Expiration date: The date through which the payoff amount is valid. The letter may also include an adjusted amount should you pay before or after the expiration date.
• Payment information: The letter will also usually tell you who to make the final check out to and where to mail it.
• Additional charges: You will be alerted to any additional fees and charges that you’ll need to include.
💡 Quick Tip: Your parents or grandparents probably got mortgages for 30 years. But these days, you can get them for 20, 15, or 10 years — and pay less interest over the life of the loan.
Do You Need a Mortgage Payoff Statement?
There are a few common situations in which you might need a payoff statement.
• Refinancing a mortgage: When you refinance your mortgage, your chosen lender pays off your old home loan with a new one, preferably with a lower interest rate and possibly a new term. When you seek to refinance, your new lender may ask you to provide a payoff statement on your current loan.
• Prepaying a mortgage: It’s possible to pay off a mortgage early. A payoff statement will show you exactly how much you’d need to pay to do so. Most prepayment penalties for residential home loans that originated after January 10, 2014, are prohibited. Still, check before you decide to prepay.
• Working with a debt relief company: If you’re having trouble managing your debts, you’ve fallen behind on payments, or you otherwise need mortgage relief, you may choose to work with a debt relief company that can help negotiate with your lenders. The company will need to see payoff statements to get an idea of the scope of your debt.
“No matter what method works best for you, it’s important to cut spending as much as you can while you’re tackling your debts,” said Kendall Meade, a Certified Financial Planner at SoFi.
• Collections and liens: A lender might send you a payoff statement if you’ve fallen behind on your payments and they are sending your debt to a collection agency. In this case, the payoff statement may tell you how much you need to pay to stop the collection action.
If your lender decides to seize your home to recoup unpaid mortgage payments, they may place a lien on the property. They may send a payoff statement that alerts you that your property will be seized if the specified amount isn’t paid in full.
There are other ways to figure out how much you owe on your mortgage loan. You can talk to your lender and ask for a verbal payoff quote. This will provide an estimate, but understand that it is not a legal agreement and isn’t binding.
The Takeaway
If you have a home loan, you may want to request a mortgage payoff statement, especially if you’re thinking about refinancing or paying off your mortgage early. Requesting the mortgage payoff letter does not initiate any formal processes, so it’s fine to think of it as an information-gathering exercise.
Looking for an affordable option for a home mortgage loan? SoFi can help: We offer low down payments (as little as 3% - 5%*) with our competitive and flexible home mortgage loans. Plus, applying is extra convenient: It's online, with access to one-on-one help.
SoFi Mortgages: simple, smart, and so affordable.
FAQ
How do I get my mortgage payoff statement?
Contact your loan servicer to request your mortgage payoff statement.
When should I get my mortgage payoff statement?
Request your mortgage payoff statement when planning to prepay your mortgage, refinance, or consolidate debt.
How long does it take to get a mortgage payoff statement?
Generally speaking, you should receive your mortgage payoff statement within seven business days of your request.
Photo credit: iStock/Vadym Pastukh
*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.
SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.
SoFi Mortgages
Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility for more information.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
