Lending language made clearer

Financial terms, banker vocabulary, lending buzzwords—what do they all mean?

You’re not alone if you occasionally puzzle over their definitions. Here are some explanations.

Acceleration clause: A common provision of a mortgage or note providing the lender with the right to demand that the entire outstanding balance be immediately due and payable in the event of default.

Collateral: Property pledged to assure repayment of debt such as real estate or chattels.

Chattel: Tangible personal property. It’s typically not real estate. Chattel would include tractors, grain and livestock.

Security agreement: A legal instrument signed by a debtor granting a security interest to a lender in specified personal property pledged as collateral to secure a loan.

Co-signer: An individual, in addition to the borrower, who signs a note and thus assumes responsibility and liability for repayment.

Covenant: A legal promise to do or not to do specific acts; or a promise that certain conditions do or do not exist. An example would be to provide financial statements within 90 days of your year-end. A breach of a covenant can lead to legal remedies and can be a basis for foreclosure.

Origination fee: A fee charged by a lender at the time a loan is originated to cover the costs of administration, evaluating credit, checking legal records and verifying collateral.

Prepayment penalty: An amount charged by a lender on a loan paid prior to its maturity. In other words, if you pay off your loan early or refinance it, you will owe the lender a fee.

Assignment of loan: The transfer of title, property, rights or other interests from one person or entity to another.

Legal lending limit: This is a legal limit on the total amount of loans and commitments a financial institution can have outstanding to any one borrower. The limit usually is determined as a specified percentage of the financial institution’s own net worth or equity capital. Its purpose is to avoid excessive exposure to credit risk of an individual borrower.

Loan participation: A situation where loan funds provided to a borrower are shared by two or more lenders. For example, a loan participation would occur when the loan amount exceeds the lending limit of bank and that bank sells (participates) part of the loan to another lending institution.

Loan committee: A committee of executive loan officers and/or directors of a financial institution who establish lending policies and approve loan requests that exceed the lending authority of individual loan officers.

Pro forma statements: Financial statements that are projected for future time periods. Balance sheets, cash flow statements and income statements are projected to determine the expected future financial status.

Right of rescission: A provision of the federal Truth in Lending Act, which gives a borrower the right to rescind a borrowing transaction—such as change your mind—within three business days on any transaction in which the principal residence is used to secure the loan. This only applies to home loans.

Risk rating: A measure used by lenders to evaluate the amount of credit risk associated with a loan transaction. The lender may use credit scoring or risk-assessment procedures to evaluate loan requests and group borrowers into various risk classes for purposes of loan acceptance or rejection, or for loan pricing. This measure is also used by lenders to determine levels of loan monitoring and loan documentation.

Editor’s note: Dennis Roddy is a Midwest-based agricultural consultant with K·Coe Isom. With more than two decades of experience in ag lending and farm management, as well as real-world farming and ranching experience, he is uniquely qualified to help farmers and ranchers operate profitably. Contact him at [email protected].