When it comes to banking and finance, there are some keywords that you should be familiar with. Knowing the common banking jargon is a smart way to ensure you can effectively manage your accounts and understand exactly what you are dealing with when it comes to money. Here are some of the most common financial terms you should understand.
Common Financial Terms Explained
Navigating the financial landscape can seem like deciphering a foreign language, with its abundance of complex terms and concepts. By unraveling the intricacies of common financial terms, we aim to empower individuals with the knowledge needed to make informed decisions. From investments to savings, understanding these key concepts is crucial for anyone looking to manage their finances effectively.
Core Credit Concepts
- Credit Score: A credit score is the number the credit bureaus give every consumer based on how well they manage their finances. Your credit score is one of the most important financial terms to be familiar with. Credit scores range from below 580 to above 800 and reflect your creditworthiness by considering things such as your total debt, payment history, number of credit accounts, and more. A good credit score, those above 670, means better interest rates, which can save you thousands of dollars on interest charges.
- Credit Limit: The amount of credit extended to you via a credit card or other type of loan is called a credit limit. It is the maximum amount you are allowed to spend using that method of payment. Banks use your credit score to determine the amount of credit they can extend to you based on your payment history. It is important to use your credit wisely, though, as spending the maximum amount of your credit limit has a negative effect on your credit score, which can cause it to drop.
Income Related Financial Terms
- Gross Income vs. Net Income: It’s important to know the difference between the financial terms gross income and net income, especially when it comes to applying for a mortgage or other loans.
- Gross Income is the total amount of pay earned before taxes and other payroll deductions.
- Net Income is the amount of your pay after taxes, and other deductions are taken from your gross earnings.
If you earn $500 for working all week, this is your gross pay. Once your employer deducts the required state and federal taxes of $100 and other payroll deductions of $50, the net pay, often called “take-home pay” would be $350. When applying for loans, lenders qualify everyone using the same guidelines, so they all use the gross income when calculating debt-to-income ratios for loans.
Loan Language
- Amortization: Financial terms like amortization are important when discussing the repayment of loans. Amortization is the process used to determine the amount of equal monthly payments for fixed-rate loans over the term. Since the total of each loan payment includes a portion of interest and principal, this process is used to determine the amount of each in every fixed-rate mortgage, auto loan, or other loan other payment made.
- Interest Rate: The cost of borrowing money is determined by the interest rate charged on the loan. Those with good credit can qualify for lower interest rates, which can save thousands of dollars in interest payments during the course of the loan. Lower credit scores can mean higher interest rates on loans, meaning the cost of borrowing money is going to cost a bit more.
- Compound Interest: This type of interest is paid to you versus by you and is earned via savings accounts and investment products. Depending on your interest rate and the amount of money in your account, compound interest can really add up. To determine compound interest, multiply the amount of money in your account by the interest rate each year. If you have $1,000 earning 5% interest each year, you’ll have $1,050 at the end of year one. During the second year, you will earn an additional 5%, giving you $1,102.50 at the end of the second year.
Rates and Ratios
- Annual Percentage Rate (APR): The APR is the rate you are charged each year for purchases on a loan or credit card. The lower the APR, the less money you pay in interest charges.
- Annual Percentage Yield (APY): The APY differs from APR because it is the annual rate of return on your money that includes the compounding of interest on an account. The higher the APY, the more money you earn.
- Debt-to-Income Ratio (DTI): Your DTI is the main way lenders determine your ability to qualify for and repay loan payments. Your DTI is your monthly payments (debt) divided by your gross monthly income.
Transaction Terms
- Automatic Clearing House (ACH): The electronic network used by financial institutions to transfer money between accounts is known as the ACH. This is how electronic bank transfers like direct deposits from employers and payments to creditors are paid.
- Overdraft: When you don’t have enough money in your account to cover a purchase, sometimes the bank will honor the transaction anyway. This is called an overdraft. There is typically a fee for the bank to cover the overdraft, unless you take advantage of account overdraft protection, which allows you to go over the balance in your account without incurring any fees.
Investment Instruments
- Term Share Certificate (Certificate of Deposit, CD): A CD is a savings product that offers a fixed APY on an account for a set period of time called a maturity date. CDs typically offer a higher interest than a normal savings account and are a great investment option.
Navigating Banking Policies
From credit scores and work income to investment terms and loan lingo; knowing important financial terms is crucial for your long-term success. Understanding these financial terms and how they can affect your money enables you to effectively navigate banking policies and make informed financial decisions.
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