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
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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. The higher your credit score, means better interest rates, which can save you thousands of dollars on interest charges.
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Credit Limit: The amount of credit extended to you via a credit card or other revolving loan is called a credit limit. It's the maximum amount you're allowed to spend using that method of payment. Financial institutions use your credit score to determine the amount of credit they can extend to you based on your payment history. It's important to use your credit wisely, 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
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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.
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Gross Income is the total amount of pay earned before taxes and other payroll deductions.
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Net Income also known as your "take-home pay", is the amount of your pay after taxes, and other deductions are taken from your gross earnings.
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If you earn $500 for working all week, this is your gross pay. Once your employer deducts the required state and federal taxes of say $100 and other payroll deductions of $50, the net pay, or “take-home pay” would be $350. When applying for loans, lenders qualify borrowers using their gross income when calculating debt-to-income ratios for loans.
Loan Language
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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 monthly payment amount for loans such as mortgages, auto loans, or other non-amortizing loans.
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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, leading to higher costs for borrowing money.
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Compound Interest: This type of interest is paid to you and is earned via savings accounts and investment products. Depending on your interest rate and the amount of money in your account, the compound interest can add up. To determine your 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
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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.
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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.
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Debt-to-Income Ratio (DTI): Your DTI is one of the main ways 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
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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.
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Overdraft: When you don’t have enough money in your account to cover a purchase, sometimes the financial institution will honor the transaction leaving your account in the negative. This is called an overdraft. There is typically a NSF (nonsufficient funds) fee involved by the financial institution to allow the transaction to process.
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Overdraft Protection: Overdraft protection is an optional service that avoids overdrafts in your account. When you signup for this service, you'll designate a backup account such as a savings, to transfer additional money needed to cover a purchase. There is typically a fee for overdraft protection, however the fee is often less than an overdraft charge.
Investment Instruments
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Share Certificate (also known as a CD): Share Certificate (or CD) is a type of 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 for short and long term goals.
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Money Market Accounts: An interest-bearing account with unique features not found in other types of savings accounts. They may require higher minimum balance requirements but often pay higher interest rates than a traditional savings account. Money Markets are unique in that they also offer check writing, electronic withdrawals and transfers similar to a Checking Account. However, most Money Market Accounts have withdrawal limits.
Navigating Financial Terms
Understanding important financial terms is crucial for achieving long-term financial success. From credit scores and income to investments and loans, navigating financial jargon can be confusing. At Allegiance, we offer personalized guidance to help you navigate these terms and set you up for success on your financial journey. Contact us today for one-on-one support.