Understanding basic money terms and concepts that affect your financial health is the first step toward financial literacy. Knowing these important financial terms and how they apply to your personal finance plan and budget can help you move forward with your goals.
Savings Terms to Know
Compound interest: You’ll essentially be earning interest on interest. When you deposit money into your financial account, such as a savings account or a retirement account, the bank will pay you interest on your initial deposit and any interest it earned. Here’s how it works: Say you start with a deposit of $10,000 in your savings account, which has an annual interest rate of 0.2 percent. That means you’ll make $20 every year. Now, that extra $20 in your account will earn also interest. The first year, you’ll have $10,020, the second you’ll earn $20.04 in compound interest for a principal balance of $10,020.04. And it continues to grow year after year as long as you keep the money in your account.
Short-term savings: Whether you’re saving for a vacation or new appliances, a short-term savings plan will help you make those purchases without accruing nonessential debt.
Long-term savings: This type of plan focuses on saving money for your long-range goals, such as a down payment on a house, a college education or an advanced degree, a new car, or a wedding. Planning ahead of time and setting aside money each month may help minimize debt incurred from these larger expenses.
Emergency savings: This type of savings should be set aside for any unforeseen life event that could be a risk to your finances. Cecilia Bailey, Community Education Administrator with Regions Bank, recommends you have enough money in your savings account to cover living costs for six to nine months. But starting your savings with $1,000 will offset some of the more common emergencies such as car or home repair, unexpected travel, or medical expense. “An emergency is not really an emergency if you have the funds to pay for it,” says Bailey.
Retirement savings: While it can be difficult to save for something that you won’t benefit from in the near future, planning for your golden years is an important part of your long-term financial health and security. The earlier you start saving for retirement, the more value you’ll get out of every dollar you save, due to compound interest.
Credit Terms to Know
Credit: Credit is money that a bank or business allows you to use now and pay back in the future. Credit is available in many forms, including credit cards, lines of credit, personal loans, and more.
Credit score: Your credit score can impact your ability to get credit, the interest rate you will receive, and the credit limits you will be given. This numerical score, based on several factors, can help lenders identify certain risks based on your credit history. Your score ranges from 300 to 800+, with scores above 700 considered good credit and above 750 considered excellent credit. “You may be able to help build a good credit score by paying all of your bills on time and keeping balances on credit cards at or below 30 percent of your credit limit,” Bailey says.
Lending Terms to Know
Debt-to-income ratio: This is the sum of your monthly debt payments divided by your gross monthly income. When you’re applying for credit, this ratio gives lenders a chance to determine whether you’ll be able to manage the payments every month.
Collateral: When you apply for a loan, you may offer your lender property or money as collateral, which the lender can use to recoup its costs if you default on the loan. This type of loan is considered a secured loan, which is commonly used in home mortgages and auto loans.
Equity: Your equity in an asset is the amount of money you owe on a mortgage or loan subtracted from the value of your owned property. Most commonly, you’ll have home equity in real estate, but you may also have equity in other financial assets. You can use the equity in your house or condo as collateral for a home equity loan or line of credit.
By understanding these basic personal finance terms, you can work to build your credit score, and pay off or minimize your debt and store enough savings for a secure future.