Most people don’t realize that personal finance has a language all its own, and unfortunately, many people are financially illiterate. Not understanding the definitions of commonly used financial and credit terms can be frustrating, intimidating, and ultimately expensive. It is important to familiarize yourself with common credit and financial terms.
Here are a few of the most common financial terms that you need to know.
Credit and Finance Terms
Compound Interest
Compound interest is the interest earned on the amount deposited, plus any interest accumulated over time when you are saving or investing. When you borrow through loans, compound interest is the interest that is charged on the original loan amount, as well as the interest charges that are added to the outstanding balance over time. Simply, it is essentially “interest on interest” earned (for savings/investments) or owed (for loans). It will make your savings or debt grow at a faster rate than “simple interest,” which is calculated only on the principal amount.
FICO Score
FICO stands for the Fair Isaac Corporation, the company that created the methodology for calculating a credit score based on several factors, including payment history, length of credit history, and the total amount owed. It is a three-digit number used by financial institutions and lenders to determine a borrower’s creditworthiness. The FICO score ranges from 300 to 850. The higher the credit score, the better the terms and the lower the interest rate you’ll receive on loans or credit cards. Conversely, people with lower credit scores, below 620, may get higher interest rates and have a harder time getting approved for a loan or credit card.
Life Insurance Terms
Permanent Life Insurance
Permanent life insurance, also known as whole life insurance, provides coverage over the lifetime of the insured person and offers accumulation of cash value, which is the investment component. The owner of the policy, which may or may not be the insured, can withdraw or borrow money from the accumulated cash value after a certain period, known as the surrender period. Premiums are typically more expensive for permanent life insurance than for term life insurance, because it covers the whole life of the insured.
Term Life Insurance
Term life insurance provides coverage over a certain period, usually from five to 30 years. If the insured individual passes away within that given period, his beneficiaries receive a payout. If the individual does not die within that period, the policy expires with no cash value. The policy owner can renew the policy after the term is over or cancel the policy at any time without penalty.
Premium
Premiums are small incremental payments made (monthly, quarterly, semiannually, or annually) to an insurance company over time in return for protection from significant financial losses, based on the scope of your policy.
Retirement Savings Terms
Defined-Benefit Plans
Employer-sponsored retirement plans, like pensions, are retirement benefits promised by employers based on a formula they determine that may include an employee’s tenure or length of employment, their earnings history, and their age. Some employers require employees to contribute a specific amount to the plan. Many companies no longer offer this type of benefit because of the high cost.
Defined-Contribution Plans
This retirement plan offers benefits that the employer, employee, or both make contributions to on a consistent and regular basis. The most common defined-contribution plans are 401(k) and 403(b), where the money that goes into these accounts comes from pretax earnings, so you don’t pay taxes on the amount contributed every year.
Understanding these common financial terms will help you make wiser financial decisions.
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