It goes without saying that everyone should know the basic terms of finance. We should all know the difference between interest and principal, savings bonds and treasury notes and what a stock is. But what other terms should we have in our dictionary of finance?
It turns out that our financial literacy is more important than most of us realize. And the more you know the more educated you can be when you take out a loan, buy a house, sign up for a credit card and so on.
Below are a few terms that should be understood before making any financial decision.
Prime Rate: This is one of the most widely used terms – or benchmarks- in setting home mortgage rates and credit card rates. It is also known as the prime lending rate as it is the rate that banks charge their most credit worthy customers – usually large corporations. You personal credit rate for your home mortgage, car loan or credit card line is prime plus a percentage rate that your credit report determines. Late payments on past debts, defaults and bankruptcies can negatively affect your personal rate which is added to Prime.
Amortization: Generally when taking out a loan of any sort, you will want to make payments on that loan. Those payments that you make on a regular basis which are a total of your principal, interest and any recurring fees, are amortized. They are regular payments made over a period of time. When you sign a loan agreement – like for your mortgage – you are provided the amortization schedule. You can use this schedule to track your progress as you get closer to paying off the debt.
Annual Percentage Rate (ARM): I am always surprised at how many people don’t know what their annual percentage rate is. Basically, the APR is the percentage rate you will pay over the life of a loan. But it is not necessarily all you will pay. It is indicated on your amortization schedule and is different from the interest rate. As a mandated disclosure in the truth in lending act, it is the set rate that a person pays on a fixed loan. Because the APR only includes lender fees and not any other accrued payments, it is not necessarily the most accurate rate you are paying at the time. For a more detailed rate at any given time, the Interest Rate can be calculated using all fees and interest a lender charges.
Regardless of the loan you are applying for, financial literacy is pertinent. Make sure you brush up on any term you may not be able to define in your loan documents! It is important for you to know your financial terms so you are able to teach your kids about money too!