Real Talk: The Big F ... (Financial Terms)
Have you ever asked yourself, "who let me make this decision?!" Yah, same. This whole adulting thing is super exciting yet, at the same time, nerve-rackingly terrifying. Grown-up responsibilities with grown-up consequences? When did this happen?
You now have to make your own decisions about money, earn your own income, and pay for your own things. And with these responsibilities comes a lot of lingo that can be hard to follow, let alone understand how it applies to "ME" ... So together, we're going to talk "The Big F" ... Financial Terms.
It's totally not as boring as you think; and I'm going to do my best to real talk you through these financial terms and help you understand why you should give a $%.
Gross Income: The amount of money you earn before taxes and deductions. If you know what you earn hourly and multiple it by the number of hours you work per pay period, this is your gross income.
Hourly Rate: $10
Hours Worked (per pay period): 80
Gross Income: 10 x 80 = $800
Net Income: The remaining amount of money you earned after taxes and other deductions have been subtracted from your gross income. So take our gross income example ☝️. Your gross income is $800 per pay period. But before you get any of that hard-earned green, there are taxes, insurance payments, and possibly investment deductions. After all that's said and done, the money you actually receive is your net income. Welcome to adulting at its best!
Hint: Think of net income as a fisherman's net. What you "net" is what you get to keep.
Finance: To finance something means to pay for it over time. You could personally finance, or you could finance through a creditor. For example, the latest and greatest iPhone just came out and you must have it. You get the phone and your monthly phone bill goes up to cover the cost of the phone over a set period of time. This is financing.
Debt: The amount of money that you owe to creditor(s). Whatever money you owe a person or a company is your debt.
Asset: Any monetarily-valued item owned by a person. This can be your crib, ride, or grandpa's pocket watch you inherited.
Net Worth: Basically, the difference between assets you own, money you have, and your outstanding debt. This can be positive or negative. Let's do a little math, shall we?
$1,000 in your checking account
+$1,000 value of your car that you own outright
$2,000 total amount you own
-$500 credit card debt
$1,500 is your net worth
Bankruptcy: This is a legal process that involves a person or business declaring himself/herself/itself unable to pay outstanding debts. Filing for bankruptcy provides a way for repayment, decrease of debts, or to possibly get rid of the debt altogether. It's often the last resort for people because of the less than stellar impressions associated with filing for bankruptcy. Filing can give lenders the sense that a person is untrustworthy and unreliable. Usually banks, lenders, and creditors won't be comfortable giving money to a person that has that type of credit history. And remember, a bankruptcy will show on your credit record for several years.
Impact alert: This option shouldn't be taken lightly; it will negatively impact credit scores. Depending on the type of bankruptcy filed, this could remain on your credit report for 7 - 10 years!
Credit Bureau: A company that collects an individual's credit rating related information and makes it available to credit card companies, financial institutions, etc. They have information about your credit history. There are 3 major credit bureaus: Equifax, Experian, and TransUnion.
Credit Score: The credit bureaus assign a number to you that indicates to lenders your "creditworthiness". In the US, most credit scores range between 300 to 850. The higher the score, the more financially trustworthy the borrower is considered to be.
Tip: Are you wondering what your credit score is? Federal law allows you to get a free copy of your credit report every 12 months!
Credit History: A person or company's record of paying debt. Credit history, or credit report, includes a history of your credit accounts including payments made, missed payments, and credit inquiries.
FICO Score: This is a certain type of credit score named after the company that created this particular calculation formula - the Fair Isaac Corporation. This credit score is determined by many factors including credit history length, payment background, and your total debt. FICO scores range from 300 to 850. The higher your score, the better. #lifegoals
Credit Check: An examination of someone's credit history. Companies and lenders check out your credit history to see if you're a good candidate for a loan. They want to measure out the likelihood of you paying them back if they decide to give you a loan. Yah, they'll want that money back. During a credit check, it's likely that the lender will receive your credit score.
Hard Credit Check: AKA "hard inquiry" or "hard pull". A hard credit check is usually done when you apply for a form of credit (mortgage, car loan, credit card, etc.) Creditors often do a hard inquiry to review your credit history and determine if they would like to extend credit to you or not. As part of your application for credit, you have to authorize the credit check.
Impact alert: A hard credit check may affect or lower your credit score because it could indicate you are getting ready to take on debt. They stay on your credit report for around two years.
Soft Credit Check: AKA "soft inquiry" or "soft pull". Soft credit checks usually happen as part of a background check, possibly for a job or if a creditor is considering giving you a pre-approval offer. These soft credit checks can be done without your authorization. Checking your own credit score is considered a soft inquiry.
Impact alert: A soft credit check will not lower your credit score.
Risk: Creditors assess the risk to determine the chance of a financial loss because of a borrower's failure to pay back debt. This doesn't necessarily mean that you won't get approved for a loan. But it does mean the cost of credit could be pricey for you. The reason? Creditors have to assume that some of the high risk consumers they extend credit to will not pay them. Let me translate:
Lender: A person or institution that makes money available with the expectation that they will get repaid over a set period of time (term).
Creditor: A person or company that extends credit to an individual - this could be in a form of a credit card or loan - with the expectation that the money borrowed will be paid back over time with applicable fees and interest.
Principal: The amount of money owed to satisfy a debt obligation. The principal balance does not include accrued interest or fees. Let's say you are approved for a $500 loan at a 15% interest rate.
Term: The amount/length of time you have to repay the amount you borrowed, plus fees and interest.
Credit: An arrangement where a lender gives a specific amount of money to a borrower for a particular amount of time, and then it needs to be repaid by the borrower. There are typically fees and interest applied to the outstanding (principal) balance.
Credit Limit: The largest amount of money that you can borrow at any one point in time - this could be on a credit card or loan. If you've "maxed out", this means that you have reached or exceeded the amount you can spend - you've hit your credit limit.
RL example: You apply for a credit card. The credit card company (the creditor) approves your application and gives you a credit limit of $500.
Collateral: Sometimes a creditor may request collateral in order to extend credit to you. This is an asset promised as repayment if you don't pay back the credit borrowed.
RL example: You own your car, so it's an asset. You need some cash, so you promise your car (asset) as collateral. That means, if you don't repay your loan, the creditor can take your car because you broke your promise.
Lien: A lender's legal right to the collateral (remember, that's the thing you used to back your promise to repay the loan) until the debt is repaid. It's like your lender put an invisible note on your collateral saying that they have rights to the property. When you pay off the loan, they remove that invisible note.
Refinance: To refinance a loan means to roll the loan into a new term. With a refinance, you sign new loan agreements and agree to pay interest and fees on the new term. Depending on what type of loan you are refinancing, you may be able to refinance to get a lower rate.
Impact alert: A credit check may be done to refinance your loan. Talk to your lender to understand if a credit check is part of the refinance process.
Debt Consolidation: When you have several debts (think loans, credit cards), it may be worth consolidating your debt to get a lower interest rate. A debt consolidation loan allows you to combine all your debt into a single source. Here's how it works: You borrow one large loan to pay off all the other loans. Then you just have to pay a single loan.
RL example: You have 2 student loans, one with a monthly payment of $250 and one with a monthly payment of $350. These loans have high interest rates of 10% & 11%. A bank has given you a loan offer with a 5% interest rate that will cover your two loan balances. So, you decide to consolidate your debt by accepting the loan from the bank. You pay off your two student loans using your bank loan proceeds, and you just have the one bank loan with a monthly payment that has a lower interest rate.
Interest Rate: This is a percentage of the borrowed amount that is repaid to the creditor for borrowing the money. Real talk - it's the cost of your credit. Interest accrues on the amount you owe (your principal balance). And on each payment, you will owe a portion of your principal balance along with accrued interest. To complicate things even more, there are different types of interest rates:
Fixed rates: Rates that do not change. If the lender puts in writing that your fixed interest rate is 3.2%, the interest rate will stay at 3.2% for your entire term.
Floating rates: Rates that are variable or can change, AKA "variable interest". This means that over the life of the debt obligation, your rate can change (it can go up or down). This is most commonly seen with mortgages and credit cards.
CAUTION: Typically, rates will vary with the market. This can certainly help you, but it can also cost you a lot more $$. Speak with a financial advisor to determine the best type of rate for you.
Interest Accrued (on a loan): Accrued interest is the interest on a loan that has accumulated or built up. The interest builds up between one payment and the next, and accrues based on your principal balance (the amount you owe). The interest can accrue daily or monthly. If you have a student loan, when you make your monthly payment the funds go toward your interest before your loan principal. Actually, if you have any fees, the line of succession is typically: Fees, interest, and then principal.
APR (Annual Percentage Rate): This interest rate is for the whole year on the money borrowed, including fees or extra costs. APR is a method of measuring the total price charged for funds per year. When getting a loan, there are other charges and fees that get connected to it, and that is combined with the cost of interest to get the APR. APR combines the complete amount of interest payable and other fees and charges, then averages that over the loan term and shows as a percentage.
Flat Fee: A fixed payment amount that doesn't change regardless of use or workload completed. No extras, no surprises. It's like going to the United States Post Office and scoring one of those "if it fits, it ships" boxes, also known as a "flat rate" box. For a predetermined cost, you can put as little or as much that can fit into that shipping box and still just pay that unchanging fee. Or if you're buying something online and the website has a flat shipping rate. That means no matter how much you spend, as little or as much, you're still going to pay the same shipping fee.
Whoa, financial talk can be overwhelming. But you can't avoid some of these adulting hard truths. The reality is: you can't make it through life without money. So it's important to understand these financial terms to be able to make them work for YOU. I've had to educate and re-educate myself on terms, because in most cases, these aren't words we're spouting about every day. (If you don't use it, you lose it, my friends!) There's no shame in continuing to refresh your brain 'til the knowledge sticks. I hope I've explained these terms as clear as La Croix. Until next time.
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