The DebtGuru’s Guide to Common Finance Terms

By Mike Peterson
In December 24, 2014

It’s my last post of 2014.  I can hardly believe another year is over!  I thought I’d close the year with a quick and easy guide to some commonly used financial terms.  If you’ve never been quite clear about the difference between a “hard credit inquiry” and a “soft credit inquiry” or you’ve always wondered exactly what an APR was, keep reading!

APR

Otherwise known as “annual percentage rate,” this common credit card term refers to the interest rate that your credit card company charges you if you don’t pay your balance off in full.  Your APR is mostly determined by your credit score, and the better your credit the lower your APR will be.   For example, people with near-perfect credit may have accounts with 10% or lower APR.  People with average credit scores are more likely to get around 15% or so.

Many credit card companies will offer super-low “introductory” APRs to new customers, but it’s important to know what the APR will be after the introductory period (this should be easy to find out because creditors have to follow very specific rules about how and why they can change your APR).  It’s also important to know that if you miss payments or make late payments, you may see your APR jump up to what’s called a “penalty” APR (penalty APRs can be 25% and up).

APY

This one stands for “annual percentage yield” – and it’s the amount of interest you can expect to earn per year from a savings account.  If you’re shopping around for a savings account that will give you the most savings “bang” for your buck, it’s helpful to look at APY and do some comparison shopping.

Compound Interest

Put simply, this term describes “interest earning interest” – and like APY, it can be helpful to consider when you’re choosing a savings or investment vehicle.  Of course, if you’ve got credit card debt, compound interest can be less-than-helpful, as you end up getting charged interest on top of your existing interest.  You can find a more in-depth discussion of compound interest in this post.

Credit Counseling

Credit counseling is a service that helps people improve their finances and pay down existing debt.  Credit counselors typically review your debt, income, budget, and spending – and help you come up with a plan for repayment.  In some cases, they negotiate with creditors for new payment terms.

Credit Report

Your credit report contains detailed information about your use of credit, and it is often used by lenders to determine your creditworthiness.  A credit report typically contains information about your credit accounts and loans – and it also includes information about your payment history, late payments, and recent “hard” credit inquiries.  By law, you are entitled to one free credit report per year from www.annualcreditreport.com.

It’s important to know, though, that your credit report is not the same as your credit score, which brings us to the next term . . .

Credit Score

Your credit score is the three-digit number that credit reporting agencies use when deciding your creditworthiness – that is, how likely you are to pay or default on a debt.  This number is used to determine your eligibility and interest rates for credit cards, home loans, and more.  The information on your credit report directly influences your credit score, which is why it’s so important to keep an eye on your credit report.

Debt-to-Available-Credit Ratio

This is simply a measure of how much of your total available credit is currently in use, and it is another factor used to determine your credit score.  If you want to improve or maintain your credit score, you should aim to keep your debt-to-available credit ratio as low as possible.

Debt-to-Income Ratio

Another measurement that can influence your credit score.  This ratio measures how much of your monthly income goes toward debt repayment, including credit cards, student loans, car payments, and mortgage payments.  Just like your debt-to-available-credit ratio, you want to keep this figure as low as possible.

Diversification

This word’s root – “diverse” – gives you a clue about its meaning.  Diversification refers to investing in a variety of different things in order to guard against too much risk.  An example of a diversified investment portfolio might include cash savings, stocks, bonds, and real estate.

Emergency Fund

If you read this blog regularly, you probably know this term pretty well.  As the name suggests, an emergency fund is money that you set aside for unexpected events such as a home or car repair, an illness, or even the loss of a job. Ideally, your emergency fund should contain at least three months of living expenses.

Don’t have an emergency fund?  Check out this video or this post for tips on preparing for unexpected money emergencies.

Hard Inquiry

A hard inquiry is a type of credit inquiry that appears on your credit report when you apply for a new line of credit (such as a credit card, a bank loan, a car loan, and so on).  Unlike “soft” inquiries, “hard” inquiries can show up on your credit report – this is why applying for too many lines of credit in a short amount of time can ding your credit score.

Soft Inquiry

Unlike a “hard” credit inquiry, a “soft” credit inquiry doesn’t affect your credit score.  An example of a “soft” inquiry is checking your own credit report.

Net Worth

The total value of everything you own, minus everything you owe.  Want to know your net worth?  Add the money in your checking and savings accounts, plus the money you’d get if you sold your house, car, and other possessions.  Then, subtract your credit card debt, mortgage, student loans, and any other outstanding debts to determine your net worth.  The less debt you have, the higher your net worth – one more great reason to get out of debt!

Secured Credit Card

A secured credit card is an alternative to a traditional credit card.  Typically offered to people with bad credit (or no credit history at all), a secured card is backed by a large cash deposit.  Although secured cards typically have low limits and high interest rates, they are helpful to people trying to rebuild or establish credit.

Unsecured Credit Card

Any credit card that isn’t a secured credit card is an unsecured credit card.  “Unsecured” simply means that there is no cash collateral backing the card.

That’s it for now!  Are there any terms that you’d like to see on a future blog post?  Leave me a comment and let me know!

 

Happy New Year!

 

Mike is the author of “Reality Millionaire: Proven Tips to Retire Rich” and he has been published in a variety of local and national publications including Entrepreneur Magazine, Deseret Morning News, LDS Living Magazine, and Physicians Money Digest. He holds a B.S. in business administration from the University of Phoenix.