Personal Finance Terms You Should Know
The first step in navigating your personal finances
It can be difficult to talk about money. No — I don’t just mean it can be an awkward discussion topic. If you have heard the term overdraft or refinancing and realized that you only vaguely understand what they mean, then you know that personal finance can seem like a daunting topic at first.
Your personal finances are just that — personal. You should be able to understand the ins and outs of your essential financing questions.
You don’t have to be a financing expert to handle your finances properly. Understanding the basic terminology will allow you to navigate your personal finance and, potentially, help you grow your money.
Here is a brief explanation of financing terms that will give you the basics of what you need to know to start prioritizing your finances.
- Credit Score/FICO Score
Your credit score, or FICO Score, is a number calculated by considering multiple finance factors from your past, including your credit history, your loans, and how much you currently owe. Credit unions and loan distributors use your credit score to determine your credit or loan eligibility.
Your credit score is extremely important since having bad credit or not enough credit can prevent you from being able to buy a home, sign up for a phone plan, get an apartment lease, get a car loan, etc.
FICO is an acronym of the company that designed the credit score calculation — Fair Isaac Corporation. The term FICO score and credit score are used interchangeably.
FICO scores fall between a range of 300 to 850, though a “good” credit score falls around 670. Credit scores over 740 are “very good.” If your score is below 650, the chances are that you may not qualify for credit or loans, or that you will see high interest rates if you are approved.
If you want to raise your credit score, you can pay off loans on time, keep your credit card balances low, and build a long credit history by not canceling credit cards too often. Missing payments or opening unnecessary credit lines can lower your score.
2. Compound Interest
Albert Einstein called compound interests the Eight Wonder of the World.
When you put money into a savings account, your bank pays you interest every month for simply having money in that account. Let’s say your monthly interest is 1%.
When you deposit $100 into your bank account and keep it there long enough, your bank pays you interest. Now, you have $101. Then, it pays you an additional 1% on that 101. Now, you have $102.01. The cycle goes on. You pretty much make money on top of your money on top of your money.
That’s why starting savings early is so important. The earlier you start saving and investing, the more time you have to build your wealth. So, even if you only have $100 to invest, it will grow overtime!
3. 401(K) and Roth IRA
You may have heard the phrase that “it is never too early to plan for your retirement,” but it is true!
You may recognize the 401(K) as its less official title, the retirement plan. Employers often offer a 401(K) plan, allowing employees to designate a portion of their paychecks in an account. The money placed in a 401(K) account is not taxed yearly.
Once you hit the qualified 401(K) age, which is usually 59 ½ years old, you gain access to the account. Withdrawals from the account are then taxed as if it is income.
401k is a great easy way to start investing, especially since many employers offer 401k matches. This means you will pretty much get free money from your employer every year as a benefit. If your employer offers matching, please take that free money!
A Roth IRA is another type of retirement plan. With a Roth IRA, an individual sets up an account through an investment firm. This is great for people who are self-employed or own a business because you don’t have to depend on an employer to open this account.
You can withdraw money from a Roth IRA account before you are of retirement age, though withdrawals have taxes and penalties. However, withdrawals become tax and penalty-free once you are of retirement age, unlike 401(K) withdrawals.
4. Net worth
You may have seen the term net worth when Googling your favorite celebrity. I mean, how bizarre that Star Wars star Mark Hamill’s net worth is $18 million when his co-star Harrison Ford has a net worth of $300 million.
The common misconception of net worth is that it means the amount of money that someone has. However, it is more than just that.
Net worth is calculated by adding your money, investments, and account balances. For example, the current market value of your home is an addition to your net worth as an investment. After calculating your assets, your network also subtracts anything you owe, such as mortgage or loan balances.
I personally like to use the Mint app to monitor my net worth. I connected all of my financial accounts such as my checking, saving, retirement, investment, and credit card accounts. Mint does the math for me and shows me my overall net worth after my liabilities, such as credit card balances.
I’ve personally really enjoyed watching my net worth go from the negative when I had more debt to now when I have a pretty decent amount of cash and investments that have pushed my net worth into the positive.
5. Interest Rate
If you have opened a bank account or taken out a loan, then you have heard the term interest rate. But, what exactly does it mean?
Borrowing money doesn’t come without a price. Interest rate is that price. An interest rate is a percentage charged monthly or yearly for holding money.
When opening up a savings account, you will agree to a percentage that the bank will pay you as they hold your money. On the other hand, when taking out a loan, you will be paying interest rates to the loan company for loaning you their money.
6. Minimum balance
The minimum balance is the amount you must have in your account at all times to keep your account open and to avoid fees.
Some banks charge a fee if your balance falls below the minimum balance set for your account. Other banks will keep you from certain benefits, such as not accruing interest if your balance is below the minimum.
7. Overdraft
An overdraft occurs when you spend more money than is in your checking account. Essentially, it is spending more money than you have.
Most bank accounts have overdraft fees that are automatically charged once your account is in the negatives. Since you spent more money than was in your account, you are then spending the bank’s money rather than your own. As such, overdraft fees tend to be pretty hefty and will put your account further in the negative.
8. Savings vs. Checking accounts
Understanding the distinction between a savings account and a checking account is essential when planning your personal finances.
You can think of checking accounts as the bank account you use daily. Your checking is made for spending, allowing you to make bill payments, withdraw from ATMs, and make changes when shopping.
Savings accounts store and accumulate funds that you are not looking to tap into for everyday use. These accounts are also often set up to gain interest rates that will help increase your savings over time.
9. Refinancing for loans
Many people find themselves in times where they struggle to make their loan payments each month. If you find yourself drowning in your bills, it may be time to refinance.
Refinancing your loans means that you are replacing your current credit agreement with another loan program with lower interest rates or monthly payments to fit your personal financial situation better.
Now that you are familiar with these essential finance terms, you are on your way to mastering your personal finance plan! For more personal finance tips and tricks, check back on my blog or check out my YouTube channel.
