It can be a bit tricky to make sense of your money when you don’t know the lingo. Money terminology often contains abbreviations or familiar words used in funny ways. We’ve rounded up a list of must-know money terms to help you get a good understanding of your finances.
Asset allocation refers to how you’ve divvied up your assets, either into cash, bonds or stocks. Usually, the goal is to get a fair balance when it comes to risk and reward. For example, if you have 100 percent cash, the risk of your assets losing value is low, but the likelihood that they will gain much over time is also low. Stocks usually have a higher rate of return, but also a higher risk. Depending on where you are in life, you might prefer more risk, or no risk with no return.
The principal is the actual amount of money you borrowed. For example, if you bought a $200,000 house, put down $40,000 and took out a mortgage of $160,000, the $160,000 is the principal. A principal is also the initial amount you invested in stocks or another investment vehicle.
Amortization is a complicated term that refers to a relatively simple concept. It’s the paying off of a loan in fixed installments over a set period. When you take out a 15-year or 30-year mortgage, your payments are amortized over the 15 or 30 years. Although you typically pay the same amount each month, how the money is used differs across the life of the loan. Usually, when you first start paying back a mortgage, more of your payment goes towards interest each month. As the principal on the loan decreases, the amount of interest you owe decreases – so you end up paying more towards the loan itself.
Also called an adjustable rate mortgage, an ARM is a home loan with a variable interest rate. It is different from a fixed rate mortgage because the interest rate can increase or decrease with the market. If you have a fixed rate loan, your interest rate will remain the same throughout the life of the loan.
Annual Percentage Rate
The annual percentage rate, or APR, is the yearly cost of a loan, such as a mortgage or credit card debt. It’s not just the interest charged by a lender, it’s the interest plus fees and any penalties. A credit card that charges two percent interest each month has an APR of 24 percent, for example.
Compound interest can help or hurt you depending on circumstances. It’s a good thing when money in a savings or investment account earns compound interest. This allows the interest from your initial deposit to start earning interest. This can help your investments or savings to increase quicker over time. However, compound interest can hurt you when you don’t pay the interest due on a loan because that amount will be added to the principal and the interest itself will start earning interest.
Annual Percentage Yield
Annual percentage yield, or APY, is not the same thing as APR. APY is the rate of return when compound interest is involved. For example, if you have a bank account that earns one percent interest a month, the APR is 12 percent. But, since the one percent compounds, the APY is slightly more than 12 percent as long as you leave the initial deposit and the interest in the account for a full year.
Have you come across money terminology that has you scratching your head? We’re happy to explain the meaning of any new-to-you terms. Contact us at CESI Solutions, today!
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