Understanding Financial Terms: April's Key to Smarter Decisions

April marks Financial Literacy Month, a time to focus on empowering ourselves with the knowledge we need to make smarter money decisions. Understanding financial terms is a crucial step in taking control of our financial future. In this blog, we'll cover six essential terms that fall into three categories: lending, credit, and savings.

 

Lending Terms

 

Collateral

Collateral refers to an asset you offer to a lender as security for a loan. Common examples include using your home or car to secure financing. The risk is that if you fail to make payments, the lender may seize the collateral. Understanding collateral helps you weigh the risks of borrowing against the security of the assets you own.

 

Equity

Equity represents the value of ownership you have in your home. It is calculated by subtracting the mortgage balance from the current market value of the property. As you pay down your mortgage, your equity increases, which can be used for various purposes, such as accessing home equity loans for future financial needs.

 

Credit Terms

 

Annual Percentage Rate (APR)

APR is a critical metric to understand when comparing borrowing options. It reflects the true cost of borrowing, including interest and other fees, expressed as an annual rate. Knowing the APR helps you make informed decisions when considering loans or credit card offers.

 

Annual Fee

An annual fee is a charge that credit card companies may impose for using certain cards. While some cards have no annual fee, others may charge one in exchange for specific benefits, such as rewards or premium perks. Being aware of these fees helps you evaluate whether the benefits outweigh the cost.

 

Savings Terms

 

Compound Interest

Compound interest is the process by which interest is added to the principal sum of a deposit, allowing you to earn interest on the interest already accumulated. For example, if you have $1,000 in a savings account with a 5% annual interest rate, you'd earn $50 in the first year, but in subsequent years, you'd earn interest on $1,050, and so on. This exponential growth underscores the importance of saving early and consistently.

 

Pay Yourself First (PYF)

Pay Yourself First is a budgeting strategy where you allocate a portion of your income to savings before covering other expenses. This technique ensures that you prioritize savings and gradually build a financial cushion, contributing to your long-term security.

By understanding these key financial terms, you take an important step toward achieving financial independence and making informed decisions. Small steps, like familiarizing yourself with these concepts, can make a significant impact on your financial journey over time.