Commonly Used Financial Terms

Photo by Christopher Chan

Money market account,  403(b), IRAs.  We think we understand these basic financial terms, but do we really? And does not comprehending the full definitions create problems?

The following definitions for the 10 most commonly used financial terms may help you straighten out a mess or, better yet, prevent one.

1. 401(k): A retirement investment plan that allows employees to put a percentage of earned wages into a tax-deferred investment account. The plan is selected by the employer. Also known as a "salary reduction plan." Non-profit organizations offer 403(b) plans as employees can't accept profit sharing or dividends.

2. Annual Percentage Rate (APR): The interest rate you'll pay for a whole year (as opposed to monthly) on loans, mortgages and credit cards. A fixed-rate APR changes infrequently but, if it does change, the creditor is legally required to tell you before doing so. A variable-rate APR changes occasionally and is often tied to another interest rate, usually the prime rate or treasury bill rate. 

3. Certificate of Deposit (CD): A time deposit commonly offered to consumers by financial institutions. CDs are similar to savings accounts in that they're insured and, thus, are virtually risk-free. They're different from savings accounts in that they have a fixed interest rate and a specific fixed term, usually three months, six months, or one to five years. You receive all the interest that has accrued on a CD if it is held to maturity but will be fined if you cash it out before the term has expired.

4. Credit: Borrowed money you use to purchase something, with the agreement you'll repay the money at a set time. The terms of credit vary depending on the agreement, including the interest rate, repayment schedule, etc.

5. Credit bureau - Similar to a bank but, instead of being owned by investors, it is owned and controlled by the members. While the profits from a bank are distributed to the investors, the profits from a credit union are returned to the members of the credit union in the form of lower loan interest rates and higher dividends.

6. Individual Retirement Account (IRA): A retirement-plan account that offers some tax advantages for retirement savings. AN IRA allows you to set aside a certain amount of earned income every year. The interest and your contributions are tax-free until you cash in the IRA at retirement. Roth IRAs have become popular because the holder is taxed on contributions at the time of deposit, not when they withdraw funds at retirement.

7. Interest: A fee paid on borrowed assets. Interest is the price paid for the use of borrowed money or the money you earn on deposited funds (as in a savings account). Think of interest as the cost for renting money. When you deposit money in a savings account, you typically receive interest on a percentage of the amount in that account. When you borrow money, you pay interest to the lender as a percentage of the amount owed. The percentage of the principal paid as a fee over a certain period of time (usually per month or per year) is called the interest rate.

8. Money Market Account: A bank account with an FDIC-insured financial institution that has a relatively high interest rate but requires little notice (or no notice) for withdrawals. You can write checks on a money market account while still earning interest, unlike a standard checking account. Financial institutions often require a minimum balance for a money market account and only allow for a certain number of transactions in a given time period. However, the interest rate typically is higher than on a standard savings account.

9. Mortgage: The transfer of property to a lender as security for a loan of money. A mortgage is not a debt in itself but rather the security for a debt. Once the conditions of a mortgage have been satisfied or performed (usually full payment of the mortgage), ownership of the property is turned over to the debtor. Mortgages can be taken out on many things but most commonly refer to property. The  interest on a fixed-rate mortgage remains the same throughout the term of a loan. The interest rate for an adjustable-rate mortgage (ARM) periodically changes based on a variety of factors.

10. Mutual Fund: A mutual fund is a professionally managed type of collective investment fund that pools money from many investors and invests it in stocks, bonds, short-term money market instruments, and/or other securities. In essence, a mutual fund is a basket for a number of investments that are too numerous and complex for the typical investor to manage.