Commonly Misunderstood Financial Terms

Commonly Misunderstood Financial Terms

Written by Caitlin Wood
Last Updated July 25, 2014

The world of personal finance can be extremely complicated and confusing, especially if you’ve just entered it by purchasing your first house, getting a credit card for the first time or looking to take out your first loan. While even trying to understand certain financial terms can be quite a daunting task it’s also an important one. The better you’re able to grasp certain term the better equipped you’ll be to deal with any personal financial situation. Below is a list of some commonly misunderstood financial terms and their definitions to help you master your financial life.

Appraised Value: An appraiser will assign a value to a house based on the how much similar houses were sold for in the neighbourhood and the conditions and features of the house in question.

Asset: A house or a piece of land are two personal assets that most people might have. What makes something an asset is whether or not it will increase in value in the future. Therefore something like a car is not an asset as it will probably decrease in value over time (unless of course it is a vintage car that has become a collector’s item).

Budget: A personal budget is when an amount of money is set aside for a particular task. People often make budgets for day to day activities so that they won’t over spend their money. The money saved and put aside for a vacation or trip is also often called a budget.

Collateral: Often when an individual needs a personal loan they will put up collateral in order to get the loan. The collateral is usually an asset, something that is worth a great amount of money, which will then be taken away from them in case they are unable to pay back the loan.

Debt Negotiation: When someone is unable to pay off their debt on time and in full they can work with a credit counselling who will negotiate with the creditors on their behalf. The point of the negotiation is to reduce the amount of debt that is owed. This is sometimes also referred to as debt settlement.

Debt-to-Income Ratio (DTI): This is the percentage of your gross income (income before taxes) that you put towards paying off any debt. There are two kinds of DTIs:

  1. Front-end ratio: The amount of income that goes toward your housing costs (including all expenses such as insurance and taxes)
  2. Back-end ratio: The amount of income that goes toward paying off any debt that you have (including the debt covered by the front-end ratio).

Depreciation: This is a term that is use to describe something that will decrease in value over time, cars and computers or laptops are examples of things that decrease in value over time.

Expenditures: The amount of money you allocate towards spending on everyday need and services.

Garnishment: When you are unable to pay back a loan that you have and your creditor is given legal permission to take what you owe them, through the seizure of an asset.

Income: Whatever money you receive for doing a task or performing a service, whether it’s from your main job or a secondarily job.

Insurance: A service that you pay for to protect yourself and your money in case of an emergency or accident. Most commonly people get health insurance for medical expenses, home insurance in case of theft or natural disaster and car insurance for accidents.

Insurance Deductible: A deductible is the amount of money you are required, based on your insurance policy, to pay out of your own pocket before your insurance company will pay anything. Let’s say your health insurance has a $1000 deductible for the year. Any amount you spend over $1000 will be reimbursed by your insurance company, but if you only spend $900 you won’t get anything back.

Insurance Premium: Is the amount of money you’re paying for your insurance plan. Even if you never use your insurance you still have to pay for it. An insurance plan typically has an annual payment that must be paid even if the insurance is never used.

Introductory Rate: This refers to a temporary (at least 6 months) interest rate that is usually lower than average. It is offered by a credit card company to try and attract new customers.

Investment: Investments are made to grow money; people strategically invest their savings in order to make more money for their future.

Liquidity: Generally speaking liquidity is the money that is in your bank account, but it is also any form of money that you can get a hold of right now or even the money you can produce in a short amount of time. Having some liquidity is also a good idea, it’s usually the money set aside for emergencies.

Mortgage: A mortgage is a strategic long term debt that you choose to enter in order to purchases a house or property. The property is then used as collateral for the loan.

Savings: Is the liquid money you have saved from the salary you are getting from a job. Savings usually occurs after you have paid for all of your required monthly bills and expenses.

Secured Debt: A mortgage is a secured debt. It is a loan that needs something (like a house) to be put up as collateral. If you are unable to pay off the loan, whatever you have used as collateral will be seized to pay for your debt.

After having read through all of these personal finance terms we hope you’re now ready to conquer all of your financial issues or delve into the world of personal finance, with confidence, for the first time.

Caitlin is a graduate of Dawson College and Concordia University and has been working in the personal finance industry for over eight years. She believes that education and knowledge are the two most important factors in the creation of healthy financial habits. She also believes that openly discussing money and credit, and the responsibilities that come with them can lead to better decisions and a greater sense of financial security. One of the main ways she’s built good financial habits is by budgeting and tracking her spending through the YNAB budgeting app. She also automates her savings so she never forgets to put aside a portion of her income into her TFSA. She believes investing and passive income is key to earning financial freedom. She also uses her Aeroplan TD credit card to collect Aeroplan points so that she can save money when she travels.

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