Demystifying financial jargon

Forget Italian or Spanish, sometimes the language of finance can prove downright baffling! If you’re struggling to understand the difference between your APR and your LTV’s or feel baffled by the over-abundance of finance jargon – rest assured, you’re not alone! Anyone trying to manage their finances responsibly knows it can be downright confusing when faced with phrases you simply don’t understand.
But never fear – we’re here to take the fear from financial jargon, empowering you to take full control of your finances.

Why understanding financial jargon matters

Confusing financial terms can lead to costly mistakes. Whether it’s signing up for the wrong type of loan or misunderstanding the fine print in a contract, getting to grips with the terms and language is crucial. So, whether you’re planning to take out a loan, are buying a new home or just want to manage your own business more effectively, our guide will demystify the terms, leaving you empowered to ask the right questions and make smarter financial decisions.

Key financial terms everyone should know

Interest Rate
Interest is the amount of money a lender charges you to borrow their money. It’s usually written as a percentage, which is the interest rate. The amount of interest you’ll pay could vary because of factors like your credit score and the type and structure of loan you need.While this may seem straightforward, there are different definitions and calculations of interest such as flat rate, fixed rate, variable rate, and APR. We break them down for you next:

Flat rate
This is a simple method used to calculate the annual interest charge on a loan as well as the monthly instalment.
- Why it matters: Ultimately this is your way to work out how much you’ll be repaying on a loan each month.
- Example: If you’ve got a loan of £10,000 with a flat rate of interest of 10%, your interest charge for the year will be £1,000.

APR (Annual percentage rate)
This is the total yearly cost of borrowing money, expressed as an annual percentage. It’s NOT just the interest rate as it includes any fees or charges associated with the loan, so it represents the total cost of credit.
- Why it matters: Understanding this much-used term helps you compare loans and credit card costs and gives a much clearer picture of which option really is the cheapest.
- Example: If a loan advertises an interest rate of 5% but an APR of 7%, the additional 2% will include other costs such as origination or set-up fees.

Fixed rate vs variable rate
A fixed-rate loan has an interest rate that stays the same throughout the life of the loan. A variable rate loan’s interest rate can fluctuate – this is usually based on market conditions and can be unpredictable.
- Why it matters: Depending on which option you choose, you could end up paying more or less for your loan. If you opt for a fixed-rate you know exactly how much you’ll pay each month but you might miss out on lower interest rates in future. Opting for a variable rate can save money if interest rates fall but similarly, you’ll pay more if rates rise.
- Example: You’ve been accepted for a £10,000 loan for 48 months at a fixed interest rate of 10%, despite any market changes or economic volatility that may occur, your interest rate will remain at 10% for 48 months.

DTI (Debt-to-income ratio)
This is the percentage of your gross monthly income (the amount before tax) that goes toward paying debts. Lenders may use it to help assess your ability to manage both your monthly payments and to repay the money you want to borrow.
- Why it matters: The lower your DTI, the more likely you’ll be approved for a loan.
- Example: If you earn £3,000 per month and your total monthly debt payments are £900, your DTI ratio is 30%.

LTV (Loan-to-Value Ratio)
The loan-to-value ratio is a measure of the amount of the loan compared to the value of the security. Lenders use this ratio as an indicator of the potential risk of the loan.
- Why it matters: Generally, the lower the loan-to-value ratio, the lower the risk of loss to the lender, should they take possession of the collateral in the event of default.
- Example: If you buy a house worth £200,000 and borrow £160,000, your LTV ratio is 80%.

Capital
Sometimes also referred to as principal, the capital is the initial amount of money you borrow or invest but doesn’t include any interest.
- Why it matters: Interest you have to pay is based on the initial capital amount which means the higher the capital amount, the more interest you’ll pay over the life of the loan.
- Example: If you take out a loan for £10,000, that £10,000 is the capital.

Repayment schedule (or amortisation)
The repayment schedule refers to the gradual repayment of a debt over time through scheduled payments.
- Why it matters: Each payment goes towards both the interest and the capital, with more going to interest at the beginning of the repayment term, with an increasing amount repaying the capital as the loan progresses.

Equity
When used in the context of property or a business, equity is the value of an asset you own outright, minus any debts or liabilities. So if your house is worth £250,000 and you owe £150,000 on your mortgage, your equity in the house is £100,000.
- Why it matters: Equity is important because it builds wealth. Increasing your equity in your home, for example, may make it easier to borrow more in future, or sell at a larger profit.

Collateral
Collateral is the term used to describe the security against your loan, such as your car, house, machinery, or stocks/shares.
- Why it matters: If you fail to repay your loan, your lender can take possession of these assets to recover any money owed.
- Example: When borrowing money to buy a house with a mortgage the property itself serves as collateral.

Term
This is the length of time over which you agree to repay the money you owe.
- Why it matters: The longer the term, the lower your monthly payments, but the more interest you’ll pay overall. A shorter term means higher monthly payments, but you’ll pay less interest over that time.
- Example: Opting for a 30-year mortgage over a 15-year mortgage means lower monthly payments but you’ll pay more interest overall.

Default
Default happens when you fail to make the required payments on a loan.
- Why it matters: It can lead to overdue payment fees and charges which in turn could cause problems with getting credit in future, as it may impact adversely on your credit rating. It may also result in potential legal action from the lender.

Secured and unsecured loans
A secured loan is backed by collateral while an unsecured loan is not.
- Why it matters: It can impact on the rate of interest charged on your loan. Secured loans can have lower interest rates as they typically carry less risk of financial loss for the lender. Because unsecured loans aren’t backed by any collateral they can be seen as higher risk and therefore have higher interest rates.

How to use your new-found knowledge

Understanding these common financial terms makes you better equipped to make informed decisions about loans, credit and money management, leaving you free to take control of your finances once and for all.