Financial Glossary
Common loan and finance terms explained in simple language.
APR (Annual Percentage Rate)
The yearly cost of a loan expressed as a percentage rate. APR includes the interest rate plus any fees or additional costs, giving you a more complete picture of the total borrowing cost.
Example: A loan with 5% interest and $200 in fees might have an APR of 5.5%.
APY (Annual Percentage Yield)
The real rate of return earned on savings or investments, taking into account the effect of compounding interest over one year.
Example: A savings account with 2% APR compounded monthly has an APY of about 2.02%.
Amortization
The process of paying off a loan through regular scheduled payments over time. Each payment covers both principal and interest, with the proportion changing over the loan term.
Example: A 30-year mortgage is amortized over 360 monthly payments.
Principal
The original amount of money borrowed in a loan, excluding interest and fees. As you make payments, the principal balance decreases.
Example: If you borrow $20,000 for a car, that $20,000 is your principal.
Interest
The cost of borrowing money, typically expressed as a percentage of the principal. Interest is what the lender charges you for the privilege of using their money.
Example: On a $10,000 loan at 6% interest for one year, you'll pay $600 in interest.
DTI (Debt-to-Income Ratio)
A percentage that compares your total monthly debt payments to your gross monthly income. Lenders use DTI to assess your ability to manage monthly payments and repay debts.
Example: If you earn $5,000/month and have $1,500 in debt payments, your DTI is 30%.
PMI (Private Mortgage Insurance)
Insurance that protects the lender if you default on your mortgage. PMI is typically required when your down payment is less than 20% of the home's purchase price.
Example: With a $5,000 down payment on a $200,000 home (2.5% down), you'll pay PMI until you reach 20% equity.
Origination Fee
An upfront fee charged by a lender for processing a new loan application. Typically expressed as a percentage of the total loan amount.
Example: A 2% origination fee on a $10,000 personal loan would be $200.
Down Payment
An initial upfront payment made when purchasing something with financing. A larger down payment reduces the amount you need to borrow.
Example: A 20% down payment on a $25,000 car would be $5,000.
Loan Term
The length of time you have to repay a loan. Common terms are 3, 5, 15, or 30 years, depending on the type of loan.
Example: A 60-month auto loan has a 5-year term.
Fixed Interest Rate
An interest rate that remains the same throughout the entire loan term, providing predictable monthly payments.
Example: A 30-year mortgage with a fixed 4% rate will have the same interest rate for all 30 years.
Variable Interest Rate
An interest rate that can change over time based on market conditions or an index rate. Monthly payments may go up or down.
Example: An adjustable-rate mortgage (ARM) might start at 3% but adjust annually based on market rates.
PITI (Principal, Interest, Taxes, Insurance)
The four components of a typical monthly mortgage payment: loan principal, loan interest, property taxes, and homeowners insurance.
Example: If your mortgage payment is $1,500, it might include $800 principal+interest, $400 taxes, and $300 insurance.
Equity
The portion of an asset that you truly own. For a home or car, it's the difference between the market value and what you still owe on any loans.
Example: If your home is worth $300,000 and you owe $200,000 on your mortgage, you have $100,000 in equity.
Refinancing
Replacing an existing loan with a new loan, typically to get a better interest rate, lower monthly payments, or change the loan term.
Example: Refinancing a mortgage from 6% to 4% could save thousands in interest over the life of the loan.
Escrow
A third-party account where funds are held temporarily. For mortgages, lenders often collect money for property taxes and insurance in an escrow account.
Example: Your lender collects $400/month for property taxes and holds it in escrow until the annual tax bill is due.
Prepayment Penalty
A fee charged by some lenders if you pay off your loan early. Not all loans have this penalty, so it's important to check your loan terms.
Example: Some mortgages charge 2% of the remaining balance if you refinance within the first 3 years.
Secured Loan
A loan backed by collateral (an asset the lender can take if you don't repay). Secured loans typically have lower interest rates.
Example: An auto loan is secured by the car itself. If you stop paying, the lender can repossess the vehicle.
Unsecured Loan
A loan not backed by collateral. Because they're riskier for lenders, unsecured loans typically have higher interest rates.
Example: Personal loans and credit cards are usually unsecured - there's no asset for the lender to claim if you default.
Credit Score
A numerical representation of your creditworthiness, typically ranging from 300 to 850. Higher scores indicate lower risk and can qualify you for better loan terms.
Example: A credit score of 750+ is considered excellent and typically qualifies for the lowest interest rates.