Ignorance might be bliss, but it can cost you big if you're in the dark about your hard-earned dollars. The current financial crisis is a good reason to get a basic understanding of common financial terms, says investment coach Deborah Owens, author of A Purse of Your Own: An Easy Guide to Financial Security. Here's a cheat sheet to help you walk the talk.
1. Credit utilization
The proportion of your credit limit that you've actually borrowed. This accounts for about 30 percent of your credit score, says Barry Paperno, consumer operations manager at FICO, formerly Fair Isaac Corp., the company that developed the much-used FICO credit score.
In terms of impact on your score, Paperno says, it's the percentage you should focus on — not the dollar amount of debt. For instance, if you owe $100 on a $500 limit, you are 20 percent utilized. If you owe $1,000 on a $5,000 limit, you're still 20 percent utilized. "There's no difference in terms of the score, even though you owe $900 more on the other," explains Paperno.
2. Accrued interest
The amount of money that you are owed, or owe, since the last time an interest payment was made or received. Suppose you have an investment that pays interest twice a year, and you need to sell it before the next interest payment will be made. You'll want to collect your prorated share of the interest when you sell it — that's the accrued interest, says Justin Krane, a Los Angeles-based financial life planner.
3. Subprime borrower
A borrower whom a lender considers to be a high risk. According to Denise Winston, a financial lifestyle expert at the website Money Start Here, when you apply for a loan, the lender uses underwriting guidelines to approve or decline your request and determine terms such as interest rate and duration of the loan. Many factors can put a borrower in a subprime category: low credit rating (generally a credit score below 640), low net worth, high debt-to-income ratio, and unverifiable or irregular income.
Subprime classification can have a big impact on your financial health. If your interest rate is bumped up by just 0.25 percent on a mortgage of $250,000, that will cost you more than $14,000 extra over the life of the loan. It could also affect whether you get a job, because some employers do a background check on job applicants that includes looking at your credit rating.
4. Charge off
When a lender officially gives up on a debt and counts it as money lost. Ken Clark, author of The Complete Idiot's Guide to Boosting Your Financial IQ, warns that "the biggest misconception is that the debt is forgiven or forgotten about," says Clark. "It's not." The loan is likely to be sold to a collection agency that "will pay pennies on the dollar for the right to hound you."
Few things will damage your credit score like a charge off, says Clark, so if you're in trouble on a loan, do everything you can to work with your creditor to keep paying, perhaps on new terms.
5. Short sale
When a home is sold for less than the amount owed on it. A short sale can happen if the owner is unable to keep up the payments, says Winston. "This process must be approved by your lender and is often an alternative to foreclosure." A short sale is a long, intensive, complex business transaction and can be very stressful, Winston adds.
6. Negative amortization
When your loan balance grows because your payments are too low to cover even all of the interest due. Negative amortization (neg-am for short) is also known as "deferred interest," says Paul Havemann, vice president of HSH.com, a financial publishing company. "If you have a loan with negative amortization, it means that with every payment your loan balance is growing, not shrinking."
Havemann cautions that if you engage in negative amortization, you've got to plan for larger outlays down the road. "That deferred interest must be paid eventually, so be ready for it," he says. During the housing crisis, too many people weren't and got caught on a financial treadmill.