Tax exemptions. Exchange-traded funds. Amortization.
When talking about finance, it’s easy to get lost in the lingo, especially since most of us never had a personal finance class in school.
That’s probably why a recent FINRA study found that two in three Americans can’t pass a financial literacy test.
If you’d like to join the conversation, you first have to master the language. Here are five terms you might be using wrong and what they actually mean in the world of finance.
1. Student loan refinancing and consolidation
What people think it means: People often use these terms interchangeably, but they don’t necessarily mean the same thing. It’s important to understand the difference so you make the right choice with your student debt.
What it actually means: Student loan refinancing refers to the process of taking out a new loan with a private lender, in the amount of some or all of your current student debt.
You’ll still owe the same amount of money after refinancing, but you might qualify for lower interest rates. Plus, you can choose new repayment terms.
Federal student loan consolidation, on the other hand, is the process of taking out a Direct Consolidation Loan from the Office of Student Aid. When you take out a consolidation loan, you merge your federal loans into one new one.
This process will simplify your monthly payments, and it could make you eligible for new repayment plans. But it leaves you with a similar interest rate — the average of your previous rates rounded up to the nearest one-eighth of a percent.
Student loan refinancing is usually best for people looking to lower their interest rate, while consolidating is more about simplifying your payments and extending the terms on your loans.
2. Interest rate, annual percentage rate, and annual percentage yield
What people think it means: Interest rates, annual percentage rate (APR), and annual percentage yield (APY) are a few other financial terms that people mix up. But these terms don’t share the same meaning.
What it actually means: All these terms indicate how interest accrues on your debt or adds on to your savings. But APR is a more comprehensive term than interest rate, and APY is the most comprehensive of all.
An account’s interest rate refers to how much interest adds up on your loan or savings account, and it’s expressed as a percentage of your balance. APR is also a percentage, but it includes both the interest rate and all the fees that accrue over the course of a year.
APY goes a step further by indicating how that interest compounds, whether on a daily, weekly, or monthly basis. Because APY takes compounding interest into account, it’s usually a higher number than APR and interest rate.
Although your account’s interest rate, APR, and APY might not differ much, it’s important to understand what you’re looking at so you can compare multiple offers on an apples-to-apples basis.
3. Credit score
What people think it means: The one number all lenders and creditors use to evaluate you.
What it actually means: Far from having one single credit score, all of us actually have several.
A number of companies assess credit scores, and each has a slightly different proprietary formula. One of the most trusted scores is the FICO score, but Vantage 3.0 is a popular model, too.
A single formula could produce three different scores, depending on whether it’s using information from TransUnion, Equifax, or Experian. And you can never tell exactly what score a lender will look at when you apply for a loan or mortgage.
Finally, different lenders use different types of scores to evaluate you. A car loan lender, for instance, might look at your FICO Auto Score, while a credit card company would likely consider your FICO Bankcard Score.
Since there are so many score types, it’s a good idea to track multiple credit scores, whether through a free service like Credit Karma or via your credit card accounts.
And don’t panic if one score is lower than another. They might never match up exactly, but by keeping up with debt payments and using credit responsibly, you can make sure all of your various credit scores go up.
4. Tax exemption, tax deduction, and tax credit
What people think it means: These terms get mixed up a lot, but they affect your taxes in different ways. Knowing what they mean will help you save the most money on your returns.
What it actually means: Tax exemptions and deductions reduce your amount of taxable income, while a tax credit actually lowers your tax bill.
Everyone can claim a personal exemption. For 2017, the amount is $4,050. Plus, you can claim exemptions for members in your household.
Deductions work similarly, but they’re often for more specific reasons. The standard deduction has to do with whether you’re single, married, or head of household. Itemized deductions let you reduce your taxable income if you spent money on mortgage interest, medical bills, or other qualifying expenses.
Tax credits, on the other hand, lower your tax bill for reasons such as paying college tuition or child adoption fees.
Tax credits are often your best option, since they reduce your taxes dollar for dollar. Exemptions and deductions, on the other hand, only adjust your taxable adjusted gross income (AGI).
By understanding the difference between exemptions, deductions, and credits, you can choose the best one for your situation and keep more cash in your pocket.
5. Financial advisor
What people think it means: You might think a financial advisor can help you with all things related to money, but most are a lot more specialized than that.
What it actually means: Not all financial advisors are created equal, and some are a lot more knowledgeable — and more legitimate — than others. One financial advisor might specialize in investment strategy, while another could help you with estate planning or insurance.
Before consulting a financial advisor, figure out exactly what kind of help you’re looking for. You should also make sure the financial planner is reputable, and not just charging you for advice you could easily find for free online.
The Certified Financial Planner Board is a great resource for finding a CFP-certified financial advisor who meets your needs.
Empower yourself with financial knowledge
Whether you’re paying off student loans or applying for your first mortgage, it’s easy to get overwhelmed with financial jargon.
By learning the true definitions of important terms, you can make smart decisions with your money. Your future finances will thank you later.
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