Unit 3, Part 1: Personal Saving and Borrowing

20 terms. Say what each one means, then open the card to check.

• Opportunity cost

  The value of the next-best choice you give up when you decide how to use your money or time.

  Example. Iris puts 300 dollars into savings instead of buying a fictional concert ticket she also wanted, so the concert is the opportunity cost of saving.

• Emergency fund

  Money set aside in an easy-to-reach account to pay for surprise costs, such as a car repair or a lost job, without borrowing. A common guide is three to six months of essential expenses.

  Example. Marco’s essential costs are 1,500 dollars a month, so he aims to keep 4,500 to 9,000 dollars in a savings account he can reach quickly.

• Pay yourself first

  A habit of moving a set amount into savings as soon as you are paid, before spending on anything else, often by an automatic transfer.

  Example. On each payday, 80 dollars moves from Dana’s checking account to her savings account automatically, before she pays any bills.

• Simple interest

  Interest paid only on the original amount, the principal: interest = principal x rate x time. It is the same each year.

  Example. A fictional bond pays 5 percent simple interest on 1,000 dollars, so it pays 50 dollars every year.

• Compound interest

  Interest paid on the principal and on interest already earned, so the balance grows faster each period: balance = principal x (1 + rate) to the power of the number of periods.

  Example. 1,000 dollars at 5 percent compounded yearly grows to 1,050 dollars after one year and 1,102.50 dollars after two.

• Annual percentage yield (APY)

  The yearly return on a deposit once compounding is counted. Compounding more often makes the APY a little higher than the stated rate.

  Example. A fictional account with a 3.6 percent stated rate compounded monthly has an APY of about 3.66 percent.

• Inflation

  A general rise in prices over time, which means each dollar buys less. Savings lose buying power when their interest rate is below the inflation rate.

  Example. If a fictional savings account pays 1 percent while prices rise 3 percent, the money buys about 2 percent less after a year.

• Liquidity

  How quickly and easily an asset can be turned into cash without losing value. Cash and checking accounts are the most liquid.

  Example. Money in a checking account can be spent today, while a fictional house would take months to sell, so the checking account is far more liquid.

• Certificate of deposit (CD)

  A bank deposit that pays a fixed rate for a set term, such as one or two years. Taking the money out early usually costs a penalty.

  Example. A fictional bank pays 4.5 percent on a two-year CD, but withdrawing early costs three months of interest.

• Deposit insurance

  Government-backed protection for bank and credit union deposits: in the U.S., up to 250,000 dollars per depositor, per insured bank, for each ownership category. It does not cover stocks or mutual funds.

  Example. If an insured bank fails, a person with 40,000 dollars in its savings account gets all of it back, because it is under the limit.

• Annual percentage rate (APR)

  The yearly cost of borrowing as a percentage of the amount borrowed. On many loans it also counts certain fees; on a credit card it is usually just the interest rate, and fees are separate.

  Example. A fictional card with a 24 percent APR charges about 2 percent of the balance each month in interest.

• Revolving credit

  Credit you can use, repay and use again up to a limit, such as a credit card. The balance and payment can change each month.

  Example. Lena has a fictional card with a 2,000 dollar limit; she spends 500, pays it off, and can then spend up to 2,000 again.

• Installment loan

  A loan for a fixed amount that is repaid in equal payments over a set term, such as a car loan, mortgage or student loan.

  Example. Theo borrows 9,000 dollars for a fictional used truck and repays it in 48 equal monthly payments.

• Grace period

  On a credit card, the time between the end of a billing cycle and the due date. On many cards, paying the full statement balance by the due date means no interest on new purchases.

  Example. Ana pays her 300 dollar statement balance in full by the due date every month, so she never pays interest on her purchases.

• Credit report

  A record of how a person has used credit: accounts, balances, payment history, inquiries and items such as bankruptcies. Consumers can get free reports from each of the three nationwide credit bureaus.

  Example. Before applying for an apartment, Kai downloads his free reports and finds a card he never opened, which he disputes.

• Credit score

  A number, such as a base FICO Score from 300 to 850, that sums up the credit report to predict how likely a person is to repay. Payment history and amounts owed count most.

  Example. Two fictional applicants want the same loan; the one with the higher score is offered a lower interest rate.

• Credit utilization

  The share of available revolving credit a person is using: total card balances divided by total credit limits. A lower share generally helps a credit score.

  Example. Jo owes 600 dollars on cards with limits that add up to 3,000 dollars, so her utilization is 20 percent.

• Cosigner

  A person who signs a loan with the borrower and agrees to repay it if the borrower does not. The loan also appears on the cosigner’s credit report.

  Example. Because Leo has no credit history, his aunt cosigns his fictional car loan, and she must pay if he misses payments.

• Debt-to-income ratio

  Monthly debt payments divided by gross monthly income. Lenders use it to judge whether a borrower can afford another loan.

  Example. Sam earns 4,000 dollars a month before taxes and pays 600 dollars a month on loans, a debt-to-income ratio of 15 percent.

• Debt avalanche and snowball

  Two ways to pay down several debts: the avalanche puts extra money on the highest-interest debt first, which saves the most interest; the snowball pays off the smallest balance first for quick wins.

  Example. With a 24 percent card and a 7 percent loan, the avalanche puts extra money on the card first.