GLOSSARY OF TERMS
Choose one of the categories below to narrow your choiceFinance, Banking, and Consumers
Annual Percentage Rate (APR)
The annual percentage rate of a loan basically tells you how much that loan would cost you in a year, even if it is paid off sooner or later. It's the percentage of the amount borrowed that you would pay in a year.
Here is a simple example... If you borrow $100 with 5-percent interest and the loan is for a year, your APR would be 5 percent. However, if you borrow the same $100 with the same 5-percent interest, but it's due in one month, the APR would be 60 percent (5 percent times 12, because it would cost you $5 for the same $100 every month).
Similarly, if a credit card has a monthly interest rate of 1.5 percent, the APR actually would be 18 percent, because you would be paying 1.5 percent each month for 12 months (1.5 x 12 = 18).
APR is useful in comparing loans because you're comparing how much each loan would cost over the same period of time.
Other common situations make the calculation more complicated. What's important for the purposes of our discussions is the basic understanding provided above.
In financial transactions, the basis is the amount you paid for something that you're now selling.
If you sell an investment such as stock or real estate, your tax liability is determined by your profit (how much you sold it for minus the basis).
A way of lending money.
They way a bond typically works is you lend a set amount of money to the borrower. You then receive regular interest payments at the bond's interest rate.
After some time, the bond matures, at which time your initial investment is returned.
Bonds often are bought and sold by financial institutions based on whether they believe they can get a better return from some other type of investment.
Bonds carry a risk that the borrower will default - by not being able make the regular interest payments or pay the amount of the bond when it comes due. Typically higher-risk bonds pay higher interest rates.
Bonds that are rated high (very likely to pay its lenders) are referred to as investment-grade bonds. They typically offer a low interest rate.
Bonds considered likely to default offer a high interest rate in exchange for the added risk. They are referred to as high-yield, low-grade, or junk bonds.
For more on junk bonds, read the Investopedia description.
Income you make by investing money (as opposed to earning a salary for your labor).Referenced by...
A tool that lets you prevent potential creditors from viewing your credit report.
This is useful in preventing identity theft, because the thief will not be able to open a new account in your name.
Freezing your credit must be done individually with each credit reporting agency.
If you later apply for credit, you first would need to unfreeze your credit at each credit reporting agency. This often must be done at least a few days ahead of time. You then would need to refreeze your credit (again at each agency) if you want the continued protection.
Depending on the state you live in, credit reporting agencies can charge a small fee to both freeze and unfreeze your credit.
For more, see the Federal Trade Commission primer.Referenced by...
Your credit report and score estimate the risk of lending you money.
Your credit report contains a list of your accounts (such as credit cards and loans), including information such as your credit limit, your outstanding balance, and your payment history.
Your credit score is a number that is calculated based on the information in your report. It often is referred to as a FICO score - an acronym for Fair Isaac Company - the company that developed the algorithms that calculate your score for the agencies.
The higher your score the more a bank is likely to lend you, and the lower your interest rate may be. But it can be used in other ways. An apartment might charge a higher security deposit if your credit score is low. It might affect whether you are offered a job.
You have three credit scores - one from each of the main credit reporting agencies. You're entitled to a free copy of your credit report from each of the three agencies. To find out how, visit our Resources page.
Credit Reporting Agencies
Companies that monitor your credit history - including accounts you hold and your payment record. The three main companies that perform this function are...
If you fail to make payments on a loan or credit card, for example, the bank may report the delinquency to any of these agencies.
The information is used by companies you want to conduct certain types of business with, such as applying for a loan or credit card, renting an apartment, buying a cell phone under a contract, or even applying for a job.
Something that is offered for sale at a price significantly below value because the owner needs to sell it quickly.
The Dodd-Frank Wall Street Reform and Consumer Protection Act is a 2010 law intended to prevent a recurrence of the financial crisis that hit the nation in 2008.
Click here to read our explanation of the bill.
When you take out a loan to buy something expensive such as a car or a house, you often will pay a small portion of the price up front, and then borrow the remainder.
The money you pay up front is what's called the down payment.
2016 regulation from the Department of Labor (DOL) that requires financial planners recommending investments for retirement accounts to provide advice in your best interest, rather than theirs.
For example, while an advisor is required to recommend investments suitable to your goals, he can suggest an investment that will earn him a higher fee - rather than one that would provide you with the best return. This rule prevents that.
It also is known as the Conflict of Interest Rule.
Click here to read the White House fact sheet for the rule.Referenced by...
Insurance to cover a gap in values.
For example, a new car is worth less immediately after you take ownership. If you finance your car and crash it soon after buying it, your insurance might not pay enough to cover the entire loan - leaving you responsible for the difference. Gap insurance covers that difference.
Gap insurance can be relatively inexpensive when purchased through your auto insurance company. However, a car dealer may offer it to you directly - at potentially more than 10 times the amount an insurance company would charge.
A law that prohibited commercial banks from investment activities and set up the Federal Deposit Insurance Corporation (FDIC) to guarantee bank deposits.
The law?s strict separation of commercial and investment banks was eliminated by the Gramm-Leach-Bliley Act of 1999.
Investment designed to make money regardless of whether the stock market rises or falls.
Hedge funds are made available to only wealthy investors. As a consequence, they are the least regulated by the Securities and Exchange Commission (SEC), under the presumption that these investors can handle the potential risks.
For more about hedge funds, read the Investopedia report.Referenced by...
Indexing to Inflation
Allowing an investor to pay less tax on the profit of an investment, by allowing the basis (the amount you bought it for) to be increased to account for inflation.
How it works
Normally, when you sell a stock, you pay taxes on your profit - the amount you sold it for minus the basis. If you sold a stock for $150 that you had bought for $100, you would be taxed on the $50 profit.
With indexing to inflation, the basis becomes what you would have paid in today's dollars after accounting for inflation. So if you sold the same stock for $150 that you bought for the same same $100, but there had been 10 percent inflation over the time you owned it, you could claim a basis of $110, and you would be taxed on only $40.
A lender that does not deal directly with the borrower when creating the loan.
For example, if you buy a car and the dealer processes the loan, the bank supplying the money (and that you make your payments to), is considered an indirect lender - because it dealt with the dealer rather than with you.
The primary cost of a loan.
In the simplest example, if you borrow $100 with a 5-percent interest rate, the cost of the loan would be $5 (you would pay back a total of $105).
Mortgage Backed Security
When an investment bank or Government Sponsored Enterprise buys a bundle of mortgages from a lender, they in turn sell shares of those mortgages to investors. These investments are backed by the value of the property the mortgages are for. They therefore are called mortgage backed securities.
Theoretically, they are safe investments because they are made up of many mortgages. If only a few borrowers defaulted, there still would be enough pay investors their profit.
A few things happened however, that contributed to 2006 mortgage crisis (this is not the complete story, but we're presenting a small slice of it here to help understand mortgage backed securities)...
A company whose income is reported on the owner's individual income tax return.
In other words, the income is passed through from the company to the owner.
A short-term loan typically used to cover a temporary need - such as an emergency car repair or a smaller than usual paycheck due to an irregular work schedule.
Payday loans also are referred to as cash advance loans, deferred deposit, and deferred presentment loans - depending on the laws in a particular state.
For a more in-depth explanation of payday loans, read our discussion of this issueReferenced by...
A plastic card that allows you to buy things without using cash. There are a few basic types of these cards. Transactions with them appear to work the same, but the ways they process your money differ.
In recent years, cashless purchases do not necessarily require an actual card. You can, for example, pay for something with a credit card linked to your mobile phone. You simply hold the phone over an electronic reader, and the transaction is processed as if you had used a physical credit card.Referenced by...
Lending practices that exploit borrowers, including....
When a merchant tries to influence a purchaser to use a credit card that charges the merchant a lower swipe fee.
Credit card companies may include anti-steering provisions in contracts with merchants - preventing the merchant from attempting to steer customers away from their card.
A type of loan offered to someone who might be considered too much of a risk for a traditional loan - whether due to a low credit score, low income, or other factors.
Because of the added risk, subprime loans are provided at a higher interest rate than traditional loans.
For more about subprime loans, read the Investopedia story.
The fees a merchant pays to a credit card company when you pay for something using a card.
Swipe fees are passed onto consumers. It's usually in the form of higher prices for everyone, because paying with a credit card rarely costs more than paying any other way. They cost the average household $400 a year in higher prices.
That hurts lower-income families more than higher-income ones. Because lower-income families pay more often using cash, they don't receive rebates and other benefits cards offer, yet they they still pay the added costs.
Too Big To Fail
A term used to describe a financial institution or other business so large that if it fails, the effect to the economy could disastrous for many people outside the actual institution.
For example, a failure of a very large bank could result in people not being able to access their money.
The government works to both prevent these failures from happening, and to provide assistance if they do happen.
For more, read the Investopedia article.Referenced by...
Laws that govern the amount of interest that can be charged on a loan. Usury laws are enacted to protect consumers by preventing a bank from charging excessively high interest rates.
A federal regulation, part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, that prohibits banks from engaging in certain speculative investments.
For more, read the Investopedia explanation.Referenced by...