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Glossary of Credit Terms

Kimberly Griffiths -- What do all those terms on your monthly credit card statements mean?

When was the last time you read the volumes of paperwork you receive from your bank in regards to your credit card account?

The below list of terms isn't intended to be a complete list, but rather a compilation of research that was conducted when trying to understand my own financial accounts. If you have terms you would like to see, please let me know and I will add them! Additionally, this list of terms will be available on the One Paycheck at a Time Web site.

Adjusted Balance Method

A method occasionally used by banks to calculate the interest due on a credit card or other form of open-end credit. This method uses the billing period for the previous period. It then subtracts any payments made since the end of the period. For example, if your previous ending balance were $1,000 and you made payments of $400, your adjusted balance would be $600.

Annual Fee

A charge for services rendered similar to a membership fee. A fee that you pay a lender or credit card company for the privilege of credit. Annual fees generally apply to forms of open-end credit such as credit cards or home equity lines of credit.

Typical credit card annual fees are $0 to $100. If you continue to use credit cards, consider negotiating with your lender to waive this fee or seek another lender. It may be cheaper to pay an annual fee if the interest rate on your card is low enough.

Annual Percentage Rate (APR)

The yearly percentage rate of the finance charge. It is not unusual for credit card companies to change an interest rate especially if tied to other interest rates such as a prime rate or Treasury Bill rate. This is referred to as a variable rate. If an interest rate is locked in at a specific rate, it is referred to as a fixed-rate.

Billing Period

The number of days that a lender uses to calculate the interest you owe on a loan or credit card.

Calculating an Average Daily Balance

A method widely used by banks to calculate the interest due on a credit card or other form of open-end credit, such as a home equity line. To calculate, add your daily balances for each day in a billing period, which is usually 30 days. Divide by the number of days in the billing period.

The result is your average daily balance. The lender multiplies this by the periodic interest rate to calculate how much interest you owe for the month. For example, if your total of daily balances equals $30,000 for a 30-day period, your average daily balance is $1,000. If the periodic interest rate is 12% (1% monthly), your interest expense would be $10.

Cash Advance Fee

A fee charged by a credit card company for the privilege of drawing cash from your borrowing limit. Unlike a regular charge, cash advances begin incurring interest from the day you take the advance. The interest rate is often the maximum allowable rate.

Ceiling Rate

The maximum interest rate that a lender can charge you. This rate is usually automatically imposed if you become delinquent in your payments.

Compound Interest

Interest which is calculated not only on the initial principal but also the accumulated interest of prior periods.

Consolidation

Loan consolidation combines multiple loans with higher interest rates or larger payments into a single loan with a lower interest rate or payments.

Loan consolidation is similar to a refinancing but is usually done to reduce payments or the interest rate. Other reasons to consolidate include switching to a fixed-rate loan from a variable-rate loan or vice versa and changing the length of the loan term.

Credit Card

Any card that may be used repeatedly to buy products and services on credit which is typically issued by banks, retail stores, and other businesses.

Daily Balance

The amount you owe at the end of the day on a credit card or other form of open-end credit, such as a home equity line. The amount changes whenever you make a payment or use credit. Lenders calculate your interest based on an average of your daily balances over a billing period.

Finance Charge

The dollar amount you pay to use credit.

Fixed Rate

A loan in which the interest rate does not change during the entire term of the loan. For an individual taking out a loan when rates are low, a fixed rate loan would allow him or her to "lock in" the low rates and not be concerned with variable rate fluctuations.

Grace Period

A pre-determined specified length of time, typically 20-25 days, during which you can pay your credit card balance without paying a finance charge.

The additional period of time a lender provides for a borrower to make payment on a debt without penalty. Check with your card company to find out how long your grace period is, and whether it applies only if your balance is paid in full.

Interest

The fee charged by a lender to a borrower for the use of borrowed money, usually expressed as an annual percentage of the principal; the rate is dependent upon the time value of money, the credit risk of the borrower, and the inflation rate.

Introductory Rate

Rates offered for a temporary period and are used as a marketing tactic by creditors to generate new business. The length of time, or introductory period, that a teaser rate is available depends on the product.

For credit cards, it may be three to six billing periods or months. For auto loans, the teaser rate may apply for the entire loan term, depending on levels of dealer inventories.

"Over the Limit" Fee

Lenders also charge high fees on any charges that temporarily exceed the amount you are allowed to borrow. Like cash-advance fees, these are fees that you pay for the privilege of having access to credit that is more than your borrowing limit. These kinds of charges should be avoided, if at all possible.

Principal

The amount borrowed, or the part of the amount borrowed which remains unpaid (excluding interest). The part of a monthly payment that reduces the outstanding balance.

Periodic Interest Rate

The periodic interest rate is the fractional amount of an annual interest rate. It is used to calculate interest for a period shorter than a year.

For example, if you calculate interest on a 360-day year, you have 12 billing periods of 30 days each. If the annual interest rate is 8%, the periodic rate for one month is 0.67% (.08/12). The periodic interest rate for one day is 0.022% (assuming a 360-day year).

Secured Credit Card

A credit card linked to a savings account. The funds contained in the account may be claimed by the company issuing the card in the event that the holder fails to make the necessary payments. This arrangement allows the issuer to take on riskier credit card applicants.

Simple Interest

The interest calculated on a principal sum, not compounded on earned interest.

Variable Rate

Any interest rate of a loan that changes on a periodic basis. The change is usually tied to movement of an outside indicator, such as the prime interest rate.

Movement above or below certain levels is often prevented by a predetermined floor and ceiling for a given rate also called adjustable rate. For example, you might see a rate set at "prime plus 3%." This means that the rate on the loan will always be 3% higher than the prime rate. Prime rate changes regularly to take into account changes in the inflation rate.

Note: The content of this article is intended for educational purposes only and it should not be interpreted as financial advice. For advice that is specific to your circumstances, please consult your tax and financial advisor.

Kimberly Griffith is the author of One Paycheck At A Time, www.onepaycheckatatime.com, ISBN: 1591133327, a 200-page workbook, containing budget management exercises for an entire year of paychecks. The author has herself been through the vicious cycle of debt and provides a no-nonsense system to managing your money paycheck to paycheck. You customize the journal based on your pay schedule and learn the necessary tools for making ends meet.

© 2005 Kimberly A. Griffiths

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