Sunday, July 3, 2022

Banking jargon explained

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Adetunji Matthew
Adetunji Matthewhttp://www.aidthestudent.com
I’m Adetunji Matthew, an Economist, Social Media Manager, software Developer/Marketer Sales Consultant, and Ecompreneur. I’m popularly known as “Matt” As an artist and designer, I aim to create something brilliant daily. Eager to learn more, I use my free time to get better at w hat interests me, whether it's researching, teaching, or even something entirely new.
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If you’ve spent any time at a bank or on bank websites, you’ll notice they throw around a lot of words that they expect you to understand. But well, you just don’t. With more technical terms than a physics textbook, the world of banking can be difficult to navigate. Here we break down some common words used in banking that will be helpful for you to know. Use this guide to brush up on your financial vocab and be fazed no more.

Basic financial terms explained

Before we dive into the really meaty stuff, let’s check that we know what the basic banking terms mean. We’ll be using some of these later on to describe the more complicated phrases, so it’s worth making sure that you’ve got a good grounding.

BANK. This is the place where people store their money to keep it safe. A bank can also lend money to help you pay for school, or to buy things like a car or house.

BANK ACCOUNT is where your money is held. The bank stores your money, and allows you to keep track of your account activity, or ‘transactions’.

TRANSACTION happens when you put money in your account (deposit) or take money out (withdrawal). Paying a bill or transferring money is also considered a transaction.

An ACCOUNT BALANCE is the amount of money in your bank account at any given time.

SAVING means setting aside the money you have instead of spending it right away. Usually people save their money for big purchases or events – like college or university, a house, a big trip, a car, etc. Typically, you will put your money in a savings account or investments until you have enough to buy what you want.

What is a current account?

A current account is a one-stop-shop for managing your day-to-day finances. Most people will just refer to it as their bank account, and it’s usually where your Maintenance Loan or salary will go.

As a student, you’ll most likely have a student account (and a graduate account once you’ve left uni), but these are just different types of current account.

Read: Current Account Vs. Savings Account: Which is right for you?

INTEREST. There are two types of interest that you should be aware of. The first type is the interest that a bank pays you for keeping your money with them. Because interest is paid as a percentage of your bank balance, the more you have in your account, the more interest you get paid. The second type of interest is what the bank charges you for borrowing money.

BUDGET. This is something that can help you keep track of money that’s coming in and the money that’s going out. A budget can help you identify what money you have available to save, spend and give.

DEPOSIT is the money you put into your bank account. Your account balance goes up when you make a deposit.

WITHDRAWAL is when you take money out of your bank account. Your account balance goes down when you make a withdrawal.

An overdraft is like a buffer attached to your current account, giving you some money just in case you ever use up all of your own.

You may be charged a fee or interest (or both) by your bank for entering your overdraft. It’s therefore important that you keep on top of your finances and don’t go too far into your overdraft.

Student bank accounts often come with an interest-free overdraft, which (as the name suggests) allows you to use a certain amount of your overdraft without paying interest. The overdraft may also be fee-free, meaning you won’t be charged for using it.

The final key aspect of overdrafts is that they can be split into two sections:

  • Planned overdrafts – These are also known as arranged overdrafts, and they refer to ones that you’ve agreed with your bank. When confirming this with them, you’ll also agree on any interest rates or fees attached to your planned overdraft.
  • Unplanned overdrafts – Unplanned, or unarranged, overdrafts come into play when you exceed your planned overdraft allowance. At this point you’re likely to be charged much higher interest rates and fees, so avoid it if possible!

An AUTOMATED TELLER MACHINE (ATM) is a self-service machine where you can take care of your basic banking transactions. For example, you can deposit a cheque, pay a bill, transfer money from one account to another, or withdraw cash. You use your Client Card and PIN to access your account and make whatever transactions you need.

PIN (or Personal Identification Number) is the special passcode you use whenever you want to use your bank card or otherwise access your bank account (like at the branch). To keep your money safe, it’s important to keep your PIN private – don’t share it with anyone!

CLIENT CARD is also known as your bank card, and you get it when you open a bank account. It lets you access your accounts while in a branch, at an ATM or a store, or through online banking. Most of the time, you use it alongside your PIN or RBC Online Banking password.

CREDIT CARD is a card that gives you access to a certain amount of money, known as a credit limit. When you use a credit card, the money doesn’t come out of your account right away. Rather, you have to pay off the credit card balance by a certain due date. If you don’t, you’ll get charged interest, which is a percentage of the amount you owe.

DEBIT happens anytime money comes out of your account. For example, if you send someone an e-Transfer, or if your cell phone bill comes out of your account each month, that transaction will show up as a debit.

What’s the difference between credit and debit cards?

credit card is essentially an agreed way of borrowing money on a consistent basis. That’s not to say you don’t have your own money to spend – it just means that you’re delaying the point at which you’re using your money.

Sadly you will have to pay back the money you’ve spent on a credit card, with interest often added on too.

If you ever want to get rid of a credit card, you can cancel them fairly easily. But remember, you’ll need to pay off any outstanding debt on the card before you’re completely shot of it!

debit card is a card that gives you access to the money in your current account. When you use a debit card, you’re either spending your money or dipping into your overdraft.

CREDIT happens anytime money goes into your account. So if someone sends you an e-Transfer, or you deposit a cheque from your grandmother, that will show up as a credit.

Credit is a phrase that’s used in conjunction with lots of other words (like credit card or credit rating), but it can be used by itself in one of two ways:

  • To be ‘in credit’ means that you have more than £0 in a given account. You’ll see this on your current account if you’re not overdrawn, or on a bill if you’ve accidentally overpaid (meaning that your account with that company is in credit, because it has more money in it than needed).
  • To ‘have credit’ means that you’ve borrowed money from a lender.

VIRTUL VISA DEBIT is a card used for online purchases when you don’t have a credit card. Purchases made with your virtual visa debit are taken from your chequing account.

More complex financial terms explained

Right, we’ve covered the basics. Now let’s look at some slightly more complex terms.

What is a Direct Debit?

If you’ve ever been responsible for paying for your own phone contract, you’ll have probably paid via Direct Debit. In fact, most regular bills can be paid for in this way.

Setting up a Direct Debit means that you’ve told your bank to pay money to a certain organisation on a regular basis (often a specific day each month). The amount may be the same each time, but it can change when appropriate (we’ve all had to pay the price for exceeding our data allowance).

Direct Debits are controlled by the organisation that you’re paying the money to. They set it up, and they control how much and how often you pay them. This is just one of the many reasons to regularly check your bank statement, just to make sure you’ve not been over-charged.

Although Direct Debits are controlled by the organisation being paid, you can cancel them at any time – but don’t expect the company to keep providing a service if you stop giving them money.

Collateral

This is typically a tangible asset used to secure a bank loan. If you fail to make payments on the amount you borrowed or accrued interest, the bank may be able to seize and sell the property used as collateral. An example of collateral would include land, house, car, stock and business machines.

Working capital

It is more like an accounting term, but the bank usually ask business borrowers to confirm their working capital need. It is used to describe the amount, by which the business current assets exceed its current liabilities. Some people describe it as the funds the firm has available to run its day-to-day business operations. Working capital can be well managed if one understands the working capital conversion cycle.

Working Capital conversion cycle

It described the dynamics of short-term cash flows that occur during the normal operations of a business. The working capital conversion cycle is the circular process starting with purchase of inventories on credit, then to sell those inventories in cash or credit and finally to carry the resulting accounts receivable that are the proceeds of the inventory. When the receivables are paid, the firm can then use the proceeds to either repay the debts or to start the cycle all over again by purchasing new inventories. It is desirable to keep the cycle as short as possible as it increases the effectiveness of working capital.

Money laundering

This is when money gained from a crime is put into a bank or any other legal business activities so that it can be accessed safely by the criminals and terrorists. It makes the proceeds of illegal activities easier to get to.

Standing order

A regular fixed payment made out of one account to another account or beneficiary. Standing order has helped many people to transfer funds from their current account to saving account as soon as they receive salary. It can also be used by business to make payment into an escrow account when their main account reaches certain limit.

Available bank balance

The amount of money in your account that is available for immediate use. If the account has no uncleared cheque or blocked fund, then the available balance should be the same as the total or book balance.

Book balance

The book balance is the term banks use to describe the amount of money in the account before any adjustments for cheques that have not yet been cleared. It is sometimes called the ledger balance.

When other bank’s cheque is deposited in a bank, it does not get available immediately. It takes about two to three business days in some countries.

Time or fixed deposit

An agreement to deposit a stated amount in the bank for a fixed length of time during which a fixed rate of interest will be paid (unless disclosed as a variable rate). Penalties are typically levied on the interest if the funds are withdrawn before the end of the agreed-upon period.

Inactive account

Sometimes called dormant account, it is an account in which there have not been any transactions for an extended period of time (does not include bank own entries).

Debit card

A plastic card that deducts money from the designated bank account to pay for goods or services. A debit card can also be used at ATMs to withdraw cash.

Cost of funds

The interest rate paid by financial institutions for the funds that they deploy in their business. The cost of funds is one of the most important input costs for a financial institution, since a lower cost will generate better returns when the funds are deployed in the form of short-term and long-term loans to borrowers. The spread between the cost of funds and the interest rate charged to borrowers represents one of the main sources of profit for most financial institutions.

Cash reserve

Bank reserves are the currency deposits which are not lent out to the bank’s clients. A small fraction of the total deposits is held internally by the bank or deposited with the central bank. Minimum reserve requirements are established by central banks in order to ensure that the financial institutions will be able to provide clients with cash upon request.

The main purpose of holding reserves is to avoid bank runs and generally appear solvent. Central banks place these restrictions on banks, because the banks can earn a much larger return on their capital by lending out money to clients rather than holding cash in their vaults or depositing it with other institutions.

What is a standing order?

Standing orders are very similar to Direct Debits, but with a couple of key differences. Firstly, unlike Direct Debits (which are controlled by the recipient), a standing order is controlled by you. You set it up, and you control how much and how regularly the payments are made.

The other important difference is that a standing order will always be for the same amount of money. You can elect to change the amount, but this will be a permanent change – if you want to transfer a different figure each month, a standing order probably isn’t for you.

Rent payments are a perfect example of when a standing order should be used. Rent is usually paid in equal instalments every week or month, and usually on the same day.

By setting up a standing order, you can make sure that your rent gets paid without having to remember to do it (although you will have to make sure there is enough money in your account!).

What is a guarantor?

When you borrow money from a lender, or sign a contract to make regular payments (like when you agree to rent a property), you’ll usually be asked to provide a guarantor.

A guarantor is essentially your safety net. They are expected to make payments for you when you can’t, so they will need to be financially secure themselves – or at the very least, have a good credit score.

Try to think of a guarantor as a kind of insurance: hopefully you’ll never need them, but everyone’s happier knowing that they’re there just in case.

What is an ISA?

Acronyms are everywhere in finance, and this is one of the biggies. An ISA (Individual Savings Account) is a savings account that allows you to store money without having to pay tax on the interest gained.

The tax-free nature of ISAs is why they were historically a very popular way to save larger sums of money. However, in 2016 the law changed to allow a significant proportion of the population to save money in a normal savings account without paying tax on the interest.

The most complicated financial terms explained

Ok, we’ll admit it – these aren’t the most complicated financial terms out there. But they are the most complicated ones that you’ll need to worry about as a student.

Before we start, just as a warning, we’ll be looking at AERAPR and EAR. These all look pretty similar – they’re all acronyms, and they’ve all got an A and an R in them.

What’s more, they are pretty similar. But they do refer to different things, so it’s worth getting your head around what they mean.

Right, if you think you’re ready, let’s delve into these bad boys.

What are fixed and variable interest rates?

When you borrow or save money, you’ll be told whether or not it’s subject to a fixed- or variable-rate interest. Here’s a quick overview of what these terms mean:

  • Fixed-rate interest – These rates don’t change for the duration of the agreement, be that the repayment period or the time in which you keep your money in a savings account.
  • Variable-rate interest – This means that the interest rate can (and probably will) change over time, often in line with measures of inflation, like RPI (Retail Price Index).

What is RPI?

RPI stands for Retail Price Index, and is a measure of inflation. Ultimately, it tracks changes in the price of a set ‘basket’ of items that consumers regularly buy.

Some things, like milk and bread, will always in the ‘basket’, whereas other things, like gin, will come and go based on popularity. Over time, the changes in the prices of the items in the ‘basket’ are used to determine the rate at which inflation is occurring.

Ordinarily, you wouldn’t need to worry too much about RPI – but as we said above, your Student Loan accumulates interest at a rate that can be influenced by RPI.

What is AER?

AER stands for Annual Equivalent Rate – the official rate of interest for a savings account. This represents how much interest would be paid over the course of a year, and allows an easy comparison between multiple accounts (particularly as different accounts may pay interest at varying intervals).

Interest on a savings account may also be advertised as a gross rate. The specific differences between gross and AER aren’t really worth understanding, but the gist is that AER takes into account compound interest, whereas gross doesn’t.

When the interest on an account is paid annually, the gross rate and AER should be the same, because there’s no compound interest. If the interest is paid monthly, AER will be slightly higher than the gross rate as it accounts for the interest gained on the existing interest (e.g. 5% gained on the initial amount, plus 5% on the 5% that was gained last month).

The only thing you need to remember is that you should never compare AER with gross rates. AER and gross rates are different things, so you should only ever compare AER with AER, and gross with gross.

What is APR?

APR stands for Annual Percentage Rate. This refers to the official rate at which you’ve borrowed money including any associated fees, essentially giving a complete picture of how much the debt will cost.

It’s important to remember that APR does not necessarily equal the interest rate, as it also includes fees. For example, if you borrowed money at 11% APR you could have an interest rate of 9%, plus additional charges which are the equivalent of an extra 2%.

This seems complicated, but it allows a fair comparison between lenders (otherwise they could advertise a low-interest rate, but chuck loads of additional fees on top to make it more expensive than another loan with higher interest rates).What is representative APR?

You’ve probably heard ‘representative APR’ being blurted out at high speed by the voiceover on an advert for loans. This is just a guide based on the fact that at least 51% of successful applicants will get the advertised rate, while the other (at most) 49% of people could get a higher rate.

Another important APR caveat is that you might never pay the advertised APR.

Lenders will often try to entice you by offering a lower APR for a certain amount of time at the beginning of the repayment period (let’s call this APR1). After this (usually very short) time has passed, the APR will increase (to what we’ll call APR2) for the remainder of your repayments.

Note that APR2 could be a variable rate and may change at some point (although banks can’t just do this willy nilly, so try not to worry about this for now).

As you’ll have two different types of APR throughout your borrowing period, the lender will advertise what is essentially an average figure for what the APR will be until you’ve paid the money back. Since you’re likely to have APR1 for a much shorter time than APR2, the average APR will be much closer to APR2.

In simple terms, the advertised APR can sometimes just be the average APR, with the majority of your repayment period being at a slightly higher rate. Again, while this seems complicated, it does make it easier to calculate and compare the overall cost of borrowing!

What is EAR?

Last but not least, we have EAR – Effective Annual Rate.

EAR is actually very similar to APR, but while APR is only used to refer to products that exclusively lend money (such as a loan or a mortgage), EAR applies when you’re talking about a product that can also be in credit (such as a current account).

You’re most likely to see EAR being used to describe the interest on an overdraft. EAR is calculated using three factors: the interest charged if you’re overdrawn, how often interest is charged, and what the effect of compound interest is on your debt.

Again, if you dive too deep into this you can get lost. All you really need to remember about EAR is what it refers to, what it’s formed of, and that it doesn’t include overdraft fees.

Keen to learn more about your finances? Have a read of our Tips for saving money at university.

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