What do you mean when you say “personal finance terms in plain English”?
Aren’t terms like derivative, fiduciary, and depreciation plain English??
Uuummmm, yes and no. These terms are plain English for those working in the financial space-it’s their lingo-but for the many people who do not work in the financial space, these terms can seem like a foreign language!
In my honest opinion, people use financial terms to purposely confuse folks. I really believe that financial terms can be broken down so that anyone can understand them if that is what an advisor wants to do… If people are confused, then they are easy prey and can be taken advantage of.
I signed up for my first retirement account when I was 22-years-old. Did I know what I was doing? No.
Did the personal finance language sound like a foreign language? Yes.
But here is the one thing that I did know. I knew that I wanted to have some money when I was old. That’s it. That’s all I knew. And here in front of me was a person telling me that it was possible.
I signed up for that retirement account and actually read the statements when they came. I did not understand all of them, but as time went on, I understood more and more.
So, in this blog post, I want to clearly spell out some personal finance terms that you may come across. When you seek financial advice or do your own research, you will be able to better understand that advice.
Definitions are taken from the book Personal Finance by E. Thomas Garman and Raymond E. Forgue.
1. PITI. The term PITI stands for principal, interest, taxes, and insurance; it is the elements of a monthly real estate payment. It is a term you will hear when dealing with homeownership.
This term can be confusing because online calculators and loan officers may only discuss the first part of the term–principal and interest.
The second part of the term stands for taxes and insurance. These two items are the part of your payment that normally has to go into an escrow account (next definition).
In order for you to get an accurate picture of how your new mortgage payment will fit into your monthly budget, you will have to account for all four elements of your mortgage payment.
In a sentence: “Your new mortgage payment will be $1,254.34, which is your principal payment, your interest, county taxes, and your homeowner’s insurance”.
2. Escrow. An escrow is a special reserve account normally held at a financial institution, such as a bank, where money is kept until it is paid out to a third party; the money is usually for home insurance and property taxes.
Plainly–this money is the part of your mortgage payment that the lender will require you to keep “in escrow”.
From my understanding, some lenders may allow you to forgo escrow, but it is rare. I know that when I would look at my mortgage account online, I would see my escrow money go out twice a year to pay my homeowner’s insurance and my property taxes.
Although paying your escrow is supposed to be the responsibility of the lender that holds the money for that, there have been cases where lenders have not done the right thing.
If you ever get a bill from your home insurance company or your county tax office, please look into it!! Make sure that your taxes and insurance are actually being paid!
In a sentence: “Will your bank require me to keep my home’s taxes and insurance money in escrow”?
3. Debt-to-income ratio. This is a formula that lenders use to compare the amount you spend on debt repayments to your gross income (income before taxes are deducted).
It is used to see if you are a good credit risk or not. The recommended amount is no more than 36% of your gross income should be spent on your debt repayments.
This means that if your gross annual income is $50,000, your debt limit should be no more than $18,000 (multiply 50,000 x .36).
If you are trying to buy a home, you might be able to go as high as 43% of your income to pay back debt. If you are over 36%, just pay off some of your debt, so that you can go below that number.
In a sentence: “Our debt-to-income ratio was too high for us to qualify for a home mortgage”.
4. Foreclosure/repossession. A foreclosure is a specific legal process where a lender attempts to recover the balance of a loan from a borrower who has stopped making payments to the lender. The lender does this by forcing the sale of whatever was used as collateral. An example of collateral may be your car or home.
If you took out either a home loan or a car loan and stopped making the payments, the lender has the right to foreclose on your loan. And since your home or car is the collateral for the loan, then the lender will take those items back–which is a foreclosure.
You lose the item and think that is the end but not necessarily so. If the lender sells your item (car or house) for less than what you owe on it, they can still sue you or garnish your paycheck for the balance of the loan that you took out! A trip, right?? But it is true, this is legal and can happen.
In a sentence: “I will be sure to make my mortgage payment every month in order to avoid a foreclosure”.
5. Private Mortgage Insurance or PMI. PMI is insurance obtained from a private company. This insurance is for people who cannot afford to put the usual 20% down payment on a home.
In addition to paying your normal principal, interest, taxes, and insurance as a part of your monthly mortgage payment, you also have to pay PMI.
PMI is expensive and it is to protect the lender and not you. Personally, I think it is a waste of your money. If you cannot put the standard 20% down payment to buy a home, wait until you can do so.
In a sentence: “I can only afford a 10% down payment on a home, so I will have to pay PMI–that sucks!”
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