Debt is a language of its own. Anyone who’s ever had a credit card balance or signed mortgage papers or taken student loans has been bombarded with terminology that can make your head hurt.
For instance, Credible.com, an online consumer marketplace, surveyed 1,000 people about the terms of their student loans, and more than 90% failed the quiz. Even more shocking (or perhaps not): no one who took the quiz got all seven questions right.
As we kick off Yahoo Finance’s #SlayYourDebt month, let’s break down some of the big words that you’ll see when dealing with debt.
Principal
When you borrow money, the amount borrowed in the very beginning is the principal. It’s the base level of your loan before any interest, fees or penalties are added. In terms of student loans, if you’re the average class of 2017 graduate, you took out $39,400 to cover college, which means $39,400 would be your principal.
Sometimes, with large debts (like the $100,000 I owe), it can be hard to chip away at the principal because interest payments can be so high.
To think about it in credit card terms, you add to your principal every time you swipe your credit card. That $5 latte? It just added $5 to your principal.
Interest
In the simplest terms, interest is the cost of borrowing money. That means if you borrow that $39,400 to pay for college, you’ll wind up paying more than that back because of interest. If you hold on to debt for a long time, you’ll have to pay a lot more interest than if you pay it down quickly.
That’s not to say paying every loan down as quickly as possible is the right choice. With a home mortgage, for example, it can often be beneficial to spread the cost over the life of the loan to keep your cash available for other expenses. Everyone’s financial situation is different and requires a different approach.
Interest is usually calculated as a percentage of your principal.
APR
The APR is an abbreviation for the annual percentage rate. The APR is your interest rate, the percentage you’re charged to borrow. Different loans have different rates.
A credit card’s APR only comes into play if you don’t pay off your balance in full each month. If you carry a balance, your issuer charges interest (the APR) on the balance – and those rates can be pretty high.
Most federal student loans are Stafford loans (of which there are two kinds: subsidized and unsubsidized), which have interest rates in the low single-digits. When I was in school they were 4.25% for the subsidized and 6.55% for the unsubsidized. The interest rate for undergraduate borrowers of Stafford loans now sits at 4.45% for both subsidized and unsubsidized, according to the Department of Education.
Those interest rates are considered fixed rates, which means they don’t change over the life of the loan. My interest rates, despite the fact that they’re lower than what new borrowers will have to pay, won’t go up. Some interest rates, like credit cards and some mortgages are variable rate. A variable rate can’t be changed willy-nilly; there are complex rules that dictate how they lenders can change the rate.
Default
This is one of the worst words associated with debt because default means the borrower can not repay what they borrowed. Defaulting on a debt will hurt your credit score for up to seven years. That will lead to higher interest rates in the future, and in extreme cases could even make it harder to find someone to lend to you at all.
Throughout the month of June, we’ll randomly select winners and award $100 and $500 Amex/Visa Gift Cards to help eliminate your debt and conquer your finances. Visit bitly.com/yfsweepstakes to learn more and enter. Winners will be announced every Friday.