Money & You – May 2014

Simple Credit Terms: Talking the Talk

By Tommy Haws

Often, we are uncomfortable treading into unknown territory, because it seems that a different language is spoken and that makes us feel uneasy.  One case in point would be going to the doctor.  The best doctors I have ever had (or at least had the ability to feel comfortable around) are those that saved speaking in medical jargon for their colleagues, and instead spoke plainly to me when discussing my medical treatment or that of a loved one.  I know they felt like they were “dumbing it down,” but I do not see it that way.

I think the same thing happens when talking to a banker or getting any type of loan.  There are acronyms and jargon used – and because we in the financial services industry use them every day, we wonder why others do not understand what is said.   It is in that spirit that I wish to define a few terms and words that are used in the financial world that might not be known to most or all.

DTI or Debt to Income – This is an evaluation of someone’s ability to pay a loan.  Just as the name suggests, this is a simple ratio that is calculated using the person’s debt obligations as compared to their income.  For instance, a person that makes $1000 per month and pays $300 in debt payments has a DTI of 30%.  300/1000 = 0.30 or 30%.  Depending on the type of loan, this ratio will help the banker decide if they can afford to take on additional debt or if the strain on the budget would be too high.

LTV or Loan to Value – This is also a simple ratio that is calculated by showing how much the collateral of the loan is worth as compared to the loan size.  For instance, if a loan for $80,000 is on a home that is valued at $100,000, the Loan to Value is 80%.  This shows that the borrower has 20% equity in the home, so it is a better risk for the bank because the owner has some personal investment in it.

Revolving Credit – This is a debt instrument that has fluctuation balances, like a credit card, that can be paid, advanced, paid down, etc. multiple times.  There is usually a credit limit that shows the maximum amount of the debt, but the actual balance will fluctuate.

Term Credit or Installment Loan – This is a loan for a fixed amount for a fixed payment for a fixed amount of time.  A car loan might be an example of this type of loan.  It can also be a loan without collateral that has a fixed amount paid back with payments over time.

Unsecured – A loan that does not have collateral attached.  These are usually charged a higher interest rate than if there is collateral.

Collateral – Something of value that is taken as security against the loan in case of the loan not being payed as agreed.

Interest Rate – The amount charged by the bank to use their money.  When a person pays back a loan, they pay back all that they borrowed plus extra.  That extra amount is the interest.  It is usually quoted on an annual basis.  5% loan would mean that 5 percent of the loan amount would be charged to the customer over a year’s time.   Interest is charged daily, however, and paid back with monthly payments.

Credit Score – This is a score in a scale from 400 to 850 that is made by one of the three national credit reporting agencies.  They score a person based on a variety of factors – some positive to the score, such as on time payments, low balances on credit cards, few inquiries into your credit, while others are detrimental to that score.  The detrimental factors include non-payment or slow payments, collection by creditors, too much credit or too many inquiries into credit, etc.

Note – Sometimes a loan is called a note.

Mortgage – This is the document that is filed at the county clerk’s office in order to show that a home is security or collateral as part of a loan.  This gives the bank the right to take possession of the home in case of non-payment or other default reasons and sell the home to pay the loan.  This processes is called:

Foreclosure – As stated above, this is legal process for the financial institution to take possession of the property in case a loan cannot be re-paid.

Lien – A filing that shows that the financial institution has used that item as collateral on the loan and has the right to take possession in case of default.  For instance, a lien is placed on a car title for a car loan that is filed with the department of motor vehicles.

There are many other terms, but these are some of the basics.  The important point is to never be afraid to ask questions.  Good bankers never have a problem helping their customers understand what is going on.  If you ever get that feeling that someone is trying to fast talk you or tell you something that you do not understand, tap the brakes and tell them to use plain English and help you understand.  The only bad question is the un-asked one!

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