40 financial terms you need to know

11 January 2018

The Moneywise team rounds up 40 examples of confusing and commonly misunderstood financial jargon - and gives simple explanations of what they mean. 

AER – the annual equivalent rate shows you what rate of interest your savings will earn over a year, regardless of whether the account pays interest monthly or yearly.

Annuity – this allows you to trade your pension pot for a guaranteed income for the rest of your life. You don’t have to buy an annuity, but it can help provide certainty in retirement.

APR – the annual percentage rate shows how much you are charged for borrowing, making it easier to compare products. This includes the interest rate and other charges, such as arrangement fees.

Auto enrolment – to help people save for retirement, the government has made it compulsory for companies enrol employees in a pension scheme. This happens automatically, but you can opt out if you wish.

Balance transfer – this allows you to move your debt from one credit card to another. This can be a good way to minimise interest payments as most providers offer an interest-free period when you balance transfer.

Base rate – set by the Bank of England’s Monetary Policy Committee (MPC), many financial institutions use the base rate to set the interest rates they charge customers. When the base rate rises expect savings and mortgage rates to increase - and vice versa.

Bitcoin – the most popular cryptocurrency, a digital currency without a central bank - such as the Bank of England – behind it. It works in the same way as a traditional currency as you can make payments and transfer money. However, the value of Bitcoin can rise and fall unpredictably.

Capital gains tax – this tax is levied when you sell an asset that has increased in value since you bought it. You only pay tax on the gain itself, i.e. the amount its value has increased. It applies to most personal possessions worth £6,000 or more (apart from your car), property that isn’t your main home and shares not held within an Isa or tax-free account.

Cash plan – these plans cover the cost of everyday healthcare, such as dental and optical check-ups and treatment. You pay a monthly fee and the insurer reimburses you for the cost. How much cover you receive depends on the individual policy.

Claim moratoriums – these exclusions normally apply to insurance policies when you have a pre-existing condition. It means you can’t claim for certain illnesses within a specified time.

Compound interest - this is when you earn interest on the interest you’ve already earned. For example, if you have £100 in a savings account paying 10% a year, after one year you will earn £10, leaving a balance of £110. In the second year you will earn £11 in interest as you are earning interest on the first year’s interest.

Defined benefit pension – these schemes pay out in retirement based on how many years you worked for your employer and the salary you earned. These are considered the gold standard of pensions as they are generally more generous than other schemes.

Defined contribution pension – during your working life you contribute to a pension, but the amount you receive in retirement depends on how well your pension investments perform.

Equity release – also known as a lifetime mortgage, this allows you to unlock cash from your home in retirement. However, this is generally an expensive way of accessing cash as interest rates are higher than traditional mortgages.

ETF – exchange traded funds invest in a portfolio of assets in much the same way as funds. Unlike funds, they can be traded throughout the day.

FCA – the Financial Conduct Authority is the independent regulator of the UK’s financial services industry. It does not investigate individual complaints. Consumers should complain directly to a firm and then to the Financial Ombudsman Service if the provider’s response is not sufficient.

Freehold – if you are a freeholder you own both the property and the land it stands on. Detached houses are generally sold on a freehold basis, whereas flats are leasehold.

Fund – this is an investment vehicle which invests in a portfolio of assets. They are managed by a fund manager and individuals can buy into the fund through a stockbroker. Some funds target growth in value while others deliver a regular income to their investors.

IFA – an independent financial adviser searches the whole market to find the best financial products for their clients. They charge clients a fee for their services.

Income drawdown – in retirement you can choose to take an income out of your pension pot on an ongoing basis, rather than buying an annuity. This can lead to further growth in your pension, but you also risk your pension pot falling in value.

Inflation – measures the change in the cost of goods and services. As inflation increases, the cost of goods and services rises. In the UK, the consumer prices index (CPI) tracks inflation and is published by the Office for National Statistics each month.

Interest-only - a mortgage where the borrower only pays the interest on the loan each month, rather than paying down the debt itself. Customers must have an alternative repayment vehicle in place, so they can repay the initial loan when the mortgage term ends.

Investment trusts – are companies which invest in a portfolio of assets. These companies are listed on the stock exchange and individuals can then buy shares in each investment trust. Unlike funds, there are a finite number of shares available in each trust – this is called being ‘closed ended’.

Leasehold – if you own a leasehold property you have a legal agreement with the freeholder which tells you how long you own the property for. You will generally pay a ground rent to the freeholder and other service charges may apply. Most flats are sold on a leasehold basis and the freeholder is usually responsible for maintaining the communal areas of the building.

LTV – the loan to value of a mortgage tells you what percentage of a property’s cost you’re borrowing from a bank. If you borrow £150,000 for a property worth £200,000 your loan to value will be 75%. In general, providers offer lower mortgage rates to smaller LTVs.

Money mule - a form of money laundering where a criminal transfers money into an innocent person’s bank account, which in turn is transferred to another account, to disguise the source of the money.

Money transfer – this type of credit card works much like a balance transfer, but you receive the cash into your current account rather than the debt being paid off. Beware of high fees.

Negative equity – a property enters negative equity if it is worth less than the outstanding mortgage. For example, if you have a £150,000 mortgage balance but the value of your home is lower.

Open banking – an initiative to increase competition in the banking sector by allowing smaller third-party companies to access your banking data, if you give them permission to do so.

Passive investing – rather than using a fund manager to actively manage your funds, passive investors use tracker funds which move in line with an index, such as the FTSE 100. They are usually cheaper than actively managed funds.

Personal allowance – this is the amount most people can earn before being subject to income tax. The allowance is £11,000 for the 2016/17 tax year and will rise to £11,500 in 2017/18.

Personal savings allowance – basic rate taxpayers can earn up to £1,000 in savings income tax-free each year. Higher rate taxpayers will be able to earn up to £500 but additional rate taxpayers receive no allowance.

Robo advice – a form of advice which uses computer algorithms to recommend products or create investment portfolios, based on your stated financial attitudes and circumstances. Robo advice is generally cheaper than traditional alternatives.

Rolled up interest – this occurs when you do not pay off the interest on your loan each month, instead it is added to the overall amount you owe. This means you’re being charged interest on the interest and the costs can mount quickly. This type of agreement is common with equity release mortgages.

Section 75 of the Consumer Credit Act – if something goes wrong with a credit card purchase, your card company is legally obliged to refund you, even if it is the retailer’s fault. This protection only applies to credit card purchases of between £100 and £30,000, and these can’t be made through a third party such as PayPal. Even if you partially paid using a credit card, the card company is liable for the whole refund.

Shared equity – the government or a housebuilder loans you a portion of the cost of a home, buyers contribute a cash deposit and get a mortgage on the remainder. You must pay back the shared equity loan eventually, but are not required to pay it off each month like a mortgage.

Shared ownership – you purchase part of a property (typically between 25% and 75%) using a shared ownership mortgage while another party – usually a housing association - owns the rest. You pay rent each month on the portion you don’t own, but you can increase your ownership over time.

Stocks and shares – also known as equities, they allow you to invest in individual companies. The value of your shares will rise or fall depending on the performance of the company. You may also receive an income from the shares if it pays a dividend.

Trust – a vehicle to hold assets on behalf of others. An attraction of using a trust is that it can minimise inheritance tax liabilities and reduce the time and cost of transferring assets after death.

VCTs - venture capital trusts invest in smaller, higher risk companies that are not quoted on the main stock exchange. Individuals investing in VCTs can get 30% income tax credit on investments of up to £200,000 each year and are not liable to pay tax on capital gains or dividends.

In reply to by anonymous_stub (not verified)

Very helpful. I'll put this one in the favourites for future reference!

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