With hundreds of technical terms being used every day in the financial world, it’s no wonder so many people find managing their money a little daunting.
To help combat this, we’ve put together a list of basic banking terms, with the hope that it’ll help you better navigate the world of money and personal finance.
So, first up we have…
There are a couple of different scenarios where you may hear the word credit.
The first scenario is when you’re “in credit”. You’re most likely to come across this term when looking at an energy bill. If you’ve used less energy than you’ve paid for, you’ll likely be in credit – this means your supplier now owes you money.
You might also come across credit in reference to “having credit”. This means you’ve borrowed money from a lender, and have a history of borrowing and paying money back.
Debit is basically the opposite of credit. Again, you might come across the term debit when you’re looking at any of your bills. If you’re yet to pay your bills, you might be in debit, which means you now owe the supplier money.
You might also see the word debit in reference to a “debit card”. A debit card is a card that gives you access to your own money. Every time you spend on a debit card, money will be deducted from your own account.
This is in contrast to a “credit” card, which works by borrowing money from a financial institution, with the agreement that you will pay them back, with added interest.
A direct debit is a term used to describe a financial transaction, where a business withdraws funds from a person’s bank account.
Direct debits are most commonly used for recurring payments, like your bills. Your bills company will be responsible for setting up and managing how much money comes out of your account, and when. It is the receiving party that controls these payments.
It’s for this reason that it’s so important to regularly check your bank statements, or review the subscription section on Emma to see if you’re being overcharged.
Direct debits and standing orders are often thought of as the same thing. They are very similar, except with a standing order you are in control of how much is paid, and how regularly.
The best example of when you might use a standing order is for paying your rent. You will instruct your bank to pay a set amount of money from your bank account, at regular intervals, to another bank account.
The main thing to note is that standing orders are used for fixed regular payments, unlike direct debits where the monthly amount can change.
A credit score, or credit rating, is a numerical number used to determine your trustworthiness when it comes to borrowing money. Having a high credit score means you are more likely to be accepted for loans, mortgages and other occasions where it is necessary to borrow a sum of money.
Your credit score will also determine how much interest you’ll have to pay, so it’s important that you work on increasing your rating.
We have more about credit scores here.
Next on our list of basic banking terms, we have the current account. A current account is a type of bank account that is most commonly used for everyday spending.
With a current account you can withdraw cash, spend on your card and make and receive direct debits. Your current account is also where regular payments, like your salary, are most likely to be paid into.
There are tonnes of current accounts on the market. This can make choosing the right card for you and your financial situation difficult. If you’re in the UK and you need a helping hand deciding which current account you should get, head to the Save Money tab on Emma and click where it says “Compare Accounts”.
We’ve also written this really handy guide to switching bank accounts.
So, you have your current account which holds your money. Attached to this account you might also have an overdraft.
An overdraft is simply an amount of money that you can spend in case all your own money runs out.
However, there are conditions attached to using an overdraft that you need to be aware of. For one, you may be charged a fee, or interest, by your bank for using this money.
It is for this reason that you should think of overdrafts as money to be used for short term borrowing, or emergencies only. You really don’t want to end up paying any hefty fees just for the sake of it, so consider whether you really need an overdraft.
An overdraft could either be classed as an “authorised overdraft”, or an “unauthorised overdraft”. With an authorised overdraft, you agree a limit with your bank and you can spend money up to that set limit. With an unauthorised overdraft, you will have spent more money than what is available in your bank account, without setting an agreed limit with your bank.
An interest rate is best described as a percentage charged on the total amount that you either borrow, or save.
If you are borrowing money, the interest rate is the amount of money you are charged for borrowing money. You should think of interest in the same way as you think of car hire. You borrow the car, and you pay a small amount for the privilege of using the car. Using real numbers as an example, if you have £1,000 and the interest rate is 5%, you will pay £50 in interest.
If you’re saving money, interest is exactly the same except the interest is paid to you instead. In the same manner, you lend someone your car, and they give you money in return. If you add £1,000 to a savings account, and the interest rate is 5%, you will be owed £50 in interest.
This is where we take interest up a notch.
As mentioned above, when you save money, you’re likely to earn a small amount of interest on that money. Compound interest then works by earning money from the interest you’ve made. Therefore, every year that your money is in a savings account, you will be earning interest on a previous year’s interest. Not only does compound interest help your savings grow, but it also speeds up the rate to which your savings increase.
The unfortunate thing about compound interest is that the same theory applies to debt. That is why it is so important to fully understand the interest metrics you pay on credit cards. The pros of compound interest no longer apply to debt. You will be paying interest on interest earned in previous years. Your debt could quickly snowball out of control, making it harder, and longer, to pay off any remaining balance.
We’ve written a whole article about compound interest which you can read here.
Last on our list of basic banking terms we have Net Worth.
Net Worth is a single number that can be used to determine a person’s current financial position. You’ll often see Net Worth associated with judging how rich celebrities are. For example, Jeff Bezos has a net worth of nearly 200 BILLION dollars.
But, understanding your own net worth is just as important. And tracking it can be a helpful way of understanding if your finances are improving or not.
The calculation for understanding your own net worth is Assets – Liabilities = Net Worth.
If you’re interested in reading more about Net Worth, then click through to the article below.
We hope that we’ve helped to clear up what some of these basic banking terms mean. We’ll be back soon with another post detailing all the common phrases you might find when learning about investing!
Emma is a money management app that connects all your bank accounts to track your monthly spending and subscriptions. Emma will help you visualise and take control of your finances. Make sure you aren’t overspending and show you practical steps to start budgeting effectively.