Plain-English Explanations for Financial Terms That Trip Everyone Up

Financial jargon may not be complicated on purpose, but it can sure feel that way. You've seen them on loan agreements, savings account disclosures, and in the news. While you might vaguely understand these financial terms, if someone asked you to explain the difference between APR and APY right now, could you?

That’s where we come in. In honor of Financial Literacy Month, we’re breaking down several commonly misunderstood financial terms.
 

APR vs. APY: The difference that costs or earns you money.

Although APR (Annual Percentage Rate) and APY (Annual Percentage Yield) sound a lot alike, they work very differently. APR is the interest rate you pay on debt. It tells you the yearly cost of borrowing as a percentage. On the other hand, APY reflects the actual interest you earn on savings over a year, including the effect of compounding interest.

Think of it like this. When you're borrowing money, the lower the APR, the better. When you're saving money, the higher the APY, the better.

 

Net Worth: It's not just for the wealthy.

Broken down to its simplest form, net worth is what you own minus what you owe. Add up your assets (savings, your home’s value, retirement accounts, the value of your car), then subtract your debts (mortgage, credit cards, loans). The number you're left with is your net worth.

When you’re just starting, your net worth may be negative. That’s to be expected. What matters is the direction it's moving. Tracking your net worth over time is one of the clearest ways to measure your actual financial progress. 
 

Liquidity: The flexibility to keep you going.

Liquidity refers to how quickly and easily you can convert an asset into cash without losing value. Your checking account? Highly liquid. A house? Not so much because selling takes time and costs money. Liquidity matters because in an emergency, it’s the liquid assets that will help you. Want to build an emergency fund? Check out this article.
 

Compound Interest: The force that can work both for and against you.

Compound interest is the interest accumulated on the original amount (principal) and the accrued interest. It can work for you when saving and against you when borrowing.

When saving or investing, compound interest is one of the most powerful wealth-building forces available, as it allows you to grow your money on the growth you’ve already generated. On the flip side, when it's working against you, like with credit card debt or a high-interest loan, compound interest can make balances grow surprisingly fast.
 

Principal: More than just the loan amount.

Principal is the original amount borrowed or invested before interest is added. Here we’ll focus on borrowing money. When you make a loan payment, part goes toward interest and part toward reducing your principal. Early in a loan's life, more of your payment goes to interest. Over time, as the principal shrinks, that balance shifts. That’s why making even small extra payments toward principal early in a loan can save a meaningful amount of interest over time.
 

Knowledge is Power

You don't need to speak fluent finance to make good financial decisions. But knowing a few key terms puts you in a much stronger position when it's time to borrow, save, or plan. The next time you see APY on a savings offer or APR on a loan agreement, you'll know exactly what to look for.

Looking for a little more support? We partnered with GreenPath Financial Wellness to help set you up for success at no cost to you. You can request a call with one of their certified financial counselors or take advantage of online resources on your own time.