After a post-divorce client’s mortgage was paid off as part of her divorce settlement, I asked her what happened to the escrow funds. She didn’t know what I was talking about and I realized there are a lot of terms financial professionals use assuming others understand. Some of these terms may be familiar and others you may never have heard of.
ACCRUE: The ability of something to accumulate over time, most commonly used when referring to the interest, income or expenses of an individual or business. Interest in a savings account, for example, accrues so that over time, the total amount in that account grows.
ASSET: Any resource that has economic value that an individual or corporation owns. Assets are generally viewed as resources that produce cash flow or bring added benefit to the individual or company.
BANKRUPTCY: A legal proceeding in which a debtor’s assets are liquidated and the debtor is released from further liability.
BENEFICIARY: The named person(s), trust or charity that will receive the proceeds from your life insurance policy, the balance in your 401(k) or your estate after you die.
CAPITAL GAIN: A capital gain is realized when an investment’s selling price exceeds its purchase price.
CASH FLOW: One of the main indications of a company’s overall financial health. Calculated by subtracting cash payments from cash receipts over a period of time (month, quarter, year).
COMPOUND INTEREST: Interest that is calculated not just on the original loan amount, but also on the accumulated interest from previous periods. As interest is added to the loan amount, the interest calculation is applied to the entire balance, both principal & interest.
CREDIT REPORT: A summary of a person’s credit history, showing historical information such as bankruptcies, loans, late payments, and recent inquiries. Individuals can obtain one free credit report each year from each of the three credit bureaus. Equifax, Experian, & Transunion
CREDIT SCORE: A measure of credit risk that is based on activities such as credit use and late payments. Credit scores can be obtained for a fee from one of the three credit bureaus. One of the most common credit scores in the U.S. is the FICO score.
DEBT: An amount owed to a person or corporation for funds borrowed.
DELINQUENCY: When a borrower fails to repay a debt by the agreed term.
FICO SCORE: Also called your credit score. A number used by banks and other financial institutions to measure a borrower’s creditworthiness. FICO is an acronym for the Fair Isaac Corporation, a company that came up with the methodology for calculating a credit score based on several factors, like payment history, length of credit history and total amount owed. FICO scores range from 300 to 850, and the higher the score, the better the terms you may receive on your next loan or credit card.
GARNISHMENT: A legal process where a debtor’s personal property is seized in order to satisfy a debt or court award.
INFLATION: The gradual increase or rise in the price of goods over a period of time.
INTEREST: The fee paid for using other people’s money. For the borrower, it is the cost of using other people’s money. For the lender, it is the income from loaning money.
LIABILITY: An obligation to repay debt.
LIQUIDITY: The ability of an asset to be converted to cash quickly without sacrificing value or giving a discount on the price.
NET WORTH: Basic calculation of assets (what you own) minus liabilities (what you owe.) Used both for corporations and individuals to measure financial health.
PRIME RATE: The best rate available to a bank’s most credit-worthy customer, determined by the federal funds rate (the overnight rate at which banks lend to one another.)
PRINCIPAL: The loan balance on which interest is generally paid or received.
SIMPLE INTEREST: Interest calculated on the principal balance only. Interest is not accrued on interest charged.
PERMANENT LIFE INSURANCE: An umbrella term that covers several different, more specific life insurance types. In general, permanent life policies will last for as long as you pay the premiums, and they have a cash value component. Several different types of permanent life insurance are
- Whole Life Insurance
- Universal Life Insurance
- Variable Life Insurance
- Variable Universal life Insurance
The differences can be complex and go way beyond the scope of this conversation.
PREMIUM: The payments you make to an insurance company to maintain your coverage. You can pay premiums monthly, quarterly, semiannually or annually.
TERM LIFE INSURANCE: A type of policy that provides coverage over a set period, generally anywhere from 10 to 30 years. If you die within the set term, your beneficiaries receive a payout. If you don’t, the policy expires with no value.
ANNUITY: A financial product designed to grow an individual’s funds and then at some future date, pay a fixed payment for a designated number of periods. Annuities are used primarily to provide cash flow during retirement years.
ASSET ALLOCATION: The process by which you choose the mix of various asset classes, based on your goals, personal risk tolerance and time horizon. Stocks, bonds and cash or cash alternatives (like certificates of deposit) make up the three major types of asset classes, and each of these reacts differently to market cycles and economic conditions. If you diversify your portfolio across multiple asset classes you’ll spread out risk while taking advantage of growth.
BOND: A debt instrument used to raise capital by corporations, governments, and other institutions. The investor does not become part owner like a shareholder but does have a greater claim on the issuer’s income than a shareholder.
CD: Certificate of Deposit – Interest bearing note offered by banks, savings and loans, and credit unions. CDs are FDIC (federally) insured and provide interest on the investor’s money that is locked in for a certain term, usually three months to six years.
DIVERSIFICATION: Spreading risk by investing in a range of investment tools such as securities, commodities, real estate, CDs, etc.
MUTUAL FUND: A pool of funds from multiple investors who want to invest in securities like stocks, bonds, money market accounts, and other assets. Mutual funds are operated by money managers who invest capital and try to create gains for the investors.
REBALANCING: A procedure used to maintain your desired asset allocation. If your target allocation is 60 percent stocks, 20 percent bonds and 20 percent cash, and the stock market has performed particularly well over the past year, your allocation may now have shifted to 70 percent stocks, 10 percent bonds and 20 percent cash. If you want to return to that 60/20/20 asset allocation, you’ll have to sell some stocks and buy some bonds.
SHARE: One unit of ownership in a corporation, security, or limited partnership.
STOCK: A proportional share of ownership of a corporation. A company may offer 100 shares of stock and if you own 10, you have 10% ownership of the company.
YIELD: The annual rate of return for an investment expressed as a percentage.
AMORTIZATION: Paying a loan in regular payments over a fixed period of time. The monthly loan payment doesn’t change; the math simply works out how much is allocated to interest and principal each month until the total debt is eliminated.
As time goes on, more of each payment goes towards principal and less goes towards interest each month. An example is shown here where although the monthly payment is $377.42, the interest & principal amounts change based on the prior month ending principal balance.
|Month||Balance (Start)||Payment||Principal||Interest||Balance (End)|
APR: Annual Percentage Rate. The annual cost of a loan; including all fees and interest. Expressed as a percentage.
APY: Annual Percent Yield. The annual return of an investment for a one-year period. This rate includes compounding, which makes it greater than the periodic interest rate multiplied by the number of periods.
ARM: An acronym for adjustable rate mortgage, it’s a type of mortgage in which the interest rate you pay rises and falls based on how interest rates are changing in the larger market. ARMs usually start out at a fixed rate for a short period of time, which then resets annually.
ESCROW: An escrow account holds money that will later be used to pay your homeowners’ insurance and property taxes. You pay into escrow every month, usually as a portion of your mortgage payment, so that when your premiums and taxes are due, there is enough in the account to pay those bills. The mortgage servicer then pays your insurance and taxes from the pool of money that has accumulated.
An escrow account is also an account held by a third party on behalf of two parties in a real estate transaction. During the home buying process, the buyer will deposit a specified amount in an escrow account that neither party can access until the terms of the purchase contract, like passing an inspection, have been fulfilled and the sale is completed.
FIXED-RATE MORTGAGE: A mortgage that carries a fixed interest rate for the entire life of the loan. With a fixed-rate mortgage, you don’t have to worry about your payments going up if interest rates rise. The downside is that you could be locked into a high rate if interest rates go down.
LOAN-TO-VALUE: The ratio of the fair market value of the asset to the value of the loan used to purchase the asset. This shows the lender that potential losses may be recouped by selling the asset.
PRIVATE MORTGAGE INSURANCE: Also known as PMI, it’s a type of insurance that mortgage lenders require when home buyers provide a down payment of typically less than 20 percent. The premiums are usually tacked onto the amount homeowners pay each month. For some mortgages, once your loan-to-home-value ratio reaches 80 percent, you no longer have to pay PMI, but in some cases, it is permanent for the life of the loan.
RETIREMENT PLAN TERMS
401(k) PLAN: A qualified retirement plan through an employer to which eligible employees can make contributions on a post-tax and/or pretax basis.
403(b) TAX SHELTERED ANNUITIES: A qualified retirement plan for eligible employees of public schools, tax-exempt organizations and eligible ministers.
DEFINED BENEFIT PLAN: An employer sponsored retirement plan where the benefit to the employee is defined by the plan. For example, a pension, in which the employer promises to pay 75% of an employee’s ending salary, at age 65, after 20 years of employment is a defined benefit plan. Because of their high costs, many companies no longer offer this type of benefit.
DEFINED CONTRIBUTION PLAN: An employer sponsored retirement plan where the contributions are defined by the plan. A 401(k) or 403(b) where the employer offers to contribute 6% of an employee’s salary if the employee contributes 10% of their salary into the plan is a defined contribution plan. The money that goes into these accounts also typically provides a tax benefit, if you don’t make withdrawals prior to retirement age (age 59½ or older.)
KEOGH PLAN: A pension plan for self-employed individuals or employees of unincorporated businesses. It is also known as a self-employed pension.
RMD: (Required Minimum Distribution) The minimum annual amount retirement account holders are required to withdraw, starting at age 70 ½. The amount is calculated based on the IRS RMD table. RMD does not apply for Roth IRAs.
ROTH IRA: A retirement vehicle that allows certain individuals who meet income restrictions to contribute funds that have already been taxed in order to save for retirement. The withdrawals from Roth IRAs will never be taxed, including interest – after five years of the initial investment.
TAX-DEFERRED: Postponing taxes until a later date. Common tax-deferred vehicles include IRAs, 401(k), Keogh Plans, 403(b), and pension plans.
TRADITIONAL IRA: A retirement vehicle that allows you to save pretax funds for retirement. These funds are taxed upon withdrawal and may be subject to penalty if withdrawn before age 59 ½.
TAX RELATED TERMS
AGI: Short for adjusted gross income, your AGI is calculated as your gross income (e.g., what you earn from your job, a pension or from interest on investments) minus certain IRS-specified deductions.
DEPENDENT: A person who is financially dependent on your income, typically a child or an adult relative you may support. You may be able to claim certain tax credits or deductions for these dependents on your taxes.
ITEMIZED DEDUCTION: A qualified expense that the IRS allows you to subtract from your AGI that helps further reduce your taxable income. Itemized deductions can include mortgage interest you paid, medical and dental costs, or gifts to charity. Itemized deductions must be noted on IRS form Schedule A.
STANDARD DEDUCTION: A standard amount that can be used to reduce your taxable income if you decide not to itemize your deductions. Your standard deduction is based on your tax-filing status, and it’s the government’s way of ensuring that at least some of your income is not subject to tax.
About the author:
Bev Banfield is a CPA, Certified Divorce Financial Analyst®, and founder of Banfield Divorce Financial Advisors. The Denver-based company was established to help divorcing couples more easily and equitably separate their finances. Banfield has more than 30 years of experience in financial analysis, budgeting, and auditing. Contact us for more information at (303) 482-1726 or firstname.lastname@example.org. Connect with her on LinkedIn https://www.linkedin.com/in/bbanfield/