Financial Glossary: Key Terms to Know Before Consolidating Debt
Understanding the language of debt is the first step to conquering it. Use this glossary as a quick reference.
Terms Related to Loan Costs
- APR (Annual Percentage Rate)
- The total cost of borrowing money for a year, including interest and certain fees, expressed as a percentage. This is the most important number for comparing loan costs.
- Principal
- The original amount of money borrowed, excluding any interest or fees.
- Interest
- The fee you pay a lender for borrowing money. Your interest rate determines how much you pay.
- Compound Interest
- Interest calculated on the initial principal and also on the accumulated interest from previous periods. This is why high-APR credit card debt can grow so quickly.
- Amortization
- The process of paying off a debt over time through regular payments. An amortization schedule shows how much of each payment goes toward principal and how much toward interest.
- Origination Fee
- An upfront fee charged by a lender for processing a new loan application, often deducted from the loan amount before you receive the funds.
Terms Related to Repayment Methods
- Debt Snowball
- A debt repayment strategy where you pay off debts in order from the smallest balance to the largest, regardless of the interest rate. This method is designed for psychological motivation. Learn more here.
- Debt Avalanche
- A debt repayment strategy where you pay off debts in order from the highest interest rate to the lowest. This method is mathematically optimal and saves the most money on interest. Compare methods here.
- Minimum Payment
- The smallest amount of money you are required to pay each month on a debt to remain in good standing with the lender.
- Extra Payment
- Any amount you pay above the required minimum payment. Extra payments go directly toward reducing the principal, which is the key to getting out of debt faster.
Terms Related to Debt Relief
- Debt Consolidation
- Combining multiple debts into a single, new loan, ideally with a lower interest rate, to simplify payments.
- Refinancing
- Replacing an existing loan with a new loan that has better terms, such as a lower interest rate or a lower monthly payment.
- Debt Management Plan (DMP)
- A plan administered by a non-profit credit counseling agency to consolidate your credit card payments, often with lower interest rates negotiated by the agency.
- Bankruptcy
- A legal process for individuals or businesses who cannot repay their debts. It should be considered a last resort as it has a long-lasting negative impact on your credit.
Mastering the Language
Don't let confusing terms intimidate you. By understanding this vocabulary, you are better equipped to read loan documents, ask smart questions, and make informed decisions. Use this glossary as a quick reference before speaking with any lender or counselor.