Money terms you need to know

The government is drawing up plans for all pupils in England to study some form of maths until they're 18.

But many say it’s just as important for young people to understand key financial concepts to help them in their everyday lives. Here, we aim to demystify some key financial terms relating to saving and borrowing.

Compound interest

Compound interest effectively means interest on top of interest. Because compound interest is cumulative, it can have a huge impact on your savings or debt.

Albert Einstein, the famous physicist, apparently said those who understand compound interest, earn it and those who don't, pay it.

What earning compound interest looks like

If you put £10,000 into an account with a 5% interest rate and where interest was paid annually, after a year, you'd have £10,500.

However, if you put £10,000 into an account with the same interest rate but interest is paid monthly, you'd have £10,511.62 at the end of the year.

This is because the amount of interest paid each month then earns interest each following month.

With monthly interest being compounded, you could end up with £16,470 after 10 years – assuming the interest was added to the account balance, you didn't make any withdrawals and the interest rate stayed the same.

What paying compound interest looks like

If you took out a £250,000 loan with an interest rate of 5% a year, paid back over 25 years, you'd end up paying £438,600, including interest of £188,600.

AER vs gross rate

When looking at savings accounts, you may see the terms 'annual equivalent rate' (AER) or 'gross rate'.

The AER enables you to compare savings accounts that may calculate or pay interest differently. It shows the rate of interest you would earn over a year, taking into account any bank charges, compound interest or bonuses.

The gross rate is the rate of interest used to calculate how much interest you would receive. The interest is then added up and generally paid either monthly or annually.

If interest is paid only once a year, there will be no difference between the AER and the gross rate. But if you save in an account that pays interest monthly, you will benefit from more compound growth, and the AER will reflect this.

For example, Chase's easy access saver accountpays a competitive interest rate – plus we calculate your interest daily and pay it monthly. This explains why the AER is higher than the gross rate.

18+, UK residents. A Chase current account is required to open a saver account. T&Cs apply.

How APR works

Just as the AER lets you compare savings accounts, the 'annual percentage rate' (APR) does the same for credit cards and loans.

The APR includes interest rates and compulsory charges attached to borrowing – such as a one-off or an annual fee. The APR lets you easily compare different providers so you can choose the one that offers the best rate.

Be aware that the APR for credit cards doesn’t take into account charges for making cash withdrawals, late payment fees or any rewards you earn from using the card.

The actual rate of interest you pay will depend on how you use the card. If you repay what you’ve spent on the credit card in full each month, in most cases, you won’t pay any interest.

Loan-to-value ratio

You’ll typically see 'loan to value' (LTV) in relation to mortgages.

LTV reflects the amount you're borrowing compared to the value of the asset you are buying.

For example, if you bought a property worth £220,000 and had a 10% deposit of £22,000, you'd need to borrow £198,000 – that would be your mortgage amount.

Your LTV is 90% because your deposit covers 10% of the property price.

The higher your deposit, the lower your LTV. This equation can be important because lenders are likely to offer you a lower interest rate if you have a low LTV.

Borrower default

A default means you've stopped making the required repayments on a credit agreement, like a loan, credit card or mortgage.

If you miss one or two payments, you'll generally be charged a late payment fee.

But if you miss at least three payments in a row, dependent on the lenders agreement, the lender may say you have defaulted. That could lead to a lower credit score and difficulty borrowing in the future. If you're worried about debt, charities like StepChange (Opens in new window) may be able to help.