Sponsored by University Federal Credit Union
Personal finance is complicated. The acronyms mush together like alphabet soup (IRA, APR, CD, FDIC…). And don’t get us started on the stock market. But when you consider U.S. finance education requirements, the confusion makes sense. Only five states require high school students to take a semester-long personal finance course. To help out with what many of us didn’t learn in high school, University Federal Credit Union has put together a beginner’s guide to personal finance.
1. What is a FICO score?
A FICO score, aka your credit score, is a number assigned to you by FICO financial software. The program looks at variables like your payment history, number of open credit and debit accounts and amount of debt and gives you a score between 300 and 850. Credit scores help determine eligibility for loans, leases and mortgages.
2. But does it hurt my score when I check it?
No! It’s a good idea to check your credit score, especially when you’re considering a large purchase like a house or car. When you or another person checks your score (like in a background check), it’s considered a soft inquiry. However, hard inquiries do have an effect on your score.
3. OK, so what’s a hard inquiry?
A hard credit inquiry is when a financial institution checks your credit to help them make a lending decision like approval for a credit card, loan or mortgage. Usually, you have to authorize these checks and they will lower your score by a few points. Luckily, hard checks only stay on your credit report for two years, and their negative effect often decreases long before that.
4. What exactly is a credit union?
Credit unions are financial institutions that offer the same services as banks, but operate differently. Unlike banks, credit unions are hyper-local organizations that require members to live or work in specific communities. Credit unions are owned by their members which also often results in more personable service.
5. Do credit unions have better rates than banks?
Yes, generally. Banks are for-profit corporations. They use customers’ money to invest and make more money as a profit. Credit unions are not-for-profit institutions that return the money they make back to their members. This usually takes the form of lower rates and free services.
6. What is a 401K?
A 401K is one of the most popular types of retirement savings accounts. Companies offer 401K plans to their employees. The other common retirement savings option is an IRA (Individual Retirement Account) which has two types: Traditional and Roth.
7. What’s the difference between Traditional and Roth IRAs?
When you contribute to your Traditional IRA, your deposit is tax deferred. This means you don’t pay taxes on the money until you withdraw it. On the other hand, Roth IRA contributions are taxed before investing so you don’t owe anything when withdrawing your money during retirement.
8. So how much should I contribute to my retirement savings account?
The simple answer is as much as you can afford. The specifics, including maximum contribution limits, get more nuanced for each type of account.
401(k): When you sign up for your company’s 401(k), you specify a percent of your paycheck that will automatically be invested into your retirement account each pay period. Often, your employer matches this amount up to a certain percent. This means that your employer adds the same amount of money you do (up to a limit) to your investment account to help encourage savings. To save the most money, you should always contribute as much as your company matches.
IRA: If you do not have access to a 401(k) (or if you want to save in both types of accounts), you can contribute to an IRA. Most financial advisers recommend making deposits on an automatic schedule each month.
Retirement savings grow exponentially thanks to compound interest, so saving early in any type of account will pay off big by the time you retire.
9. Wait, what’s compound interest?
First, let’s talk about earning interest. When you deposit money in an eligible savings account, you make a small profit because the bank lends your money out and charges someone else for using it. The profit you earn is called interest and different savings accounts earn different amounts of interest depending on the account’s interest rate or annual percentage yield (APY).
Compound interest is simply a term that describes the extra money you earn from a savings account year after year. For example:
You deposit $1,000 in a savings account with a 5% APY. After a year, you earn $50 for a new balance of $1,050. Next year, you earn 5% APY on the new balance, earning $52.50. The increased amount that you earn each year is what’s known as compound interest. At first blush, the increase may seem insignificant, but in 10 years, you’ll have earned $628 without lifting a finger.
10. What is APR and why does it matter?
APR (Annual Percentage Rate) is another form of interest, but instead of representing the money you earn like compound interest does, it represents the additional percent you pay for the privilege of borrowing money from the bank. For example:
Your credit card has a 13% APR and at the end of your monthly billing period, you still have a balance of $250. Because you didn’t pay off the full balance, the credit card provider adds $2.71 to your balance for that month. If the same thing happens every month, it will end up costing you an extra $32.50 annually. This is why carrying a large balance with a high APR makes paying off credit cards difficult. Avoid this extra payment by only spending within your means and paying off your balance every billing period.
For more financial advice, visit University Federal Credit Union’s Learning Center or call 801-481-8800 to find the nearest branch and speak with a credit counselor.