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Financial documents often contain words that may seem familiar, but whose precise meaning in an agreement can differ from their everyday use. Most people, for example, know what “interest”, “collateral”, “fee” or “conversion” means, but may not know exactly how these terms apply in a particular document. Each can affect how much a customer ultimately pays and when.
Knowing the precise definitions is particularly useful when taking out a loan, exchanging currency or sending money. The nominal interest rate and the effective interest rate, for example, are two different measures.
In this blog, we explain 15 important financial terms to understand before signing an agreement.
Essential Financial Terms
Whether you use the services of a bank, a microfinance organisation or another financial institution, you will encounter at least some of the terms below in an agreement. Understanding them can help you review the conditions and avoid common problems caused by misunderstandings.
1. Loan Principal
The loan principal is the amount a customer has borrowed and has not yet repaid. It should not be confused with the total outstanding balance, which also includes accrued interest, fees and, sometimes, other costs specified in the agreement. As the principal decreases, the amount of interest may also change.
2. Nominal Interest Rate
The nominal interest rate shows the percentage charged on the principal of a loan. It does not include other costs associated with borrowing. It is one of the starting points when assessing an offer, but it does not provide the full picture.
3. Effective Interest Rate
The effective interest rate provides a broader measure of the cost of a loan. Along with the nominal interest rate, it takes into account mandatory financial costs associated with the loan and the expected timing of payments. Once the effective rate has been calculated, you will know the total amount to be repaid.
4. Loan Instalment
A loan instalment is the amount a borrower must pay at a particular time according to the repayment schedule. It generally includes a portion of the principal and interest. The amount depends on the terms of the product and the agreed schedule.
5. Loan Term
The loan term is the full period during which the borrower repays the loan according to the schedule agreed in the contract. It largely determines the amount of each instalment and the number of payments.
The term is usually expressed in months. For example, if the agreement specifies a loan term of 24 months, the loan must be fully repaid by the end of that period.
6. Repayment Schedule
A repayment schedule shows when payments are due and how much must be paid. It may also show the principal, interest and other costs separately. Depending on the agreement, payments may be scheduled daily, weekly, monthly or at other intervals. Repayment schedules with payments less frequent than once a month are now rare in the banking system.
Read the schedule carefully before signing the agreement, as failing to follow it usually results in an additional penalty.
7. Annuity
An annuity is a specific form of loan repayment schedule. Under an annuity schedule, the borrower makes payments at predetermined intervals, with each instalment covering principal and interest. The borrower pays the same amount at each payment date.
Under a standard declining-balance schedule, instalments may change gradually as the principal is repaid. An annuity schedule does not provide for this type of change.
8. Loan Tranche
In a financial context, a tranche has two meanings: a portion of a loan to be disbursed or a portion to be repaid.
In the first case, the institution releases the loan in parts. For example, you may borrow GEL 10,000 but receive it in weekly tranches of GEL 1,000 over 10 weeks. In the second case, the term refers to the repayment schedule, under which the borrower repays a particular portion, or tranche, by a specified date.
9. Collateral
Collateral is property or an item used to secure a loan. A financial institution takes its value into account when issuing the relevant type of loan.
For example, a gold pawnshop issues loans secured by collateral. An expert values the item, and an amount equivalent to its value is approved as the loan limit. The collateral generally remains with the lender and is returned to its owner once the pawn loan has been repaid in full.
10. Currency Exchange Rate
An exchange rate shows the value of one currency in another. Financial institutions publish a buying rate, at which they buy currency from customers, and a selling rate, at which they sell it to customers. These rates differ because buying and selling are separate transactions, and each institution sets its own commercial rate for each.
The National Bank’s official exchange rate is not the same as a commercial rate. It is calculated using transactions on the interbank market and serves as an indicative rate. The exchange rates offered by individual banks and microfinance organisations are therefore rarely identical to the National Bank’s official rate.
11. Conversion
Conversion is the exchange of one currency for another. It can be carried out in cash, without cash or, if the financial institution permits, through a combination of the two. For example, you may bring cash to a branch and receive the converted amount in your account.
Mixed-form transactions usually involve additional requirements, so check the conditions in advance.
12. Money Transfer
A money transfer is an international transaction in which funds are sent from one country to another. Such transfers are made through international money transfer systems, including RIA, Intel Express and Western Union.
13. Fee
A fee is an amount charged by a financial institution for a particular service or transaction. It may be fixed or calculated as a percentage of the transaction amount.
14. Credit History
A credit history records a person’s past and current credit obligations and how they have been managed. Financial institutions use this information to assess a borrower’s past financial behaviour.
A credit score is based on this history. The higher the score, the more reliable a person may appear to a financial institution and the greater their chances of receiving a loan, instalment financing or another service.
15. Overdue Payment
An overdue payment occurs when a person does not make an agreed instalment according to the schedule set out in the agreement. The consequences depend on the specific contract. Financial institutions generally impose penalties, the terms of which depend on the product and repayment schedule.
You do not need to memorise every detail of an agreement. It is important, however, to understand what you are signing and which conditions to review before making a decision. For a loan, these may include the term, effective interest rate and repayment schedule. When exchanging currency, they may include the applicable buying or selling rate and any fees.
Understanding basic financial terms makes it easier to interpret the conditions of a service and plan your budget with a new financial obligation in mind.
