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10 Financial Terms Everyone Should Know

10 Financial Terms Everyone Should Know

 
Understanding financial matters can be difficult if you don’t understand the jargon. Becoming familiar with these 10 financial terms may help make things clearer.

 

 1. Time value of money

The time value of money is the concept that money on hand today is worth more than the same amount of money in the future, because the money you have today could be invested to earn interest and increase in value.

 

Why is it important? Understanding that money today is worth more than the same amount in the future can help you evaluate investments that offer different potential rates of return.

 

2. Inflation

Inflation reflects any overall upward movement in the price of consumer goods and services and is usually associated with the loss of purchasing power over time.

 

Why is it important? Because inflation generally pushes the cost of goods and services higher, any estimate of how much you’ll need in the future–for example, how much you’ll need to save for retirement–should take into account the potential impact of inflation.

 
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Key Numbers for 2015

Key Numbers for 2015Every year, the Internal Revenue Service (IRS) announces cost-of-living adjustments that affect contribution limits for retirement plans, thresholds for deductions and credits, and standard deduction and personal exemption amounts. Here are a few of the key adjustments for 2015.

 

Retirement plans

  • Employees who participate in 401(k), 403(b), and most 457 plans can defer up to $18,000 in compensation in 2015 (up from $17,500 in 2014); employees age 50 and older can defer up to an additional $6,000 in 2015 (up from $5,500 in 2014)
  • Employees participating in a SIMPLE retirement plan can defer up to $12,500 in 2015 (up from $12,000 in 2014), and employees age 50 and older will be able to defer up to an additional $3,000 in 2015 (up from $2,500 in 2014)

 
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Do you understand the definition of financial aid?

 
Do you understand the definition of financial aid?The term “financial aid” goes hand in hand with paying for college. But it can mean different things to different people, and often the term is used in various ways, even by colleges.

 
“Financial aid” is money that can help students pay for college. Many people think of student loans when they hear the term financial aid, but loans are just one part. In addition to loans, financial aid includes scholarships, grants, and work-study jobs. Scholarships and grants are gifts; they do not need to be repaid. Loans, on the other hand, have to be repaid with interest, while work-study jobs are a work obligation for the student. Aid can be need-based or non-need-based, though most people think of financial aid as being strictly need-based.

 
Loans. The main sources of loans are the federal government and private lenders. Students with the greatest financial need are eligible for the government’s subsidized Stafford Loan and Perkins Loan (“subsidized” means Uncle Sam pays the interest while the student is in school and during certain other periods); all students are eligible for the government’s unsubsidized Stafford Loan. The loan amounts are capped each year.

 
For parents, the government offers PLUS Loans, which let parents borrow up to the full cost of their child’s education. Private lenders also offer student loans and parent loans. Generally, the government offers more favorable loan repayment options than private lenders, most notably several income-sensitive repayment options.

 
Grants & scholarships. Though students with the greatest financial need typically qualify for a federal Pell Grant, the main source of grants and scholarships for the majority of students is colleges. College grants and scholarships can be based on financial need (as determined by the college’s own aid form) or on merit, whether academic, athletic, or some other talent. Colleges vary widely in the type (need-based or merit-based) and amount of grants and scholarships they offer. As your family researches college options, exploring these differences is probably the single biggest thing you can do to optimize your bottom line.

 
Work-study jobs. The government underwrites work-study jobs for the neediest students, but colleges may also offer campus jobs that are not necessarily based on need.

 

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Income-Based Repayment (IBR) for Federal Student Loans

Student LoansThe federal government’s income-based repayment program (IBR) for student loans allows qualified borrowers to tie their monthly federal student loan payments to their discretionary income. A new version of the IBR program called “Pay As You Earn” took effect on December 21, 2012 (it was originally scheduled to be phased in during 2014, but the Obama administration took regulatory measures to make it available sooner). The potential for IBR to change the landscape for college borrowers is enormous. According to the U.S. Department of Education, as of last October, about two million borrowers had applied for IBR.

What exactly is IBR?

Under the Pay As You Earn program, monthly federal student loan payments are based on income and family size (your payment is readjusted each year based on changes to these criteria). Payments are equal to 10% of your discretionary income, and payments are made over a period of 20 years, with all remaining debt generally forgiven after 20 years of on-time payments (loans are forgiven after 10 years for those in qualified public service if all payments are made on time and other requirements are met).

Note:   An earlier version of IBR capped monthly payments at 15% of discretionary income and offered loan forgiveness after 25 years.

How do I qualify for IBR?

Not everyone is eligible for IBR. To qualify, you must meet several requirements:

  1. You must have an eligible federal student loan. Loans eligible for IBR include federal Stafford Loans (subsidized and unsubsidized), Direct Loans (subsidized and unsubsidized), PLUS Loans made to graduate or professional students, and consolidation loans (that don’t include underlying PLUS Loans made to parents). Loans not eligible for IBR include PLUS Loans made to parents, consolidation loans that include underlying PLUS Loans made to parents, and private education loans from banks or other lenders.
  2. You must be a new borrower as of October 1, 2007, and you must have received a disbursement of a qualifying federal student loan on or after October 1, 2011.
  3. You must have a “partial financial hardship.” You are considered to have a partial financial hardship when the monthly amount you would be required to pay on your federal student loans under the 10-year standard repayment plan (i.e., fixed monthly payments over 10 years) is higher than the monthly amount you would be required to pay under IBR.

The Department of Education has an IBR calculator on its website that you can use to determine whether you are likely to qualify for IBR and to estimate what your IBR monthly payment would be (www.studentaid.ed.gov/ibr). The calculator considers your federal student loan balance, adjusted gross income (AGI), federal income tax filing status, family size, and state of residence. However, for an official determination of your eligibility for IBR, or to apply for IBR, you’ll need to contact your loan servicer. If you are unsure who holds your loans or who your loan servicer is, you can find out more at the National Student Loan Data System website (www.nslds.ed.gov). You’ll need your Federal Student Aid PIN to sign in to the database.

A word of caution

IBR sounds like a gold mine, right? Well, there are some things to be aware of. First, with IBR, you may pay substantially more interest over the life of the loan than you would under a standard 10-year repayment plan because you are paying your loan over a longer period of time. Second, you must submit annual documentation to your loan servicer so your monthly payment amount can be reset (if necessary) each year. Third, and perhaps most significant, you may owe federal income taxes (and possibly state income taxes) on the amount of the loan that is forgiven after 20 years. For more information on IBR, visit www.studentaid.ed.gov/ibr.

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