In the first part of our guide to explain confusing financial terms, we told you all about APR, AER, and basic bank accounts. If you missed it, check it out to get a proper idea of how interest affects you when you’re borrowing or saving money – otherwise, let’s get onto the second part!
This time, we’ll explain what it means when a Direct Debit or payment ‘bounces’, what compound interest is and what affects your credit history – and how it can have an effect on your future borrowing potential.
When you don’t have enough money in your bank account to cover a transaction, the payment will bounce (sometimes known as being returned). This means that it doesn’t go through and the payment isn’t made.
This can happen if you’ve got a Direct Debit or standing order due to pay out or a cheque that you’ve written has been presented and don’t have enough credit (or authorised overdraft) to cover it.
You can be charged for bounced / returned payments, depending on your bank or account provider. Some banks charge up to £15 for each returned payment. It might also take you into your unauthorised overdraft and there can be extra fees for this as well – again some providers charge up to £10 per day for unauthorised overdrafts.
Compound interest is when you earn interest on the interest you’ve already earned. Sounds confusing? Let’s put it like this: if you have a savings account with £100 in it and the interest rate is 5%, after the first year, you’ll have £105. For the second year, you’ll be earning the 5% interest on the £105 you have in your account, giving you £110.25. This is compound interest and while it doesn’t sound like much (an extra 25p on your savings probably won’t go very far), it can build up over time.
It’s not just for your savings though – compound interest can also affect what you owe. If the interest on your credit card is added to what you owe at the end of the month, for example, then the following month you may pay interest on the original balance plus the added interest. This means the amount you owe can quickly build up.
If you’ve ever been turned down for a credit card, a loan or a mortgage, you may be aware of your credit history. This is a record of all of the times you’ve used credit in the past six years, including things like mobile phone contracts or car finance agreements.
It records all your lines of credit and whether you’ve made your payments on time, late or not at all. It’s one of the things that lenders look at when they’re deciding whether or not to let you borrow from them. If you’ve ever had problems managing credit in the past this will show on your credit history and may make it harder to be accepted for credit or you may find that you are accepted but at a higher interest rate.
Late payments, defaults and bankruptcy all show up on your credit history for six years, so even if your problems were a while ago, they could still affect you. If you’ve made a lot of credit card or loan applications in a short space of time, this could also turn lenders away as you might seem like you’re taking on too much credit. Check out our blog on credit records to see how to access yours, what you should be looking out for, and what to do if there’s anything wrong.
See you next time for the third and final part of our confusing financial terms explainer!