100% mortgage
This is a type of mortgage where a house-buyer borrows the entire value of the property, without putting down any deposit. Perhaps symbolic of the boom times, when they reached their peak of availability and popularity, the 100% mortgage is now almost non-existent.
As they were a more risky proposition for lenders, they tended to have higher interest rates than other types of mortgage. 100% mortgages have been criticised because they allowed house-buyers to take too much risk without even having to prove that they could save up a deposit.
Annual Percentage Rate (APR)
APR describes the actual cost of credit calculated over a year. For example, if an individual has £1,000 of credit with an APR of 5%, the total amount repayable each year would be £50.
Bailout
This is when the government offers money to a large failing business such as a bank in order to prevent the consequences that arise from its downfall – such as damage to the economy or mass unemployment. Bailouts can take the form of loans, bonds, stocks or cash. They may or may not require repaying.
Bank of England
The Bank of England is the central bank of the UK. It was founded in 1694 by a group of private bankers to raise money for the crown, was nationalised in 1946, and gained independence in 1997.
With its position at the centre of the UK’s financial system, the Bank is committed to promoting financial stability and a healthy economy.
Over its 300-year history, many of the Bank’s roles have changed. It has always been the government’ banker, but since the late 18th century it has been banker to the whole banking system. The Bank also manages the UK’s foreign exchange and gold reserves and issues banknotes in England and Wales.
But it is only recently, in 1997, that the then chancellor, Gordon Brown, gave the Bank the independent power to set the base interest rate. The government now sets the target for inflation and the Bank's monetary policy committee sets interest rates to try to meet it.
Bank run
A run on a bank is when depositors lose confidence in the ability of the bank to give them their cash when they want it, so they take it all out to be on the safe side.
The amount of cash a bank actually has available is only a fraction of its total deposits, so when there's a rush of withdrawals a bank can run out of money. This can close it or even put it out of business altogether, even if it is still profitable..
Northern Rock suffered from a bank run, with depositors queuing around the block to take their money out. As a result, the government had to take it over and guarantee the deposits, to save it from going bust.
Bankrupt
This is when a person or corporation is declared, by a court of law, to be unable to meet their financial obligations.
Base rate
The base rate affects how much money costs, to lend or borrow, and is decided every month by the Bank of England (BoE). It is the rate at which the Bank targets to keep short term money market rates, through its day-to-day liquidity operations in the money markets. It affects not only how much it costs for one bank to borrow money from another bank, but also how much it costs people to borrow from banks – in the shape of mortgages and loans.
The interest rates we are charged on mortgages and loans are influenced by the base rate. Some products, like tracker mortgages are rigidly fixed to the base rate, and go up or down with it. The standard variable rate on mortgages also goes up and down according to the base rate, but its relationship is looser.
It became normal in recent years for the base rate to only change by small 0.25% increments each month, or even stay the same. This was all it took to nudge the cost of borrowing and lending in the direction the BoE and government wanted.
However, with the onset of the credit crunch, the BoE has had to slash rates by 1.5% in November and 1% in December 2008. This is an attempt to reduce the cost of borrowing and lending both between banks (called libor), and for customers.
Bear market
This describes a sustained period in which share prices fall and the value of a stock market drops as a result. It’s not uncommon for a Bear market to lose in the region of 15%-20% of its value from the peak.
Some bear markets don’t last very long - bad news creates a panic and stocks are sold off suddenly. Then when investors calm down, prices bounce back. The bear markets of 1987 and 1998 were like this.
The prolonged bear market of 2000-2002, following the bursting of the hi-tech bubble, was the worst since the 1929-1932 crash when there were three years of massive declines.
Buy-to-let mortgage
A mortgage designed specifically for landlords looking to buy a property to let to tenants.
It usually requires a larger deposit than other types of mortgage, often at least 20%. In addition, the buyer might have to demonstrate that the market rent will be sufficient to cover the monthly repayments.
Capital Gains Tax (CGT)
In very basic terms, you pay CGT if you sell something expensive for more than you paid for it. Shares, land, buildings, part of a business and antiques or jewellery are the sort of things subject to CGT. However, you may also have to pay CGT if you merely give something away or receive compensation or prize money. But if your gains come to less than £9,200 (in 2007-08) you don’t pay any.
Credit crunch
A credit crunch is when credit suddenly becomes harder to get, i.e. it costs more and requires stricter criteria before it’s given.
The credit crunch we are concerned with at the moment started last year, although the seeds for it were sown over the last few years. In 2007 in the US, people with sub-prime mortgages began having problems with their mortgage payments, triggered by a rise in interest rates. Banks bad debts began to rise sharply as a result..
To make matters worse, these debts had been sold between banks, making it very complicated to know who was most exposed to bad debt. The credit crunch was ignited when financial markets became less willing to continue to lend to banks, reducing their ability to keep growing lending, and their ability to reflect lower base rates in their lending rates to customers.
Default
Someone is said to have defaulted on a mortgage or loan when they fail to meet their monthly payment.
Deflation
This is the opposite of inflation, when the general level of prices falls.
Deflation becomes dangerous when it becomes sustained, and people hold off from spending in anticipation of cheaper prices. This means businesses can’t sell their products, make profits or pay off their debts, so they have to cut production and lay off workers.
With more people unemployed there’s less demand for goods, prices drop even further and a vicious cycle develops. This is why once deflation sets in it’s very hard to shake off.
Derivatives
A derivative is a type of investment that changes its value in line with the price of something like shares, a currency or a food crop, but the investor does not have to actually own any of these things.
They’re popular because they can be based on almost anything and they can be used as insurance to limit the risk of a particular investment.
The type that have been in the news recently are credit derivatives, which are based on the risk of borrowers not being able to repay their loans, a so-called default.
Things started going wrong in the last year or so when the companies that provide these credit derivatives - such as investment banks and insurance companies – discovered they had not made an accurate assessment about the risks they covered and had lost huge amounts of money.
Discount mortgage
Initial payments into this type of mortgage are at a rate of interest below the lender's standard variable rate (SVR), for a specified period of time, after which you revert to the SVR. Eg, if the lender's SVR is 4% and the discount is 1%, the interest rate you pay is 3%. With most discounted mortgages, the lower rate applies for two to three years, although lengthier deals are available. Usually, the bigger the discount, the shorter the period for which it applies.
Economic growth
This refers to the growth in value of Gross Domestic Product (GDP) - which comprises the total output of the country ie the value of everything produced, from all the food made to all pharmaceuticals manufactured, and from all cars assembled to all services provided.
If GDPis rising, then the country is experiencing economic growth.
When calculating economic growth, inflation has to be taken into account because if prices are higher year-on-year they could make it look as though the economy is growing even if the country had only kept the same volume of output.
If an economy has two consecutive quarters of negative growth, or shrinkage, the economy is said to be in recession.
Financial Ombudsman Service (FOS)
With its slogan “Settling disputes, not taking sides” the FOS is the official independent expert in settling complaints between consumers and businesses providing financial services. It is totally independent, and funded by the government so it is free. If you fall out with any financial institution, such as a bank, insurance company or pension company, contact the FOS at www.financial-ombudsman.org.uk
Financial Services Authority (FSA)
The FSA regulates most companies dealing in financial services, from banks to building societies, insurers and investment firms (stockbrokers and fund managers) to independent financial advisers. It can investigate, discipline and prosecute any of these companies if they suspect any kind of wrong-doing.
Financial Services Compensation Scheme (FSCS)
The FSCS is the last resort for customers seeking compensation from a financial services firm approved by the Financial Services Authority (FSA). This means that FSCS can pay compensation if a firm is unable, or likely to be unable, to pay claims against it. FSCS is an independent body, and it’s free to use.
Fixed rate mortgage
When a fixed rate mortgage is purchased, the interest rate remains the same for a period the lender and borrower have agreed to - such as two or five years, or sometimes longer, like ten or even twenty years. The rate doesn't change no matter how much the Bank of England's base rate might go up or down.
After the agreed term, the mortgage automatically changes onto the standard variable rate,or other agreed variable rate.
FTSE 100 Index
This is the most commonly quoted index for tracking the London stock market. It is made up of the 100 most valuable companies on the London Stock Exchange, representing approximately 81% of the UK market.
The other part of its name comes from the main sponsors, the Financial Times and the London Stock Exchange.
Every working day, the level of the FTSE is re-calculated each minute. The 100 companies are re-evaluated every three months, with some demoted and others from outside promoted into the FTSE 100, based on changes in their market values.
Gross Domestic Product (GDP)
This is the total value of all goods and services produced by an economy in a given period.
The GDP figures, produced every quarter, are an important indicator of the health of an economy. An allowance is made for the effects of inflation, otherwise rising prices alone could make it appear as though the GDP was improving.
When there are two consecutive quarters of falling GDP, it means an economy is in recession.
Gross National Product (GNP)
Whereas the gross domestic product (GDP) is the "value of all final goods and services produced in a country in one year"; Gross National Product (GNP) is the "value of all final goods and services produced in a country in one year by its nationals, plus income earned by its citizens abroad, minus income earned by foreigners in the country". The key difference between the two is that GDP is the total output of a region, eg. England, and GNP is the total output of only the nationals of a region, eg. the English.
Hedge funds
Hedge funds can take leveraged positions in invesments, and sell investments short, in order to make positive returns even when markets are falling. However, returns can also be more risky than via other investment strategies.
They are not open to the general public - only extremely wealthy individuals and professional investors such as pension funds and insurance companies can use them.
Hedge funds are estimated to account for up to half the daily turnover of the stock markets of London and New York.
The man credited with creating what were to become known as hedge funds was a sociologist, Alfred Winslow Jones, in 1949.
In order to beat falling markets hedge funds can take some big risks which can go disastrously wrong. But famously, in 1992, George Soros's hedge fund made hundreds of millions of pounds betting that the pound would be ejected from the European Exchange Rate Mechanism.
Individual Saving Account (ISA)
These were created by the government to encourage people to save. If you put your money in an ISA your interest is tax-free. There is a set maximum that you can put in an ISA each year - in the 2008/9 financial year it is £3,600.
Inflation
Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. Inflation can also be described as a decline in the real value of money—a loss of purchasing power. When the general price level rises, money buys fewer goods and services. A chief measure of price inflation is the inflation rate, which is the percentage change in the retail price index (RPI) (see definition below) over time.
Interest-only mortgage
With this type of home loan, the monthly payments only pay off the interest on your loan so you are not actually reducing the loan capital at all.
The lender may insist – or will at least suggest – that the borrower sets up a separate investment alongside, to pay off the capital at the end of the term of the mortgage.
Investment banks
Essentially there are two kinds of banks: commercial banks, which are those on the high street; and investment banks, who invest money and provide financial services for governments, companies or very wealthy individuals.
Governments treat the two differently. They need to make sure that if a commercial bank collapses, nobody with money in a savings account or a current account loses their money - but they are less concerned about what happens to investment banks.
Libor
Libor stands for the London interbank offered rate and is the interest rate in the London wholesale money market. Unlike the base interest rate - set directly by the Bank of England - Libor rates are set by the demand and supply of money as banks borrow from each other and from other investors to balance their books.
Banks lend to each other for any period from overnight to a year. The three-month Libor rate is the most often quoted, and in previously calm financial times, this traded at a small premium of around 0.15% over where the market thinks the base rate will on average over the next three months.
However, in the recent uncertain times banks have become afraid to lend to each other which has made Libor high even though the base rate is low – the spread has been over 2% recently.
Liquidity
In the recent financial turmoil, there’s been a lot of talk about how the big problem for the banks is liquidity.
The liquidity of an investment is how easy it is to turn it into cash. For everyday people, their most liquid investment is probably their bank account and their most illiquid their house or car.
If you desperately needed cash, you might have to sell your house or car to raise it, but if you had to sell in a hurry you might not get a very good price for them.
Many banks currently have the same problem because some of the things they have bought - especially bonds backed by mortgages in the US - are of questionable value. That means they are very difficult to sell, especially if they are trying to make back anything like the amount they paid for them.
These banks own lots of things that will probably be worth a lot of money one day, but they are finding it very difficult to obtain cash right now to continue to finance their portfolios. This phenomenon has even bankrupted banks who, on paper, are rich.
As a result banks have been reluctant to lend money to each other, making the libor rate high; or to customers, given the lack of available cash.
Loan-to-value (LTV)
LTV is the ratio between the size of a mortgage and the value of the property. If you borrow £55,000 on a property valued at £100,000, the LTV is 55%. The higher the LTV, the more of a risk a borrower is to the lender.
In the boom times, it was not uncommon for people to have an LTV of 90%, 100% or even 110%, on a new mortgage for first time buyers. Lenders were doing this partly because house prices were rising quickly, so they figured the LTVs would come down accordingly, reducing their risk.
Unfortunately, with house prices now falling, people who had high LTVs are now facing negative equity, ie they owe more on their property than the property is currently worth.
Monetary Policy Committee (MPC)
Interest rates are set by the Monetary Policy Committee of the Bank of England (see definition). The MPC sets an interest rate it judges will enable the inflation (see definition) target to be met. It is made up of nine members – five from within the B of E and four from outside. The appointment of external members is designed to ensure that the MPC benefits from diverse thinking and expertise.
Mortgage collar
Some tracker mortgages (see definition) have a collar. This is the minimum amount a mortgage interest rate on a tracker mortgage can fall to. For example, with a tracker that is 1% point above base rate but with a 3% collar. If the base rate drops below 3%, the interest rate will remain at 4% (which is the 3% collar plus 1%).
Negative equity
As far as the housing market is concerned, negative equity is when the amount owed on a mortgage is more than what the property is worth.
For example, a property owner had a £180,000 mortgage on a house that was worth £200,000, which meant they had £20,000 equity. Then the property market went down and the value dropped to £150,000, they then have a negative equity of £30,000.
Recapitalisation
This is a change in the financial structure of a corporation. For example the ratio of debts to equity may be altered. The recent bank bailouts are sometimes referred to as having been recapitalisation because their debts have been reduced.
Recession
Recession generally describes a reduction in economic activity over a period of time. The economy is generally said to be in recession if it has two consecutive quarters of negative economic growth. There can also be other criteria used to define a recession, including increasing unemployment and falling incomes.
Redemption penalty
This is the penalty you have to pay on certain mortgage deals if you want to escape (pay it off) before a certain amount of time is up. For example a two-year fixed rate mortgage might have a redemption penalty of £5000 if you want to get out of it before the two years is up.
Redundancy
This is when employees are laid off because their work is no longer required by the company due to economic, technological or other reasons. The redundant employee is usually entitled to redundancy pay based on how long they have been employed. For example, they might get one month’s salary for every year worked.
Remortgage
This is where you replace your existing mortgage with a new mortgage and release some funds from the equity that you have in your property, i.e. your new mortgage could be larger than your initial mortgage with part of the sum borrowed being used to pay off your existing mortgage and the remainder being paid to yourself. People often remortgage to pay off other debts (even though the new larger mortgage is a large debt, of course) or for things like home improvements.
Repayment mortgage
This is a mortgage where your monthly repayments are actually reducing the amount you owe – unlike an interest-only mortgage (see definition).
Repossession
This is when a lender takes possession of something that you used as a guarantee for the loan. For example, when a mortgage is taken, you agree to allow the lender to take the property (repossess it) if you fail to repay the loan in the way you agreed.
Retail Prices Index (RPI)
RPI is used to measure inflation. It tracks changes in the prices of a selection of goods and services, taking a large sample of retail items including food, tobacco, household products, transport fares, motoring costs and clothing. If the RPI goes up, it means prices have on average increased.
If the RPI - and thus inflation - is rising, then a person's wages won't go as far. This is why the RPI is often used as a basis for pay negotiations.
A small amount of inflation is considered desirable by economists, but high inflation is bad as it makes it very difficult to identify swings in demand and supply, and hence to manage the economy.
Rights issue
Basically, this is a quick way of getting shareholders to put more money into a company that urgently needs it. The shareholders are offered “rights” that entitle them to buy newly issued shares at a discount from the price at which they will be offered to the public later. So the company gets money and the shareholder hopes they are getting a bargain.
Self-certification mortgage
With most mortgages, the lender asks to see proof of your earnings, but with
self-certification mortgages you simply state what your income will be. Sometimes you may have to ask an accountant to back up your statement. They tend to come with higher interest rates than other standard types of mortgage.
During the boom it became relatively easy to get a self-certification mortgage because the security of the property protects the lender against possible default With the benefit of hindsight, this has been criticized as now some of these people are having trouble keeping up with their mortgage repayments because they overstated their earnings.
Short selling (shorting)
Short selling or shorting is the practice of selling a financial instrument (the term for a complicated financial package) that the seller does not actually own at the time of the sale. Short selling is done with the intent of later buying the financial instrument back at a lower price. Short-sellers attempt to profit from an expected decline in the price of a financial instrument.
Stagflation
The name stagflation was coined in the 1970s when stagnation of the economy and high inflation appeared at the same time.
Stagflation is very difficult for an economy to get out of because the methods the government or Bank of England would normally use to try and see off stagnation, eg lower interest rates, risks making inflation worse. And if it tries to reduce inflation it could make the stagnation worse.
Stagnation
Economic growth of less than 1% per year is considered to be economic stagnation.
Stamp duty
When buying a property worth over £175,000, a stamp duty tax of between 1% and 4% must be paid to the government.
Currently, you pay 1% duty on properties costing between £175,001 and £250,000, 3% on those between £250,001 and £500,000, and 4% on properties of £500,001 and over.
(In September 2008 the government announced a stamp duty “holiday” – raising the lower limit from the previous £125,000 to the current £175,000, for a year).
Standard variable rate mortgage (SVR)
This is the standard mortgage offered by lenders (fixed rate and tracker mortgages being the other main types).
Interest rates on SVR mortgages vary between lenders, but they have a close relationship with the Bank of England's base rate, and usually go up or down with it. A typical SVR rate is about 2% above the base rate.
Over the past decade, SVR interest rates were higher than initial rates on fixed or tracker mortgages, but now the base rate is so low, many SVR rates are actually lower.
As well as benefiting those property owners with SVR mortgages, the low SVR rates are also good news for those on fixed rate mortgages whose term has recently come to an end, or is going to do so in the near future. Fixed rate mortgages often automatically revert to SVR mortgages at the end of their term.
Stock market
A stock market is a private or public market for the trading of company stock and derivatives (see definition) at an agreed price. The size of the world stock market was estimated at about $36.6 trillion in October 2008. At that time, the total world derivatives market was estimated at about $791 trillion, 11 times the size of the entire world economy.
Sub-prime loans & mortgages
These are loans or mortgages held by people with lower incomes, unstable incomes or poor credit history. As these loans are a bigger risk for lenders, they have some of the highest interest rates.
Many lenders in the US are accused of having given sub-prime mortgages to people who were too risky, and who were then unable to keep up their repayments when interest rates rose. As repossessions went up, property prices came down - which was a major trigger for the credit crunch.
Toxic debts
In the world of banking, toxic debt has become shorthand for packages of loans that are unlikely to be repaid, such as some sub-prime mortgages.
They are “toxic” because they have destroyed a number of banking institutions that held large amounts of them. When the value of these toxic debts plumetted these banks had to record large losses, pushing some to insolvency.
Nobody really knows how much more toxic debt is out there, but in the USA alone it is thought there could be over £1,000bn of it.
Tracker mortgage
A tracker mortgage is a kind of mortgage loan whose rate of interest follows the Bank of England base interest rate (see definitions). A tracker mortgage, or base rate tracker mortgage, is a variable rate loan that changes rates depending on the level of interest rates set.
Treasury
This is the Government department responsible for all financial decisions and regulation of the financial services sector. The treasury manages the collecting of taxes, government expenditure and national debt. The head of the treasury is the Chancellor of the Exchequer. Until 1997, the Treasury was responsible for the overall management of the economy. However, the Bank of England (see definition) is now independent, and shares management of the economy with the Treasury.
Value Added Tax (VAT)
This is a tax that you pay when you buy goods and services. Last year the standard VAT was reduced to 15%, but on 1st January 2010 it goes back up to 17.5%. There are three rates of VAT in the UK: standard, reduced – for example, on domestic fuel bills; and zero for things like food and books. Where VAT is payable it's normally included in the price of the goods or service you buy.
