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189 Cards in this Set

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Choosing a career
Job search: thank you note w/in 24 hrs. The world is flat (Global work-place)
Financial planning process
Emergency fund; Number 1 goal: retirement; invest prudently; minimize taxes (invest intelligently, cover your assets, accumulate wealth for special expenses, manage the unplanned)
Five steps:
1) Eval financial health 2) Define your financial goals 3) Develop plan of action 4)implement your plan 5) review your progress, reeval, revise
Step four
Plan of action. Flexibility, liquidity, protection, minimization of taxes
Ex of assets (if less than liabilities, bankrupt)
Property (fixed), cash (liquid), savings. Liabilities: debt
Personal income statement
Income (investment interest, scholarships, entitlement (web page royalties) vs Expenses (Discretionary - want vs nondiscretionary - need.) Food (both), shelter.
Defining your financial goals
[$33/month at 12% at age 20 until 67: $1 mill]
Need a DOLLAR amount, Time (when), Interest rate to set money aside. Savings account (hsbc direct, 5.05%) Never use debit cards for online purchases.
Time value of money
Instead of $33/month, at age 30 becomes $109 and age 40 $366/month. [Estate planning: planning for your eventual death and the passage of your wealth to heirs]
15 PRINCIPLES OF PERSONAL FINANCE
1) Risk-return trade-off (delay consumption? Minimum return must be greater than inflation) 2) Time value of money 3) Diversification reduces risk 4) All risk is not equal 5) The curse of competitive investment markets (efficient markets: a situation in which investment prices instantly reflect all publicly available info and the price of any investment accurately reflects the best est of its value)
15 PRINCIPLES OF PERSONAL FINANCE
6) Taxes affect personal finance decisions 7) Stuff happens: liquidity 8) Nothing happens w/out a plan 9) The best protection is knowledge 10) Protect yourself against major catastrophes
15 PRINCIPLES OF PERSONAL FINANCE
11) The time dimension of investing 12) The agency problem-beware of the sales pitch 13) Pay yourself first. 14) Money isn't everything (Family, friends, physical healthy, faith, fiscal well-being) 15) Just do it
Review
Keeping track of expenses (quicken, microsoft money, excel), latte factor. Discretionary (charitable giving? Not nec a tax break, depends on your bracket; Am style) Nondiscretionary (savings, pay yourself first, debt payments*) [tithing, gifts-black hole, vacation]
Expenditures: fixed vs variable
Variable: an expenditure over which you have control. You are not obligated; it may vary from month to month. Fixed: no control; obligated; generally constant each month.
Expenditures
1/3 of gross salary to taxes. Rent should be <30% of take home pay (usu including utilities). But maybe pay more for transportation, costs, safety, school. Largest item after taxes. (Consider jobcorp, peacecorp, americorp) Major expenses: taxes, housing/household, medical care, food, transportation.
Accurate financial records:
1) whether you have enough liquidity for emergencies 2) whether you can meet your debt obligations 3) whether you are saving as much as you think. (pay taxes, get assistance elsewhere, track)
Time value of money
A dollar today is worth more than a dollar tomorrow. Otherwise deppreciates in value due to underlying inflation. (2.5-3% in US; relatively low sometimes at 2.5%, inflation in 100s in Zimbabwe; occasionally S. Am, Brazil, Argentina)
Excel
pv (present value) fv (future value), nper (number of per, yrs or months), pmt (payment, annuity: consistent payments), rate (interest) - Click on cells vs typing in; to determine effect of monthly payments, divide rate by 12 and nper * 12. Type 0 (payment at end of per; the default) (Interest rates always annual for class)
- Monthly basis:
- Payment in 20 yrs
Installment loans (mortgage, student loans, car loans) - Will represent lower percent of salary due to inflation. Interest on loan usu drops after 2 yrs. Invst the excess. Fv of a loan is zero.
- Paying interest
- paid first, before the principle and equity. Interest on student loans is tax deductible but interest for investments is TAXED. Inc equity: pay more monthly, increase house value (remodel?). Refinance to a lower rate.
Enough money for emergencies? Current ratio:
--month's living expenses covered ratio:
monetary assets/current liabilities. --month's living expenses covered ratio: monetary assets/ (annual living expenditures/12)
Debt ratio:
total debt or liabilities/total assets. Longterm debt coverage ratio: amount of funds available for debt repayment to the size of the debt payments. The number of times you could make your debt payments w/ your curent income.
Savings ratio:
Income avail for savings and invest/income avail for living expenses.
Compound interest:
Principal:
- Interest paid on interest due to reinvestment of interest paid on investment's principal. - Principal: face value of the deposit or debt instrument. - FV: the value of an investment in some point in time. - PV: (in todays dollars)
Rule of 72
-- Discount rate:
You can det how many yrs it will take for a sum to double by dividing the annual growth rate into 72. -- Discount rate: the interest rate used to bring future values back to the present.
Compound annuity:
Futurevalue interest factor for annuity:
Amortized loans:
An investment that involves depositing an equal sum of money at the end of each yr for a certain number of yrs and allowing it to grow. --Futurevalue interest factor for annuity: a multiplier used to determine the future value of an annuity. --Amortized loans: a loan paid off in equal installments.
Perpetuity:
- Progressive or graduated tax:
An annuity that continues forever. - A tax sys in which tax rates inc for higher incomes.
Personal exemptions:
- Itemized deductions:
Reduction in your income before you compute your taxes. - Deductions calculated using schedule A. The allowable deductions are added up and then subtracted from taxable income.
- Standard deductions:
- Marginal tax rate or marginal tax bracket:
A set deduction allowed by the IRS regardless of what taxpayers' expenses actually were. - The percentage of the last dollar you earn that goes toward taxes.
Capital asset:
- Capital gain/loss
-- Capital gains tax
An asset you own, except for certain business assets, inc stocks, bonds, real estate, or collectibles. - Amount by which the selling price of a capital asset differs from its purchase price. If the selling price is higher, a capital gain results. -- Tax paid on capital gains.
Filing status
Single w/ no dependent children; married filing jointly and surviving spouses (for up to 2 yrs); married filing separately; head of household (unmarried w/ one child or relative).
Bracket creep
- Active income
-- Portfolio or investment income
The movement into higher tax brackets as a result of inflation inc wages. - Income that comes from wages or a business. -- income from securities.
Passive income
- Gross income:
From activities in which the taxpayer does not actively participate. - Gross income: sum of taxable income from all sources.
Itemized deductions
Deductions calculated using schedule A. The allowable deductions are added up and then subtracted from AGI (adjusted gross income).
Capital Gains Tax
- Adjusted Gross Income (AGI)
The tax you pay on your realized capital gains.
- Total income less allowable adjustments.
IRA
An indiv retirement arrangement which is a tax-deferred retirement savings account allowed by the govt.
Deductible? Medical and dental expenses:
- If they exceed 7.5% of your AGI. -- Tax espenses: not if federal or soc sec, but state and local income or sales taxes and real estate taxes are; county or city income taxes are. (state sales taxes being deduct is new...) -- Home mortgage and investment interest payments: several types are; home equity loans are deductible on home equity debt up to $100,000.
Gifts to charity:
- Casualty and theft loss:
-- Miscellaneous deductibles:
If your are in the 25% tax bracket and give $1000. - Casualty and theft loss: little use b/c first $100 of losses is excluded and you can deduct losses only to the extent that the remaining loss exceed 10% of your AGI. Miscellaneous -- include unreimbursed job related expenses, tax preparation expenses, and investment related espenses - but only deduct to the extent that they are in excess of 2% of your AGI. Most people do not benefit from these deductions.
Tax freedom day
- Payroll tax:
April 17th in 2005; ~May 1
- FICA 7.65% (until $90,000) (soc sec and medicare tax) Ratio very slim today, 2:1 vs 13:1; longevity now ~82 vs 64.
AGI
Gross income (sum of taxable income from all sources) – Adjustments to Gross Income: Tax-Deductible Expenses and Retirement Contributions (traditional IRA, Keogh contributions, moving expenses, etc) = AGI
Step 4: Exemptions:
If dependents are not related to you or are simply cousins, they must have lived with you over the entire tax year.
The dependent cannot earn more than the exemption amount, unless they are children under 19 or under 24 who are full time students.
You must provide more than half of the dependent’s support.
The dependent must by a US citizen, resident, national, or resident of Mexico and Canada.
For filing joint returns, once your AGI reaches the threshold (ex. $214,050), all exemptions claimed on the return are reduced by 2% for each $2500 of AGI in excess of the threshold amount.
Step 5: After deductions and exemptions are subtracted from:
your AGI you know your taxable income. There is an alternative minimum tax (AMT) that’s aimed at preventing the very wealthy from using tax breaks to pay very little. Changes must be made or by 2010 over 25% of all tax returns could be affected by it. The AMI applies different rules in calculating taxable income and then applies a 26% and 28% tax rate to all income.
Step 6: Subtract your credits and determine your taxes due. Child Credit:
Increased to $1000 through 2010. Comes on top of the personal exemption for each child and as a tax credit it cuts your tax bill dollar for dollar. Becomes phased out after a single parent’s income reaches $75000 or a couple’s income reaches $110,000, then credit is reduced by $50 for every $1000 over limit.
Hope Scholarship Tax Credit
Parents receive a 100% tax credit for the first $1000 of college expenses during each of the first 2 years of college and also a 50% tax credit on the next $1000 of expenses for the total tax credit of up to $1500 a year for the first 2 years. Only covers tuition and books. To qualify: you must both pay the tuition and list student as dependent. Amount of financial aid and scholarship funds received affect tax credit. Phased out in incomes over $42000 and joint returns with incomes over $85000 and eliminated around $52000 and $105000.
Lifetime Learning tax credit
Third, fourth years, and graduate students may benefit from the Lifetime Learning tax credit which amounts to 20% of the first $10,000 for tuition and all eligible students in family. You can claim either the Hope credit or Lifetime Learning credit in the same year that you receive a tax-free distribution from an Educational IRA (aka Coverdell Education Savings Account).
Child and dependent care credit:
offsets your taxes in a direct dollar-for-dollar manner for the child and dependent care expenses, because you need child care if you have a job. Applies to dependent children under 13 and disabled dependents or spouse regardless of age. Maximum amount: $3000 for one dependent and $6000 for two or more and you receive only a percentage of that amount as tax credit (depends on how much you spend for them and your AGI). Limitations: payments made to relatives for child care and tax-free reimbursements under employer-financed programs for child care reduce the credit base.
Earned income credit
available to low-income taxpayers which serves as negative income tax meaning you could pay no taxes and also get money back. This is the most complicated to qualify for; maximum credits range from $400 to $4000 with no to several children. The Tax Relief Act of 2001 plans to periodically raise the earned income phase out levels.
Adoption credit:
tax credit up to $10390 for adopting a child under 18, or someone incapable of self-care.
Additional tax credits: 5
1)D
2)65
3)C
4)G
5)SS
totally disabled taxpayers and those over 65 with low incomes; taxpayers who pay income tax to another country; tax payers who purchase gasoline for nonhighway vehicles used in a business can receive tax credits on federal gasoline taxes; those who overpay soc sec taxes because they work more than one job.
Choosing a tax form. Form 1040EZ
Those with no dependents and with taxable income less than $100,000/year, who don’t itemize; status joint or single, under age 65, taxable interest under $1500, you aren’t making a deductible contribution to an IRA or a deduction for student loan interest, you don’t have alimony, taxable pension benefits, or soc sec benefits to report. Only 12 lines of information and can be done over phone.
Form 1040A:
Still limits total taxable income to $100,000, this income can come from interest, wages/salaries/tips, dividends, soc sec benefits, pensions, annuities, scholarships, IRA distributions, student loan interest, educator expenses, higher educ tuition and fees, and unemployment compensation. You don’t itemize deductions, have capital gain distributions, but no other capital gains or losses, your only tax credits are for child, educ, earned income, child, and dependent care expenses, adoption, elderly, and retirement savings contributions; Broader sources, allows for dependents and deductible contributions to an IRA.
Form 1040, long form:
mostly used. Allows for itemized deductions and adjustments to income that can result in lower taxes. Along with the form you also get a number of schedules – Form 1040 attachments on which you provide information regarding income and expenses.
Electronic Filing: Benefits
(1 FAST, 2 ACCURATE, 3 CONFIRMATION, 4 EASY PAY, 5 NO PAPERWORK)
faster refunds (few as 10 days for direct deposit and most efile refunds are issued and mailed in 3 wks); more accurate returns (IRS computers quickly and automatically check for errors, reduce chance of getting an error letter from IRS); quick electronic confirmation (acknowledgment, also via phone); delete paperwork with electronic signatures; easy payment options; taxpayers in 37 states and DC can efile their fed and state tax returns in one transmission to the IRS which are forwarded to the state agency.
May also TeleFile instead of filling out EZ form.
Filing late:
request extension after April 15, Form 4868 (App for automatic extension of time to file US indiv income tax return), no questions asked, additional 4 months. You are asked to enclose a check for any estimated taxes you owe, or you will be charged interest on taxes. Moreover, if the amount due is more than 10% of your tax bill, you’ll also be charged a late penalty of ½% per month.
Filing status:
married filing jointly and surviving spouses
You file a joint return w/ your spouse, combining incomes and deductions into a single return. If your spouse dies, you can still qualify if you have a dependent child living with you, you pay more than half the cost of keeping up your home, and you are not married.
Head of household
Someone who is unmarried and has at least one child or relative living w/ them. The advantage: your tax rate will be lower and your standard deduction higher than single status. You must be married on the last day of the tax year, have paid more than half the cost of keeping up your home, and had a child or dependent live w/ you for at least half of the year.
Amending Returns:
Use Form 1040X; you can even amend an amended tax return. There is a time limit of 3 years after the original tax date you filed and if you file an amended federal return you must also amend your state and local returns.
Being audited:
In 2003, 1/154 were audited. Reasons: error in the past; earn a lot of money (5x as likely if over $100,000); if your itemized deductions are more than 44% of your income; self-employment income Schedule C; if expenses on Schedule C amount to over 1/3 of your Schedule C income.
Steps: gather all supporting data, perhaps hire a tax accountant or attorney who may go to the audit in your place. You may appeal if you are not satisfied and see the auditor, then see your auditor’s manager, then file a formal appeal and go to tax court if necessary.
Help:
IRS; J.K. Lasser’s and Ernest & Young’s income tax guides; TurboTax, MacInTax, TaxCut. Hire a tax specialist with varying qualifications.
Koegh Plan:
A tax-deferred retirement plan for the self-employed. Ex. Deductions: A personal contribution to self-employed retirement/Koegh plan and the deduction of half of the self-employment tax.
Self-employment:
in addition to income tax, subject to Social Security tax at 15.3% until earned income from all sources reaches $87900. Ex. Income for a prize: must be listed on long form 1040 under “other income.” Gift from relatives does not appear on form because gifts are not considered taxable income. Interest on state and local debt would also not be taxed.
Maximize Deductions:
1) Using tax-deferred retirement programs. You don’t pay taxes on the money you invest and you do not pay interest on the earnings from your retirement account. Otherwise, from your $1000 you would first pay $250 in taxes and if you earn $75 in interest in the first year you pay $18.75 in taxes. In 25 years the difference is $4500 versus $11000 (or $8000 after taxes).
Maximize Deductions:
2) Using your home as a tax shelter. Mortgage interest payments are tax deductible and reduce your taxes. When you eventually sell your house, you are exempt from paying taxes on gains of up to $500,000 for couples filing jointly and $250,000 for those filing single on the sale of a principal residence. For those in the highest brackets, the deductible is worth much more and if you do not itemize deductions the tax deductibility of mortgage interest payments is of no value. If you would otherwise have itemized, the only difference is the difference between standard and itemized deductions. The amount this reduction in taxable income reduces your taxes is their value. In effect, the tax deductibility of mortgage interest payments reduces the cost of your mortgage by (1 – marginal tax rate).
The after-tax cost of a home mortgage
= before-tax cost of mortgage interest x (1- marginal tax rate).
(The value depends of payments depends on tax bracket and whether you itemize)
You can use your home as collateral, you can take out a home equity loan and deduct your interest payments. (Home equity interest is usu tax deductible versus interest on car loans.) Recalculating the cost of a home equity loan for an indiv in the 25% tax bracket on an after-tax basis becomes 6.9(1 – marginal tax rate).
3) Shifting and Bunching Deductions:
The decision between taking the standard deduc or itemizing becomes difficult when they are close in value. The concept of shifting and bunching deductions involves trying to avoid incurring deductible expenses in years that you don’t itemize. Postpone them to years when you do itemize and get credit for them.
Look to Capital Gains and Dividend Income:
If you hold an asset for a year or more, the gain is taxed at a max rate of 15% for taxpayers whose top tax bracket exceeds 15%, and 5% for taxpayers in the 10 and 15% brackets. Thus, if you were in the 35% bracket, you’d pay less than half. You also do not have to claim and pay taxes until you sell the asset. You also get a tax break on dividend income. Qualified dividends from domestic corp and qualified foreign corp are taxed at the same low tax rates as longterm capital gains. The max rate on qualified dividends is now 15% and for those in 10-15% brackets, the tax rate is only 5%.
Shift Income to Family Members in Lower Tax Brackets:
May involve lawyers and trusts (a fiduciary agreement in which one indiv holds property for the benefit of another person). Or, gifts; you are allowed to give $11,000 per year tax free to as many different people as you like. The person receiving the gift does not pay taxes either and every year you get another gift exclusion that allows you to give $11000 tax-free to as many different people as you like. It would be wise to give money little by little depending on your versus their tax brackets.
Receive Tax-Exempt Income
Interest paid on state and local govt debt is tax exempt for federal income tax purposes. If you buy a bond issued by a state or city (municipal bond), you can collect the interest and not have to pay taxes on it. Equivalent taxable yield = (tax-free yield on the municipal bond) / (1 – investor’s marginal tax bracket). The higher your bracket, the more beneficial tax-free income is.
Defer Taxes to the Future:
Traditional IRAs, Koegh plans, and 401K plans allow you to defer taxes. Roth IRAs allow taxes to be paid on the contribution and never again, so you can earn interest.
Chapter 5
Cash management:
the management of cash and liquid (near cash) assets.
Liquid assets: cash and investments that can easily be converted into cash, such as checking accounts, money market funds, and CDs. Risk-return trade-off: little risk but low return. Manage in order to avoid spending temptation.
Financial Institutions:
the passage of the Depositary Institutions Deregulation and Monetary Control Act of 1980, which allowed increased competition btwn banks and other financial institutions has resulted in a wide range of financial products for cash management.
Banks, or Deposit-type financial institutions. Commercial banks:
offer the widest variety of services (checking, savings, credit cards, safety deposit boxes, consulting, and lending. More branch offices than other institutions; build relationships with bankers. Online banking: access to your accounts; transfer funds, payments, check balance, download transaction information to your software. Some charge $4 – 6 a month.
Savings and Loan Associations, or thrifts:
Originally est to provide mortgage loans to depositors. Mutual (depositors are really the owners of the S&L. They receive dividends rather than interest on savings) and corporate (depositors receive interest rather than dividends like a commercial bank); technical difference, with dividends from mutual S&Ls treated as if they were really interest payments.
Savings and Loan Associations, or thrifts:
Since deregulation and the services offered by S&Ls and commercial banks have become very similar, with both offering almost identical savings alternatives. Saving accounts at S&Ls many times earn 1/4% more than savings at competing commercial banks. Laws require that at least 70% of the loans of federally chartered S&Ls go toward home mortgages; commercial banks invest the money they gather from depositors in many different ways. S&Ls operate on a smaller scale; however, from a depositor’s point of view, there is little difference.
Savings Banks:
Generally in northeastern US; most depositor owned, making them mutual savings banks. Like mutual S&Ls, they pay dividends rather than interest to their depositor/owners and their main purpose has been to provide mortgage funding to their depositors. Many S&Ls have changed their names in fact.
Credit Unions:
Depositor-owned financial institution, are not-for-profit cooperatives. Established by churches, universities, trade unions, corporations. Advantages: tax-exempt since they are non-for-profit organizations and are generally more efficient, smaller scale, higher interest payments. The tend to have lower fees and minimum balances; loans tend to be at favorable rates; convenience.
Nondeposit-Type
- Mutual fund companies, stockbrokerage firms, insurance companies, some firms; ex. Consumer loan with General Motors.
- Mutual funds: an investment fund that raises money from investors, pools that money, and invests it in a collection of stocks and/or bonds and is managed by a professional investment manager. Income is paid to fund owners in distributions.
Nondeposit-Type. Stockbrockerage Firms:
What to Look for in a Financial Institution:
traditionally only dealt with investments but recently introduced financial counseling, credit cards, money market mutual funds, competing with traditional banks.
What to Look for in a Financial Institution: Kinds of services; is your investment safe; costs and returns. Feel free to miss institutions.
Checking Accounts: Two types of checking accounts: interest bearing and non-interest bearing.
A non-interest bearing checking account is actually a demand deposit and can be offered only by a commercial banks. Usu the customer pays for the checking privilege by maintaining a minimum balance or being charged per check.
Interest-bearing checking accounts:
aka NOW (Negotiable Order of Withdrawal) Account. Although S&Ls cannot offer demand deposits, they can offer checking accounts but these must pay interest. Although you receive interest, you must maintain a high minimum balance in addition to paying a monthly fee. The fee represents a tax but so does the minimum balance (opportunity cost). Interest-bearing accounts generally pay less than other cash management alternatives; b/c the minimum balance forces you to hold more money in your checking account that usual (the forced balance), that checking account has an opportunity cost. (Not always preferable).
Savings Accounts:
aka time deposit b/c of minimum time period, is one step removed from a checking account in terms of risk-return trade-off; guaranteed fixed return. Less liquid and therefore more risky than a checking account and technically the bank could require a grace period before relinquishing those funds to you. Many savings accounts used to be called passbook accounts where they were registered. Statement accounts today.
Money market deposit
(MMDA) is an alternative to the savings account offered by commercial banks. Rather than a fixed rate, you receive a rate of interest that varies with the current market rate of interest; generally higher than the fixed rate on savings accounts. Some offer a limited check-writing service, generally three checks per month. Disadvantage versus savings accounts: high minimum balance, sometimes as much as $1000 and imposes penalties if your balance drops below this level. MMDAs usu pay less interest than do some of the other cash management alternatives such as CDs and mutual funds.
Certificates of Deposit
a savings alternative that pays a fixed rate of interest while keeping your funds on deposit for a set period of time, which can range from 1 month to years. The longer the higher the interest rate; if interest rates drop you still receive the promised rate, but also if they rise. Generally considered liquid assets; banks use them as a marketing tool to lure new customers by offering high interest rates; search nationally.
Money Market Mutual Funds (MMMFs):
invest in short term (generally w/ a maturity of less than 90 days) notes of very high denomination. Investors receive interest on a pool of investments less an administrative fee, which is usually less than 1% of the total investment. An MMMF draws together the savings of many individuals and invests those funds in a very large creditworthy debt issued by the govt or large corporations. Higher rate of return than individuals could afford; higher yield than money market deposit accounts of banks.
Rates vary between 2-17%; when rates are low the difference can drop to less than ½% versus several. Usu a minimum investment; limited check writing; money deposited by mail and withdrawn by writing a check versus savings accounts; pay more than savings.
Asset Management Account:
A comprehensive financial services package offered by a brockerage firm. Can include a checking account; credit card; MMMF; loans; automatic payment of any fixed debt such as mortgages; brockerage services (buying and selling stocks and bonds); and a system for the direct payment of interest, dividends, and proceeds from security sales into the MMMF. Advantages: automatically coordinates the flow of funds into and out of your MMMF; interest swept into MMMF to cover check. Annual service charge of $50 to $125, there is generally a rather large minimum balance required, ranging upward of $5000 in stocks and cash. The commissions paid on the sale of stocks associated with as asset management account may be much higher than other sources. **Weigh the service charge, high min balance, high commissions on any stock sales against their returns.
Treasury or T-bills:
short term notes of debt by fed govt ranging from 3 – 12 months; min denomination (face value that is returned to the bondholder at maturity, aka the bond’s par value) is $1000. No interest payment but appreciation. Extremely liquid investments and extremely safe; not subject to state or local taxes; but no high return (like CDs or money market mutual funds).
Govt savings bonds:
a type of security that is actually a loan on which you receive interest, generally over 6 months for the life of the bond. When the bond matures, you get back your investment/loan; the face value actually, although the amount you get could be more or less than what you paid for the bond originally. Range from $50 to $10000. Liquid because can be cashed at any time; safe; can only buy $30000 per person per year; ideally get double your money back. Not taxed at state/local level; taxes on interest can be deferred until redeemed; may be exempt from federal taxes if cashed to pay for college tuition and fees.** Convenience, purchased without fees or commissions. Not as good in comparison because of liquidity but good for longterm goals, just not emergencies.
Comparable Interest Rates:
Annual Percentage Yield: simple annual percentage yield that converts interest rates compounded for different periods for comparable annual rates. It allows you to easily compare interest rates. Truth in Savings Act. Actual balance or lowest monthly balance; most favorable if interest begins from the day you deposit it until you withdraw it.
Tax considerations:
After tax return = taxable return (1 – marginal tax rate) + nontaxable return. The higher your marginal tax bracket, the more you benefit from a tax-exempt investment. Calculate the return after both federal and state taxes. Ex. When calculating the after-tax return on a municipal bond that is tax exempt at the federal but not the state level you must adjust for state taxes.
Safety. Federal Deposit Insurance:
The FDIC (fed deposit insurance corp) insures deposits at commercial banks and S&Ls, and the National Credit Union Association insures credit unions. Today if your account is with a federally insured institution, it’s insured for up to $100,000 per depositor, not per account (ex. You can have $100,000 in checking again in savings, but you will only be insured for $100,000). However you can have one in your name and one in your spouse’s, or accounts in different ownership categories (single, joint, directed retirement accounts, or revocable trust accounts) all will be fully insured. You can also spread out your accounts among different fed insured banks.
Safety. Money Market Mutual Funds:
MMMFs are not insured by invested in a diversified portfolio of govt bonds guaranteed by the govt and short term corp bonds that are virtually risk free and can usu be predicted. Possible criminal activity of fund managers but are effectively monitored.
Establishing and Using a Checking Account.
Choose a financial institution, consider 3 Cs (cost, convenience, and consideration, and safety). The cost factor: min balance is usu $500 - $1000. Monthly fee: pay a fee regardless of your average balance and number of checks. Min balance: monthly fee depends upon how much cash you maintain; even if fee is waived you still pay the opportunity cost of having yoru funds tied up in the minimum balance with very low or no interest. Charge per check: total cost may be less than with a higher monthly fee and no charge per check. Balance-dependent scaled fees: fee declines depending on the average balance held. For NOW accounts, any interest helps offset fees and min balance requirements.
Convenience Factor:
: Safety deposit boxes (a storage unit at a bank or other financial instit in which valuables and important documents are stored for safe keeping; small fee, two keys needed one of which the financial institution has), direct deposit services (the depositing of payments such as payroll checks, directly into your checking account, electronically. Overdraft protection: an automatic loan made to your checking account; generally in $100 increments, usu high interest rates. Stop payment: an order you can give your financial institution to stop payment on a check you’ve written; small fee; effective for a limited time period but can be extended; if check is paid the financial institution is responsible.
Consideration Factor: Personal attention.
Balancing your checking account: keep track of every transaction; check for errors.
Check Clearing Act for the 21st C or Check 21: banks can substitute electronic checks for paper checks; paper substitute check is made from an electronic image of the check. You can go online to verify transactions. Money deducted from account sooner; items may be listed by check number of person you paid; bank may not return your canceled checks and your bank may charge you if you need a copy of a check to prove payment.
Cashier’s Check:
--Certified Check:
Cashier’s Check: check drawn on the bank/financial institution’s account; really a check from a bank which can only bounce if the bank doesn’t have the funds to cover it. Usually costs around $10 plus the amount of the check.
Certified Check: personal check that has been certified as good by the financial institution on which it’s drawn; funds equal to the amount of the check are then immediately frozen; cost usually $10 per check.
Money Order:
--Traveler’s Order:
Money Order: variation of cashier’s check except that it is generally issued by the postal service or other nonbanking institutions; fee varies.
Traveler’s Order: similar to cashier’s checks except that they don’t specify a specific payee, they come in specific denominations; issued by large financial institutions; accepted almost anywhere; riskless checks; generally replaced without charge; generally cost 1%.
Electronic funds transfer: EFT
EFT, any financial transaction electronically; ex. Debit cards. Advantage: not carrying cash; fast.
Automated Teller Machines: ATM or cash machine providing cash instantly and can be accessed through credit or debit card; cash is borrowed with credit cards. Swipe card and insert PIN; $3 per transaction; $2 for machine use. Crime in area but only liable for $50 if you notify bank immediately and $500 if you delay 2 days.
Debit cards:
--Smart cards:
Debit cards: a card that allows you to access money electronically in your account. Disadvantages: card blocking, use same card to pay the bill as in beginning of transaction.

Smart cards: aka memory cards or electronic wallets, variation of debit cards but withdrawing from an account stored magnetically in card. Can only be used by business issuing them.
Stored Value Cards:
gift cards, prepaid telephone cards. Single purpose/closed loop cards that can only be used in one store for one purpose and Multipurpose/open loop cards that can be used everywhere like a credit card and reloadable. Common as paychecks for Walmart, McDonald’s etc. Activation fees, maintenance fees, ATM transaction fees, reload fees, transaction limit fees, inactivity fees, dispute fees, and money transfer fees. WIDELY USED - BAD!
Fixing their mistakes:
human errors or computer errors; call bank immediately to report errors, otherwise settle disputes with Federal Reserve Board’s Division of Consumer and Community Affairs.
Chapter 6
Credit:
receiving cash, goods, or services with an obligation to pay later. Consumer credit: credit purchases for personal needs other than for home mortgages, this can include anything from an automobile loan to credit card debt.
Open credit or revolving credit:
lines of consumer credit extended before you make a purchase. Pay back debt whatever pace you like as long as you pay a specified minimum balance each month. Ex. Exxon charge card; around 7000 to choose from. Any unpaid balance plus interest on that unpaid balance carries over and becomes part of next month’s outstanding balance.
Interest rates:
annual percentage rate (APR); true simple interest rate paid over the life of the loan; only sometimes includes the loan application fee and usu not the cost of credit reports. Truth in Lending Act; some credit cards have fixed APRs (rate still varies b/c the credit card company needs to do is to inform you in writing at least 15 days before changing its rates) and some have variable APRs (usu charge prime rate plus a percentage). Some have teaser rates; most compound interest.
Calculating the Balance Owed
The method of determining the balance (or balance calculation method): varies; would not necessary if you had no outstanding balance. (71% of cardholders btwn 25-34 do not pay off their credit cards every month).
Three methods for determining interest charges on an unpaid balance
: 1) average daily balance method (used by 95% of cards; adds up daily balances for each day and then divides sum by number of days in billing period; interest payments are based on balance. 2) previous balance method (interest payments are charged against what you owed at the end of the previous billing period, with no credit given for this month’s payments; expensive) 3) the adjusted balance method (interest is charged against the previous month’s balance only after any payments have been subtracted; results in lower interest charges than the previous balance method).
Variations:
some calculate average daily balance including new purchases; others exclude them. Recent trend toward using a two-cycle average daily balance whenever entire balance is not paid off. Disadvantage: if you periodically pay off the entire balance.
Buying Money: the cash advance.
You pay interest immediately; often a higher rate than on normal purchases; usu an upfront fee of 2-4% of the amount; many require you to pay down the balance for purchases before you pay down the higher interest rate cash advance balance.
Grace period:
: the length of time, usu 20-25 days given to make a payment before interest is charged against the outstanding balance on a credit card. Then you’re charged the APR on the balance as determined by the credit card issuer. Cash advances usu have no grace period; ¼ of credit cards have no grace period. With most cards, if you do not completely pay off all your previous month’s borrowing, then the grace period does not apply and you begin paying interest immediately, even if only a penny remains.
Annual fee:
a fixed annual charge imposed by a credit card; ranging from $10-100; Am Express Platinum card charges $300. Most do not have an annual fee and others not if you use the card at least once per year. Merchant’s discount fee: percentage of the sale that the merchant pays to the credit card issuer (1.5-5% or even 10%).
Additional Fees: Cash advance fee; late fee; over-the-limit fee (average $30); penalty rates (if you do not make your minimum payments on time); changes in policies and rates (bill stuffers enclosed).
The pros and cons of credit cards:
convenience, necessary, use before paying especially if prices go up later, free extended product warranties and travel insurance possible.
Drawbacks: too easy to spend money, high rate of interest, obligating future income.
Choosing a source of open credit:
Bank credit cards: credit card issued by a bank or large corp, ex. AT&T. Many provide rental-car damage coverage for example. Annual fee.
Bank card variations: premium or prestige credit cards: such as MasterCard Platinum Card which offer credit limits as high as $100,000 or more and benefits such as emergency medical and legal services, travel insurance, rebates, warranties on new purchases; Titanium cards.
Choosing a source of open credit:
Affinity cards: a credit card issued in conjunction w/ a specific charity or organization. It carries the sponsoring group’s name and/or picture and sends a portion of the annual fee or a percentage of the purchases back to the org. But are expensive; annual fees start at $20; a large part of your charitable donation actually is donated to the issuing bank and is not tax deductible.
Secured credit cards: a credit card backed by the pledge of some collateralized asset; ex. CD.
Travel and Entertainment Cards (T&E):
credit cards initially meant for business customers to allow them to pay for travel and entertainment expenses, keeping them separate from their other expenditures; now used like traditional bank credit cards but do not offer revolving credit and require full payment of balance each month; interest-free grace period. Annual fee, up to $300, and merchant’s discount fee on each purchase.
Single-purpose cards:
--Traditional charge account
Single-purpose cards: a credit card that can be used only at a specific company; ex. Texaco. Terms vary dramatically; some allow for revolving credit but usu have no annual fee.
Traditional charge account: a charge account vs a credit card, that can be used to make purchases only at the issuing company. Ex. Phone and utility companies with grace periods; open credit accounts with no cards involved; expected to pay in full; convenient; interest-free grace period.
Credit users:
--Credit Evaluation:
Credit users: Low APR; Convenience user: long grace period, low annual fee, free benefits; both: all of the above.

Credit Evaluation: Character: responsibility in respect to debt payment, how long you’ve lived at one address, how long you’ve held your current job. Stability often passes for character.
Credit Evaluation: Capacity
Capacity (your current income level and your current level of borrowing – your level of nonobligated income; your total debt payments including mortgage should account for less than 36% of your gross pay**) and capital (size of your financial holdings or investment portfolio. Collatoral: assets or property offered as security to obtain credit. Conditions: the impact the current economic environment may have on your ability to repay any borrowing; ex being laid off because of economy.
Credit scoring:
involving the numerical evaluation of applicants. Public record and collection items: public record information collected from state and county courts, and information on overdue debt from collection agencies. Public record information includes bankruptcies, foreclosures, suits, wage attachments, liens, and judgments.
Factors that determine your credit score:
1) you payment history (35%) 2) amount you owe and your available credit (30%: amount you owe on your credit cards, your mortgage, car loans, outstanding debt, total available credit account.)
Factors that determine your credit score:
3) length of credit history (15%: the longer you have accounts open and the longer with the same creditors) 4) types of credit used (10%: the wider the variety of credit, good to have different types of credit outstanding) 5) new credit (10%: recently making a lot of applications for credit as when heading toward bankruptcy).
Monitoring your credit score
1) No errors; the Fair and Accurate Credit Transactions Act (FACT Act) allows you to request one free copy of your credit report each year from Experian, Equifax, and Trans Union. 2) Can order another from myfico.com or credit bureaus directly. Apparently 79% the credit reports it surveyed contained either serious errors or other mistakes and 25% were significant enough to result in denial of credit such as false delinquencies.
Credit Bureau and your rights
FCRA limits the length of time damaging information can remain in your file. Bankruptcy information can remain in your file for only 10 years and other negative information after 7 years.
If credit card application rejected.
1) You can apply for a card with another financial institution. 2) Find out why.
Resolving billing errors
Fair Credit Billing Act (FCBA) provides a procedure for correcting billing errors, you are allowed to withhold payment. You must notify card issuer in writing within 60 days of the statement date; sent to “billing inquiry.” Should receive notice of investigation in 30 days and card issuer has 90 days (two billing cycles). Dispute within grace period; contact regulatory agency or attorney.
Identity theft:
occurs when someone uses your name, address, soc sec number, bank or credit card account number, or other identifying information without your knowledge to commit fraud or other crimes. Pretexting: getting your personal information under false pretenses such as surveys.
Signs of identity theft:
Dumpster Diving. They rummage through trash looking for bills or other paper with your personal information on it.
Skimming. They steal credit/debit card numbers by using a special storage device when processing your card.
Phishing. They pretend to be financial institutions or companies and send spam or pop-up messages to get you to reveal your personal information.
Changing Your Address. They divert your billing statements to another location by completing a change of address form.
Old-Fashioned Stealing. They steal wallets and purses; mail, including bank and credit card statements; pre-approved credit offers; and new checks or tax information. They steal personnel records, or bribe employees who have access.
Pretexting. They use false pretenses to obtain your personal information from financial institutions, telephone companies, and other sources.
Receiving a credit card you didn’t apply for; denied credit or offered less favorable credit; receive calls or letters from debt collectors or businesses; fail to receive bills.
Step 1) contact fraud depart of major credit bureau to place fraud alert on your credit file.
2) close accounts 3) file a police report 4) file a complaint with the FTC at the govt’s consumer information site.
Reducing your balance
Beginning in 2006 most cards require that you pay 4% of your outstanding balance monthly; if you pay 18% of interest you are getting nowhere.
Protecting against fraud
Charges made before you report it missing, your liability is limited to $50 per card. Avg time: 30 hours. Save all of your receipts, compare, destroy receipts with credit card number. Do not give out your credit card number over the telephone unless you initiated the sale and private land line. Never leave a store without your card.
Trouble signs in credit card spending
Do you make only the min payment each month? Have you reached your spending limit? Pay for dinner for friends and have them reimburse you with cash? Do you wait for your monthly bill to determine how much you have charged on your credit card rather than keep track as spending occurs? Do you get cash advances? Have you been turned down for credit? Have you used savings to pay off credit card bills? Do you know how much of bill is from interest? Are you worried about your credit card bill?
If you cannot pay your credit card bills
Budget; make sure you have the least expensive credit card fitting your usage habits; might consider using savings only once to pay off card debt (average interest rate on unpaid balance is 16%). Use a secured loan or home equity loan to pay off.
Chapter 7
Single payment or balloon loan:
Generally used as *bridge or interim loans*
a loan paid back in a single lump-sum payment at maturity, or due at the end of the loan. Have relatively short maturity of less than one year. Payment is usu difficult by requiring access large sums of money when maturing. Generally used as *bridge or interim loans* to provide short term funding until longer-term or additional financing is found. Ex. Financing the building of a house with the mortgage loan being used to pay off the bridge loan and provide more permanent funding.
An installment loan
calls for repayment of both interest and principal at regular intervals, with the payment levels set so that the loan expires at a preset date. The amount of the monthly payment going toward interest starts off large and steadily decreases, while the amount going toward the principal start off small and steadily increases. As you pay off more of the loan your interest expenses decline and your principal payment increases – loan amortization. Installment loans are very common, for ex. to finance cars, appliances, etc.
Secured loans:
guaranteed by a specific asset which can be seized and sold to cover the amount due. Often the asset purchased with the funds from the loan is used for security, such as the car you borrowed money for. Repossessed collateral may not cover what you owe and you may still owe money. Other assets commonly used as security for a loan are CDs, stocks, jewelry, land, and bank accounts. Securities reduce lender risk, so lenders charge a lower rate on a secured loan than they would on a comparable unsecured loan.
An unsecured loan requires no collateral. In general, larger unsecured loans are given only to borrowers with excellent credit histories., b/c the only security the lender has is the promise. The big disadvantage of unsecured loan is that they’re quite expensive.
Fixed interest rate loan:
not tied to market interest rates; this represents the vast majority of consumer loans.
Variable or adjustable interest rate loan:
is tied to market interest rate, such as the prime rate or the 6 month Tbill rate. The prime rate (the interest rate banks charge to their most creditworthy customers. Most are set above the prime rate or the Tbill rate. Rates may be adjusted at different but fixed intervals. Usually have rate caps; the periodic cap limits the max amount the rate can jump during one adjustment. The lifetime cap limits the amount the rate can jump over the life.
Neither one is necessarily better; fixed rate loans generally cost more than variable rate loans.
A convertible loan:
a variable rate loan that can be converted into a fixed rate loan at the borrower’s option at specified dates in the future. Much less common than variable or fixed rate loans, but offer advantages of the lower cost of a variable rate loan along with the ability to lock into the savings of a fixed rate loan.
The loan contract:
spells out all conditions of the loan in exhaustive detail. If the item purchased is to be used as collateral for the loan, then the contract will contain a security agreement saying so. The security agreement identifies whether the lender or borrower retains control over the item being purchased. The formal agreement stating the payment schedule and the rights of both lender and borrower in the case of default (failure to make scheduled interest or principal payment) are outlined in the note (formal document outlining legal obligations of lender and borrower). The security agreement is standard on secured loans. Other clauses: insurance agreement clause, acceleration clause, deficiency payment clause, and recourse clause.
Insurance agreement clause:
you’re required to purchase credit life insurance to pay off the loan in the event of your death. For you, credit life insurance adds nothing to the loan other than cost. The lender benefits.
Acceleration clause:
if you miss one payment, the entire loan comes due immediately. If at that time you cannot pay off the entire the entire loan, the collateral will be repossessed and sold to pay off the balance due. Acceleration clauses are standard in most loans. However, lenders usu won’t immediately invoke the acceleration clause but instead will allow you a chance to make good on overdue payments.
Deficiency payments clause:
if you default on a secured loan, not only can the lender repossesses whatever is secured, but also if the sale of that asset doesn’t cover what you owe, you can be billed for the difference. (Ex. Collection, selling costs, attorney fees)
Recourse clause
defines what actions a lender can take to claim money from you in case you default. The recourse clause may allow the lender to attach your wages, which means that a certain portion of your salary would go directly to the lender to pay off your debt.
Home equity loan:
Aka Second mortgage
Aka Second mortgage: special type of secured loans that uses the built-up equity in your home as collateral against the loan. Generally you can borrow from 50-85% of your equity – your home value minus your first mortgage.
Advantages of home equity loans:
cost; interest is generally tax deductible up to a max of $100,000, provided the loan doesn’t exceed your home’s market value. For every dollar of interest your taxable income is lowered $1. After-tax cost of a home equity loan: before tax cost (1 – marginal tax rate). Also, they usu carry a lower interest rate than other loans and are secured making them less risky for lenders.
Disadvantages: they put your home at risk; limits future financing flexibility.
Student loans:
have low, federally subsidized interest rates given based on financial need. Most popular: Federal Direct/Stafford and PLUS Direct/PLUS Loans. Under Direct Loan Programs and federal govt makes loans directly to students and parents (PLUS Direct Loans) though the school, whereas under the Stafford and PLUS Loan Programs, he loans are made by private lenders such as banks and credit unions.
Student loans:
Close to 1/5 of all undergraduates receive these loans. The rates on Stafford loans are capped at 8.25%. PLUS Direct and PLUS Loans are for parents and the max amount is based on the total budgeted cost of education minus other financial aid, and parent’s creditworthiness; capped at 9%; but you start repaying immediately. Eligibility for deduction is phased out for single filers with AGIs over $50,000.
Automobile loan:
secured loans made specifically for the purchase of an automobile, with the automobile being purchased used as collateral. Generally short term, only 24-48 months.
Cost and Early Payment of Consumer Loans:
finance charges include: interest payments, loan-processing fees, fees for a credit check, and any required insurance fees. APR (annual percentage rate): the simple percentage cost of all finance charges; this includes noninterest finance charges.
Payday loans:
given by check cashing companies, usu $100-$500 to tide you over for 1-2 weeks, or until payday. May pay close to 800% interest.
Cost of single-payment loans: Loan Disclosure Statement:
a statement that provides the APR and interest charges associated with a loan.
Simple interest method: Interest: principal x interest x time
--Discount method:
Discount method: the entire interest charge is subtracted from the loan principal before you receive the money, and at maturity you repay the principal; you loan less b/c the interest is prepaid. The APR is larger when money is lent under the discounted method than when it’s lent under the simple interest method b/c you receive less than the stated principal.
Cost of installment loans:
repayment of both the interest and the principal occurs at regular intervals, with payment levels set so that the loan expires at a preset date. Use either simple interest or the add-on method to determine payments.
Cost of installment loans.
Simple interest method:
the most common method of calculating payments on an installment loan. Monthly payments remain the same each month, but the portion of your monthly payment that goes toward interest declines each month and more goes toward principal.
Add-on method
interest charges are calculated using the original balance. These charges are then added to the loan, and this amount is paid off over the life of the loan. Quite costly and should be avoided; usu results in an APR close to twice the level of the stated interest rate, b/c you are paying interest on the original principal over the entire life of the loan. N-ratio method can be used.
Early payment:
Under simple interest method: interest is paid only on the remaining principal so it’s relatively easy to determine how much principal remains to be repaid. Under the add-on method: if you want to repay an interest installment early, some provision should be made in the loan contract for calculating the unpaid principal. The rule of 78s or sum of the year’s digits is used.
Relationship of payment, interest rates, and term of the loan:
The trade-offs involved in maturity are lower payments and higher total finance charges versus a quicker elimination of the loan and lower finance charges.
Sources of consumer loans. Inexpensive sources:
your family; home equity and other types of secured loans are also relatively inexpensive b/c the lending agency has an asset to claim if you cannot pay up. The downside: you cannot take additional first loans out on them and lose financial flexibility.
More expensive sources:
Credit unions, S&Ls, and commercial banks are good sources. Depends on type (secured or unsecured), length of loan, variable or fixed.
Most expensive sources:
retail stores on purchases are quite expensive; generally need a solid credit rating.
Other than improving your credit rating, there are four ways to reduce the lender’s risk:
1) use a variable rate loan 2) keep the term of the loan as short as possible 3) provide collateral for the loan 4) put a large down payment toward anything being financed.
Debt limit ratio: t
: total monthly nonmortgage debt payments/total monthly take-home pay. **Ideally you should keep this ratio below 15% for emergencies, etc. Once this ratio reaches 20% you should limit the use of any additional consumer debt. Many lenders use the 28/36 rule. If your total projected mortgage payments (including insurance and real estate taxes) fall below 28% of your gross monthly income, and your total debt payments including these mortgage payments plus any consumer credit payments fall below 36%, you are a good credit risk.
Debt resolution rule:
consumer credit should be short term; if it lasts over 4 years, it’s not short term.
Controlling consumer debt:
1) Budget 2) self-control in the use of credit. See a credit counselor. Consider using savings to pay off current debt, only once: if you are only earning 4% taxes on savings and using savings to pay off consumer debt at 10-12% may be good. Another alternative: a debt consolidation loan (used to pay off all your current debts; lower your monthly payments.) Final alternative is bankruptcy, 1.6 million nationwide in 2004 (1.5% of households).
Payday loans:
given by check cashing companies, usu $100-$500 to tide you over for 1-2 weeks, or until payday. May pay close to 800% interest.
Cost of single-payment loans: Loan Disclosure Statement:
a statement that provides the APR and interest charges associated with a loan.
Simple interest method: Interest: principal x interest x time
--Discount method:
Discount method: the entire interest charge is subtracted from the loan principal before you receive the money, and at maturity you repay the principal; you loan less b/c the interest is prepaid. The APR is larger when money is lent under the discounted method than when it’s lent under the simple interest method b/c you receive less than the stated principal.
Cost of installment loans:
repayment of both the interest and the principal occurs at regular intervals, with payment levels set so that the loan expires at a preset date. Use either simple interest or the add-on method to determine payments.
Cost of installment loans.
Simple interest method:
the most common method of calculating payments on an installment loan. Monthly payments remain the same each month, but the portion of your monthly payment that goes toward interest declines each month and more goes toward principal.
Add-on method
interest charges are calculated using the original balance. These charges are then added to the loan, and this amount is paid off over the life of the loan. Quite costly and should be avoided; usu results in an APR close to twice the level of the stated interest rate, b/c you are paying interest on the original principal over the entire life of the loan. N-ratio method can be used.
Early payment:
Under simple interest method: interest is paid only on the remaining principal so it’s relatively easy to determine how much principal remains to be repaid. Under the add-on method: if you want to repay an interest installment early, some provision should be made in the loan contract for calculating the unpaid principal. The rule of 78s or sum of the year’s digits is used.
Relationship of payment, interest rates, and term of the loan:
The trade-offs involved in maturity are lower payments and higher total finance charges versus a quicker elimination of the loan and lower finance charges.
Sources of consumer loans. Inexpensive sources:
your family; home equity and other types of secured loans are also relatively inexpensive b/c the lending agency has an asset to claim if you cannot pay up. The downside: you cannot take additional first loans out on them and lose financial flexibility.
More expensive sources:
Credit unions, S&Ls, and commercial banks are good sources. Depends on type (secured or unsecured), length of loan, variable or fixed.
Most expensive sources:
retail stores on purchases are quite expensive; generally need a solid credit rating.
Other than improving your credit rating, there are four ways to reduce the lender’s risk:
1) use a variable rate loan 2) keep the term of the loan as short as possible 3) provide collateral for the loan 4) put a large down payment toward anything being financed.
Debt limit ratio: t
: total monthly nonmortgage debt payments/total monthly take-home pay. **Ideally you should keep this ratio below 15% for emergencies, etc. Once this ratio reaches 20% you should limit the use of any additional consumer debt. Many lenders use the 28/36 rule. If your total projected mortgage payments (including insurance and real estate taxes) fall below 28% of your gross monthly income, and your total debt payments including these mortgage payments plus any consumer credit payments fall below 36%, you are a good credit risk.
Debt resolution rule:
consumer credit should be short term; if it lasts over 4 years, it’s not short term.
Controlling consumer debt:
1) Budget 2) self-control in the use of credit. See a credit counselor. Consider using savings to pay off current debt, only once: if you are only earning 4% taxes on savings and using savings to pay off consumer debt at 10-12% may be good. Another alternative: a debt consolidation loan (used to pay off all your current debts; lower your monthly payments.) Final alternative is bankruptcy, 1.6 million nationwide in 2004 (1.5% of households).
MMMF
(PROFESSOR'S EMAIL AND PRESENTATION!!)
"... by pooling investments, investors can purchase higher-priced investments and, thus, earn a higher rate of return than they could get individually. MMMF almost always have a higher yield than do bank money market deposit accounts."
It states that the fund invests in higher yielding investments - T-bills, CDs, CP, etc. - and that therefore over time the total return that investors earn will be higher.
The confusion today was unfortunate, but it also underscores how very important it is that I see the presentations beforehand so that we can get rid of any mistakes, misunderstandings, obfuscations, etc.
When we get into investments in our second half, you will more clearly see the distinction between yield and return, but that is also why I want to make sure you understand the difference now.
Chapter 13: Wage earner plan and Chapter 7: Straight bankruptcy. (Chapter 11 is intended for businesses and accommodates those who exceed ch 13 debt limitations or lack regular income. Ch 12 is a special purpose personal bankruptcy only for family farmers.) Ch 7: Who can file:
if you make less than the median income in your state, have less than $100 a month of disposable income, or do not have enough disposable income to repay at least 25% of your debt over 5 years. Assets are liquidated to pay off creditors; however, filers generally are able to keep their car and some basic household possessions, w/ the homestead exemptions limited to $125,000 if the property was acquired w/ in the previous 3.3 years. Remains in credit file for 10 yrs.
Ch 13:
If you make more than the median income in your state, have more than $100 a month of disposable income, or have enough disposable income to repay at least 25% of your debt over 5 years. You design a repayment schedule so you can continue to cover normal expenses while still meeting the repayment schedule. Assets are not liquidated, and disposable income after living expenses is used to pay off debt over a 3-5 yr period. Remains on credit file for 7 years from the end of repayment.
Chapter 8
Smart buying:
Step 1: differentiate want from need; step 2: do you homework; step 3: make your purchase; step 4: maintain your purchase.
Making your purchase: See retain price, resale values, insurance premium info, reviews, evaluations. The factory invoice price is important in determining how much the dealer pays for the car, but it isn’t the whole story b/c the dealer receives a holdback* from the manufacturer.
Holdback:
amounts to 2-3% of the vehicle price; the average markup is over 6%. Some cars have rebates or additional dealer incentives. The Center for the Study of Services’ Car Bargains Service will give competitive bids from local dealers for a couple hundred dollars. For used vehicles see the Blue Book and National Automobile Dealers Association’s guide.
Financing alternatives:
higher payments for shorter time. Leasing: less than $15000 miles/yr. One-third of all new vehicles are leased and 50% of expensive model.
Two basic types of leases:
closed-end leases: 80% of all new leases. Aka walk-away leases. Many contain a purchase option for its residual value or fixed price in lease.
Open-end lease: when lease expires, the current market value of the vehicle was estimated to be as specified in the least contract. If worth less, you pay the difference. Not advantageous.
For closed-ended leases
the value of the vehicle you’re leasing is expected to decline; pay finance charges, depreciation charges, rent charge; depends on length of lease.
- Negotiate a fair agreed upon value; announce leasing interest after price is negotiated. The warranty must cover the entire least period; define “normal wear and tear”; insurance protection that would cover any early termination penalty.
- Find a vehicle that does not depreciate quickly; you may pay less on a more expensive car that depreciates slowly.
- Find one with a low rent or finance charge.
- Compare same time frame for buying or leasing a vehicle for 2 years.
Step 4: maintain your purchase.
- Choose a repair facility early. Lemon laws: if you make at least 4 attempts to fix your problem and your car is out of service for at least 30 days during the first year after purchase or the first 1200 miles – entitled to a refund.
House buying
- Usu are 25% of people’s after-tax income.
Options:
House: space, privacy, control, build equity/wealth, but repair/maintenance.
Cooperatives: co-ops;
an apartment building or group of apartments owned by a cooperation in which the residence are stockholders; you have the right to occupy your unit for as long as you own stock. Tough getting a mortgage (stock as collateral?). Pay monthly homeowner’s fee: maintenance of building, grounds, paying taxes.
Less potential for capital appreciation and can be difficult to sell.
Condominium:
apartment or complex for indiv ownership of dwelling units and joint for common areas. Still pay maintenance fees (includes taxes, water).
Recent variation: planned unit developments (PUD): esp West coast; own home and land; share development.
Apartments and rental:
affordable, low maintenance, little commitment, lack of choices (pet, remodeling).
One-Time costs:
down payment: the buyer’s equity usu 20% but alternatives (private mortgage insurance, covers lender if you default, you can pay as little as 5% down).
Closing or settlement costs: 3-7% from house (points/discount points: 1% - trade offs btwn interest rate and points which are tax deductible); loan origination fee (1 pt – reviewing loan, not deductible b/c not interest); loan application fee (usu $200-300, processing); appraisal fee (est; $200-300); other costs (title search, attorney fee, notary fee, your credit report, termite inspection).
*One time costs: 24% of house cost. Not included in calculations. Lender can change APR by 1/8 percent before settlement w/o notice.
Recurring costs:
monthly mortgage – made up of 4 costs – PITI. **Principle, interest, taxes, insurance. Escrow account: a reserve account in which funds are depositied, generally on a monthly basis, and accumulate over time until they are drawn out to pay taxes and insurance. Your PITI costs: should not exceed 28% of your pretax monthly income.
Maintenance and operating costs.