Personal finance: the process of planning individual’s spending, financing and investing to optimize his financial situation.
Personal financial plan – a plan that specifies individual’s financial goal and describes the spending, financing, and investing plans that are intended to achieve those goals.
Opportunity cost – what you give up as a result of a decision.
+ Every spending decision has an opportunity cost
Budget planning – the process of forecasting future expenses and savings
Components of a financial plan
1, Budgeting and tax planning – manage the income, determine how much to save, in general or towards a specific purchase.
2. Managing your liquidity – how much should be in checking/saving account and credit card account.
3. Financing your large purchases – Should borrow money or not.
4. Protecting your assets and income (insurance)
5. Investing your money – in securities or real assets
Evaluate your current financial position
* Assets – everything that you have ownership to
* Liabilities – what you owe
* Net worth – the value if what you own minus the value of what you own
Manage liquidity
Liquidity – access to funds to cover any short-term cash deficiencies. Liquidity can be enhanced by using money management and credit management.
* Money management – decisions regarding how much money to retain in a liquid form and how to allocate the funds among short term investment instruments.
* Credit management – decisions regarding how much credit to obtain to support your spending and which sources of credit to use.
A plan for protecting your assets and income
*any funds you have beyond what you need to maintain liquidity should be invested
-stocks
-bonds
-mutual funds
-real estate
-insurance
All investments are subject to risk
RISK – uncertainty surrounding the potential return on an investment
*manage investments to maximize return subject to an acceptable level of risk
Develop the financial plan
Step 1 – establish your financial goals
• types of goals
• set realistic goals – stronger likelihood of reaching goals
• timing of goals – short term(< 1year); intermediate(1-5 years); long term (>5years)
Step 2 – consider your current financial position
• how your future financial position is tied to your education and career choice
Step 3 – identify and evaluate alternative plans that could achieve your goals. Plans could be conservative, moderate, and aggressive
Step 4 – select and implement the best plan for achieving your goals
Internet provides information on all aspect of financial planning, such as deposit rate
Chapter 2 Planning with Personal Financial Statement
Personal cash flow statement – a financial statement that measures a person’s cash inflows and cash outflows over a specific time period.
Net cash flow = Cash inflows – Cash outflows
Factors that affect cash inflow – stage in career path, type of job
Factors that affect cash outflow – age, personal consumption behavior
Budget – a cash flow statement that is based on forecasted cash flows for a future time period.
Budget is useful for anticipating either cash surpluses or cash deficiencies. The budgeting process allows you to compare your forecasted and actual income and expenses, helping to control spending. The analysis will help you modify your spending in the future or adjust you future budgets.
Personal balance sheet: A summary of your assets, your liabilities, and your net worth.
Balance sheet reflects your financial position at a specific point in time.
Assets
• Liquid assets – financial assets that can be easily sold without a loss in value, such as cash, checking account, saving account.
• Household assets – items normally own by a household, such as a home, car, and furniture.
• Investments
o Bonds – certificates issued by borrowers to raise funds
o Stocks – certificates representing partial ownership of a firm.
o Mutual funds – investment companies that sell shares to individuals and invest the proceeds in investment instruments such as bonds or stocks.
o Real estate – land and rental property(housing or commercial property that is rented out to others)
Liabilities
• current liabilities – debt that will be paid within a year
• Long-term liabilities – debt that will be paid over a period longer than one year.
Net worth = value of total assets – value of total liabilities
Analysis of the personal balance sheet
Liquidity
Liquidity ratio = liquid assets/ current liabilities
Eg, if a person’s liquidity ratio is o.o1, it indicates that he has one cent for every dollar of current liability. The ratio is good to be greater than 1.
Debt Level
Debt-to-Asset ratio = total liabilities/total assets
A debt-to-asset ratio of 700 percent indicates an overwhelming debt level. If the ratio is higher than desirable, it might lead to repayment problems.
Saving rate
Savings rate = savings during the period/disposable income during the period
Chapter 3 Applying Time Value Concepts
The objectives of this chapter are to:
* calculate the future value of a dollar amount that you save today
* calculate the present value of a dollar amount received in the future
* calculate the present and future value of an annuity
Annuity – a series of equal cash flow payments that are received or paid at equal intervals in time.
Compounding – the process of earning interest on interest.
Future value interest factor (FVIF) – a factor multiplied by today’s savings to determine how the savings will accumulate over time. It indicates that the longer time period of investment and the higher the rate of return, the more money grows.
Discounting – the process of obtaining present values.
Present value interest factor (PVIF) – a factor multiplied by a future value to determine the present value of that amount.
Annuity due – Series of equal cash flow payments that occur at the beginning of each period.
Timelines – diagrams that show payments received or paid over time. Treat every payment individually, and then add up the individual future values.
Future value interest factor for an annuity – a factor multiplied by the periodic savings level (annuity) to determine how the savings will accumulate over time.
Present value interest factor for an annuity (PVIFA) – it determines the present value of a periodic savings level.
Financial Calculator
N – Numbers of period (weekly, monthly, annually)
I – interest rate (When annual interest rate is 12, monthly interest rate is 12/12= 1)
PV – present value, which is the initial amount deposited
PMT – payment
FV – future value of the deposit made today
FVA/FVIFA = PMT
Chapter 4 using tax concepts for planning
The objectives of this chapter are to:
- explain how to determine your tax filing status
- demonstrate how to calculate your gross income
- show how deductions and exemptions can be used
- determine taxable income, tax liability and refund or additional taxes owed
• Earned income (wage or salary is subject to FICA (Federal Insurance Contributions Act) taxes that fund Social Security (6.2% of salary up to 84800, self-employed pay 15.3% of income) and Medicare (1.45% of entire income).
• Income is also subject to Personal Income Tax.
• Contributions to your employer-sponsored retirement account, whether made by you or your employer, are not subject to income taxes until those funds are withdrawn from the account.
Gross income – all reportable income from any source, including salary, interest income, dividend income, and capital gains received during the tax year. (Tips, prizes, awards, and scholarships that exceed tuition fee also counts)
• Interest income – interest earned from investments in various types of savings accounts at financial institutions, from investments in debt securities such as treasury bonds, or from providing loans to other individuals. Note that interest income earned from investments in municipal bonds issued by state and local government agencies is normally excluded from federal taxation.
• Dividend income – income received in the form of dividends paid on shares of stock or mutual funds.
• Capital gain – income earned when an asset is sold at a higher price than was paid for the asset, such as stocks, debt instruments, and land.
o Short-term capital gain – a gain on asset that was held <12 months. Capital gain tax on short-term capital gain is based on marginal tax rate, as if it were additional income.
o Long-term capital gain – held > 12 months. Tax is lower than short-term.
o Capital gains tax – the tax that is paid on a gain earned as a result of selling an asset for more than the purchase price.
Salary + interest income + dividend income + capital income = Gross Income
Adjusted gross income – adjusted gross income for contributions to IRAs, alimony payments, interest paid on student loans, and other special circumstances.
Standard deduction – a fixed amount that can be deducted from adjusted gross income to determine taxable income. The amount of the standard deduction is not affected by the amount of income you earned during the year; instead it varies according to your filling status and whether you are over age 65.
Marriage penalty – term used to describe the fact that many two-income married people pay more in taxes than if they were single.
Itemized deductions – specific expenses that can be deducted to reduce taxable income.
* Interest expense – when people borrow money or take loans, the annual interest payments are an itemized deduction.
* State and local tax – many states impose a state income tax on people who receive income from employers in that state.
* Real Estate Taxes – owners of homes or other real estate are subject to a real estate tax imposed by the country where the property is located.
* Medical expense – people who incur a large amount of unreimbursed medical expense may deduct the expenses. However, only the amount above 7.5% gets deducted.
* Charitable gifts – charitable gifts made to qualified organizations.
* Other expenses – a loss due to casualties or theft and major job-related expenses.
Itemized Deductions = interest income + state income taxes + real estate taxes + unreimbursed medical + charity
If the itemized deductions exceed his standard deduction, he should take the itemized deduction in lieu of the standard deduction, vice versa.
Personal exemption – an allowance amount by which taxable income is reduced for each person supported by income reported on a tax return.
Taxable income – taxable income is equal to adjusted gross income (AGI) minus deductions and exemptions.
Taxable Gross Income = adjusted gross income – deductions – exemptions
Tax Liability = Tax on base +[ percentage on excess over the base * (taxable income – base)]
Tax credits – specific amounts used to directly reduce tax liability. Tax credits offset taxes, as the full amount of the tax credit is subtracted from taxes owed. A dollar’s worth of tax credits is more valuable than a dollar’s worth of deduction.
* Child credit – a tax allowed for each child in a household. It’s not available to households above certain income levels.
* College expense credits – a tax credit allowed to those who contribute toward their dependents’ college expenses. Self-supporting students can use the tax credits to reduce their own taxes.
* Coverdell savings accounts – tax-free accounts that can be used for a variety of school expenses.
* earned income credits – a credit used to reduce tax liability for low-income taxpayers.
© When calculate one’s tax liability
1. Find his gross income
Gross income = salary (after retirement contribution) + interest income + dividend income+ long-term capital income + short-term capital income
2. Find his adjusted gross income
If no contribution to an IRA account, AGI is not deducted.
3. Calculate his standard deduction
If he’s married and under 65, his standard deduction is 10000. He can choose to use standard deduction or itemized deduction.
4. Calculate his itemized deduction
Deduction total = interest expense + state income taxes + real estate taxes + medical +charity
5. Calculate exemption
Personal exemption + exemption for spouse and dependents
6. Outcome
Taxable income = adjusted gross income – deductions – exemptions
7. Calculate
Tax Liability = tax on base * [percentage on excess over the base * (taxable income – base)]
8. If there is any long-term capital gain
If he has a long-term capital gain, based on his taxable income amount, he is subject to a long-term capital tax rate. There his total tax liability will be
Total Tax Liability = tax liability + capital gain tax
Chapter 5 banking and interest rates
Two major financial institutions:
Depository institutions – financial institutions that accept deposits (which are insured up to a maximum level) from individuals and provide loans. They pay interest on savings deposits and charge interest on loans.
* Commercial banks – financial institutions that accept deposits and use the funds to provide commercial (business) and personal loans
* Savings/theift institutions – financial institutions that accept deposits and provide mortgage and personal loans to individuals
* Credit unions – nonprofit depository institutions that serve members who have a common affiliation (such as the same employer or the same community)
Nondepository institutions – financial institutions that do not offer federally insured deposit accounts, but provide various other financial services.
* Finance companies – it specializes in providing personal loans to individuals.
* Securities firms – it facilitate the purchase or sale of securities by firms or individuals by providing investment banking services and brokerage services.
* Insurance companies – it provided insurance to protect individuals or firms from possible adverse events.
* Investment companies – it sells shares to individuals and use the proceeds to invest in securities to create mutual funds.
Financial conglomerates – financial institutions that offer a diverse set of financial services to individuals or firms, such as Citigroup, Merrill Lynch.
Check float – The time from when you write a check until your checking account is reduced is referred to as the float.
Debit card – a card that is used to make purchases that are charged against a checking account.
Automatic Tell Machine – ATM
Cashier’s check – a check that is written on behalf of a person to a specific payee and will be charged against a financial institution’s account.
Money order – a check that is written on behalf of a person and will be charged against an account.
Traveler’s check – a check that is written on behalf of an individual and will be charged against a large well-known financial institution or credit card sponsor’s account.
Certificate of deposit – an instrument that is issued by a depository institution and specifies a minimum investment, an interest rate, and a maturity.
Risk-free rate – a return on an investment that is guaranteed for a specified period.
Risk premium – an additional return beyond the risk-free rate that can be earned from a deposit guaranteed by the government.
Risk premium = Specific return – risk-free rate
RP= R-Rf
Term of structure of interest rates – the relationship between the maturities of risk-free debt securities and the annualized yields offered on those securities. It’s often based on rates of return (or yields) offered by Treasury securities (which are debt securities issued by the US treasury)
Why Interest rates change?
Because the interest rate is influenced by the interaction between the supply and the demand for funds.
* Shift in monetary policy – the money supply consists of demand deposits (checking accounts) and currency held by the public. The US money supply is controlled by the Federal Reserve System. The act of controlling the money supply is referred to as monetary policy. The fed most commonly conducts monetary policy through open market operations, which involve buying or selling treasury securities. When the Fed wishes to reduce interest rates, it increases the amount of funds at commercial banks by using some of its reserves to purchase treasury securities held by investors.
* Shift in the government demand for funds – if the government reduces the amount that it borrows, there would be a surplus of funds at the original interest rate which would result in a lower interest rate.
* Shift in the business demand for funds – firms tend to reduce their expansion plans when they expect a weak economy. Therefore, they reduce the amount of funds borrowed. This decreases the aggregate demand for funds and results in a lower interest rate.
Money supply – demand deposits (checking accounts) and currency held by the public.
Monetary policy – the actions taken by the Federal Reserve to control the money supply.
Open market operations – the Fed’s buying and selling of Treasury securities.
Chapter 6 managing your money
Money management – a series of decisions made over a short-term period regarding cash inflows and outflows.
Liquidity – your ability to cover any cash deficiencies that you may experience.
The return of your short-term investment is dependent on the prevailing risk-free rate and the level of risk you are willing to tolerate.
Money Market Investments
* Checking account
Overdraft protection – an arrangement that protects a customer who writes a check for an amount that exceeds the checking account balance; it is a short-term loan from the depository institution where the checking account is maintained.
Stop payment – a financial institution’s notice that it will not honor a check if someone tries to cash it; usually occurs in response to a request by the writer of the check.
Fee – a fee is charged unless a minimum balance is maintained.
No interest – a disadvantage of investing funds in a checking account is that the funds do not earn any interest.
* NOW account – negotiable order of withdrawal
An advantage of a NOW account is that it pays interest, although it’s low.
* saving deposit
it pays higher interest rate than NOW account and funds can be withdrawn form savings account at any time.
* Certificate of deposit
A certificate of deposit (CD) offered by a depository institution specifies a minimum amount that must be invested, a maturity dare on which the deposit matures, and an annualized interest rate. CDs that have small denominations are sometimes referred to as retail CDs because they are more attractive to individuals than to firms.
CDs have higher interest rate than saving deposits. A penalty is imposed for early withdrawal from CDs, so these deposits are less liquid than funds deposited in a saving account.
CDs with longer terms to maturity typically offer higher annualized interest rates.
* Money market deposit account (MMDA)
A deposit offered buy a depository institution that requires a minimum balance, has no maturity date, pay interest, and allows a limited number of checks to be written each month.
An MMDA differs from a NOW in that it provides only limited checking services while paying a higher interest rate than that offered on NOW.
* Treasury bills
When US government needs to spend more money than it has received in taxes, it borrows funds by issuing treasury securities.
For money management purposes, individuals tend to focus on Treasury bills (T-Bills), which are treasury securities that will mature in one year or less.
T-bills are purchased a t a discount from par value. If you hold it until its maturity, you earn a capital gain which is the difference between the par value of the T-bill at maturity and the amount you paid for it.
A secondary market is a market where existing securities such as treasury bills can be purchased or sold. T-bills can be sold before their maturity with the help of a brokerage firm. Your return is the capital gains as a percentage pf your initial investment.
* Money market fund (MMF)
Money market funds pool money from individuals to invest in securities that have a short-term maturity, one year or less. Many MMF invest in short-term treasury securities, commercial paper, or in wholesale CDs.
MMF is not insured, but most of them invest safe and have a very low risk of default. MMF doesn’t provide much liquidity since the gain is based on interest rate.
* Asset management account
It is an account that combines deposit account with a brokerage account and provides a single consolidated statement.
A special type of AMA s the sweep account that sweeps any unused balance in the brokerage account into a money market investment at the end of each business day.
Money market investment Advantages disadvantages
Checking account Very liquid No interest
NOW account Very liquid Low interest rate; minimum balance required
MMDA Liquid Low interest rate
Savings account Liquid Low interest rate
Certificate of Deposit (CD) Relatively high interest rate Less liquid
Treasury bills Relatively high interest rate High minimum purchase
Money market funds(MMF) Liquid Not as liquid as checking or NOW accounts
Asset management account Convenient High minimum balance required
Risk of money market investments
* Credit risk – the risk that a borrower may not reply on a timely basis.
* Interest rate of risk – the risk that the value of an investment could decline as a result of a charge in interest rates.
* Liquidity risk – the potential loss that could occur as a result of converting an investment into cash. The liquidity risk of an investment is influenced by its secondary market.
Determine the optimal allocation of money market investments
1. Ensure the net cash flow and sufficient funds
2. Consider the liquidity of your current funds
3. Use the remaining funds in a manner that will earn a high return, within the level of risk tolerance.
Chapter 7 assessing and securing your credit
Credit – funds provided by a creditor to a borrower that will be repaid by the borrower in the future with interest.
Types of credit:
• Non-installment credit – credit provided for a short period, such as department store credit.
• Installment – credit provided for specific purchases, with interest charged on the amount borrowed.
• Revolving open-end credit – credit provided up to a specific maximum amount based on income and credit history; interest is charged each month on the remaining balance.
Advantage of using credit – build a good credit score; create the capacity to access credit in the future for large purchases.
Disadvantage of using credit – excess spending causes payment trouble.
Credit report – reports provided by credit bureaus to document a person’s credit payment history.
Credit score – a credit score is a rating that indicates a person’s creditworthiness.
Identity theft – it occurs when an individual, without permission, uses your identifying information to obtain their personal gain.
Identity theft tactics:
• shoulder surfing – this occurs in public places when an identity thief stands close to you and reads the number of your credit card as you conduct business.
• Dumpster diving – this occurs when an identity thief goes through your trash for discarded items that reveal personal information that can be used for fraudulent purpose.
• Skimming – this occurs when a store employee steals your credit card number by copying the information contained in the magnetic strip on the card.
• Pretexting – this occurs when an identity thief poses as an employee of a company with which you conduct business, to solicit your personal information. When Pretexting happens online, it’s called phishing.
• Pharming – similar to phishing, but targeted to larger audiences; directs users to bogus Web sites to collect their personal information.
Chapter 8 managing your credit
Applying for a credit card
• personal information – net cash flows, credit history, capital and collateral
• credit check
• other information that creditors evaluate – income, existing debt level
Retail (proprietary) credit card – a credit card that is honored only by a specific retail establishment.
Prestige cards – credit cards, such as gold cards or platinum cards, issued by a financial institution to individuals who have an exceptional credit standing.
Finance charge – the interest that you must pay as a result of using credit.
Simple interest rate – the percentage of credit that must be paid as interest on an annual basis.
Personal bankruptcy – when dealing with credit debt, it’s a plan to the court in which you repay at least a portion of your debt and pay attorney and filing fees.
15 must-know credit card terms
• Average daily balance – This is the method by which most credit cards calculate your payment due. An average daily balance is determined by adding each day's balance and then dividing that total by the number of days in a billing cycle. The average daily balance is then multiplied by a card's monthly periodic rate, which is calculated by dividing the annual percentage rate by 12. A card with an annual rate of 18 percent would have a monthly periodic rate of 1.5 percent. If that card had a $500 average daily balance it would yield a monthly finance charge of $7.50.
• Annual percentage rate (APR) -- A yearly rate of interest that includes fees and costs paid to acquire the loan. Lenders are required by law to disclose the APR. The rate is calculated in a standard way, taking the average compound interest rate over the term of the loan, so borrowers can compare loans.
• Balance transfer -- The process of moving an unpaid credit card debt from one issuer to another. Card issuers sometimes offer teaser rates to encourage balance transfers coming in and balance-transfer fees to discourage them from going out.
• Cash-advance fee -- A charge by the bank for using credit cards to obtain cash. This fee can be stated in terms of a flat per-transaction fee or a percentage of the amount of the cash advance. For example, the fee may be expressed as follows: "2%/$10". This means that the cash advance fee will be the greater of 2 percent of the cash advance amount or $10.
• The banks may limit the amount that can be charged to a specific dollar amount. The cost of a cash advance is also higher because there generally is no grace period. Interest accrues from the moment the money is withdrawn.
• Cardholder agreement -- The written statement that gives the terms and conditions of a credit card account. The cardholder agreement is required by Federal Reserve regulations. It must include the Annual Percentage Rate, the monthly minimum payment formula, annual fee if applicable, and the cardholder's rights in billing disputes. Changes in the cardholder agreement may be made, with written advance notice, at any time by the issuer. Rules for imposing changes vary from state to state, but the rules that apply are those of the home state of the issuing bank, not the home state of the cardholder.
• Finance charge -- The charge for using a credit card, comprised of interest costs and other fees.
• Floor -- The minimum rate possible on a variable-rate loan or line of credit, after any initial introductory rate period. For example, on a credit card with the Prime rate as its index, no matter how low the Prime rate drops, the rate on the line may never decrease below the stated rate floor.
• Grace period -- If the credit card user does not carry a balance, the grace period is the interest-free time a lender allows between the transaction date and the billing date. The standard grace period is usually between 20 and 30 days. If there is no grace period, finance charges will accrue the moment a purchase is made with the credit card. People who carry a balance on their credit cards have no grace period.
• Minimum payment -- The minimum amount a cardholder can pay to keep the account from going into default. Some card issuers will set a high minimum if they are uncertain of the cardholder's ability to pay. Most card issuers require a minimum payment of two percent of the outstanding balance.
• Over-the-limit fee -- A fee charged for exceeding the credit limit on the card.
• Periodic rate -- The interest rate described in relation to a specific amount of time. The monthly periodic rate, for example, is the cost of credit per month; the daily periodic rate is the cost of credit per day.
• Pre-approved -- A credit card offer with "pre-approved" only means that a potential customer has passed a preliminary credit-information screening. A credit card company can spurn the customers it invited with "pre-approved" junk mail if it doesn't like the applicant's credit rating.
• Secured card -- A credit card that a cardholder secures with a savings deposit to ensure payment of the outstanding balance if the cardholder defaults on payments. It is used by people new to credit, or people trying to rebuild their poor credit ratings.
• Teaser rate -- Often called the introductory rate, it is the below-market interest rate offered to entice customers to switch credit cards or lenders.
• Variable interest rate -- Percentage that a borrower pays for the use of money, and which moves up or down periodically based on changes in other interest rates.
Chapter 9 personal loans
Loan contract: a contract that specifies the terms of a loan, as agreed to by the borrower and the lenders.
• amount of the loan
• Interest rate. The common types of interest rates are:
o APR – it measures the interest and other expenses as a percentage of the loan amount on an annualized basis.
o Simple interest rate – Interest on a loan computed as a percentage of the existing loan amount (or principle).
o Add-on interest method – a method of determining the monthly payment on a loan; involves calculating interest that must be paid on the loan amount, adding together interest and loan principle, and dividing by the number of payments.
• Loan repayment schedule – personal loans are usually amortized, which mean repaying the principal (the original amount loaned out) through a series of equal payments. A lean repaid in this manner is said to be amortized.
• Maturity – with respect to a loan, the life or duration of the loan.
• Collateral – assets of a borrower that back a secured loan in the event that the borrower defaults. When a loan is used to purchase a specific asset, that asset is commonly used as collateral. A loan that is backed or secured by collateral is referred to as a secured loan, not being unsecured loan. A payday loan is a short-term loan provided in advanced of a paycheck.
Cosigning – some borrowers are only able to obtain a personal loan if someone with a stronger credit history cosigns.
Home equity loan – a loan where the equity in a home serves as collateral for the loan. It has more favorable terms then other personal loans. It has a relatively low interest rate because home serves as collateral, backing the loan. Also, the interest paid on a home equity loan is tax-deductible up to a limit.
Market Value of Equity in home = market value of home - mortgage balance (debt owed)
Interest rate on Home Loan – a home equity loan typically uses a variable interest rate that is tied to a specific interest rate index that changes periodically. Interest that is paid on a home equity loan of up to 100,000 is tax-deductible.
Tax savings in One year from Home Equity Loan = Amount of interest paid * marginal tax rate
• When apply for a personal loan, you need to disclose your personal balance sheet and cash flow statement so that the lender can evaluate your ability to repay a loan. A loan contract specifies the amount of the loan, interest rate, maturity, and collateral.
Chapter 10 purchasing and financing a home
Market analysis – an estimate of the price of a home based on the prices of similar homes in the area.
Fixed-rate mortgage is a mortgage in which a fixed interest rate is specified until maturity. Monthly mortgage payment for a fixed-rate mortgage is based on an amortization schedule, which discloses allocation of the mortgage payment.
Adjusted-rate (variable-rate) mortgage is a mortgage where the interest owed changes in response to movements in a specific market-determined interest rate (benchmark).
Caps – maximum and minimum fluctuations in the interest rate on an adjusted-rate mortgage.
Decision to use which interest rate depends on expectation of future interest rate.
Special types of mortgage
• Graduated payment mortgage – a mortgage where the payments are low in the early years and then rise to a higher level over time.
• Balloon payment mortgage – a mortgage where the monthly payments are relatively low, but one large payment is required after a specified period to pay off the mortgage loan.
• Interest-only mortgage – adjusted-rate mortgages that allow home buyers to pay only interest on the mortgage during the five few years.
Mortgage refinancing – paying off an existing mortgage with a new mortgage that has a lower interest rate. You may consider it when quoted interest rates on new mortgages decline. When refinancing, you will incur closing costs. Thus you should consider refinancing only if the benefits (expected reduction in interest expenses over time) exceed the closing costs.
Closing costs
• loan application fee
• points – a fee charged by the lender when a mortgage loan is provided; stated as a percentage of the purchase price
• Loan origination Fee
• Appraisal fee
• Title search and insurance
Total cost of owning a home = expenses associated with the home – tax savings from owning it – expected value of the equity of the home at the end of the period
Chapter 11 auto and homeowner’s insurance
Risk is defined as exposure to events or perils that can cause a financial loss.
Risk management represents decisions about whether and how to protect against risk.
Premium is the cost of obtaining insurance.
Underwriters – from an insurance perspective, are hired to calculate the risk of specific insurance policies, decide what policies to offer, and what premiums to charge.
Insurance agent – recommends insurance policies for customers.
Captive (or exclusive) insurance agent – works for one particular insurance company.
A. Liability coverage
1) Bodily injury liability – it protects you against liability associated with injuries caused by the policyholder.
2) Property damage liability coverage – it protects you against losses that result when the policyholder damages another person’s property with his car.
Financial responsibility laws – they require individuals who drive cars to purchase a minimum amount of liability insurance.
B. Medical Payments coverage
It insures against the cost of medical care for you and other passengers in your car when you are at fault in an accident.
C. Uninsured or Underinsured motorist coverage
It insures against the cost of bodily injury when an accident is caused by another driver who is not insured.
Underinsured Motorist coverage insures against bodily injury and drivers who have insufficient coverage.
D. Collision and Comprehensive Coverage
Collision insurance insures against costs of damage to your car resulting from an accident in which the policyholder is at fault.
Comprehensive coverage insures against damage to your car that result from floods, theft, fire, hail, explosions, riots, and various other events.
Deductible – a set of dollar amount that you are responsible for paying before any coverage is provided by your insurer.
Homeowner’s insurance – it provides insurance in the event of property damage, theft, or personal liability relating to your home.
Cash-value policy – it pays you for the value of the damaged property after considering its depreciation.
Replacement cost policy – it pays you for the actual cost of replacing the damaged property.
Home inventory – it contains detailed information about your personal property that can be used when filing a claim.
Personal property floater – an extension of the homeowner’s insurance policy that allows you to itemize your valuables.
