Personal Finance Exam 3
Interest
A periodic charge for the use of credit.
Joshua borrowed $500 for one year and paid $50 in interest. The bank charged him a $5 service charge. What is the finance charge on this loan? (LO5.4)
$50 (Interest) + 5 (Service Charge) = $55
In problem 5, Joshua borrowed $500 on January 1, 2012, and paid it all back at once on December 31, 2012. What was the APR? (LO5.4)
$55 (finance charge) ÷ 500 (loan total)= 11% APR
In problem 5, if Joshua paid the $500 in 12 equal monthly payments, what is the APR? (LO5.4)
20.3%
What is the difference between a credit card and a debit card?
A credit card extends credit and delays your payment. A debit card electronically subtracts money from your savings or checking account to pay for goods and services at the time of purchase
Open-end credit
A line of credit in which loans are made and repaid on a continuous basis.
What are the major sources of: Expensive Loans
Finance companies, credit cards, retail stores
Capacity
Financial ability to meet credit obligations
A few years ago, Simon Powell purchased a home for $110,000. Today, the home is worth $150,000. His remaining mortgage balance is $50,000. Assuming that Simon can borrow up to 80 percent of the market value, what is the maximum amount he can borrow? (LO5.2)
Present market value of Simon's home = $150,000. Simon can borrow up to 80 percent of the market value, or $120,000. Simon still owes $50,000 mortgage on his home. Therefore, he can borrow an additional $70,000 ($120,000 - $50,000).
What are the factors a lender cannot consider according to the law when offering credit?
Race, nationality, age, sex, marital status, public assistance
Robert Sampson owns a $140,000 townhouse and still has an unpaid mortgage of $110,000. In addition to his mortgage, he has the following liabilities: Visa $565 MasterCard 480 Discover card 395 Education loan 920 Personal bank loan 800 Auto loan 4,250 Total $7,410 Robert's net worth (not including his home) is about $21,000. This equity is in mutual funds, an automobile, a coin collection, furniture, and other personal property. What is Robert's debt-to-equity ratio? Has he reached the upper limit of debt obligations? Explain. (LO5.3)
Robert's total debt (not including mortgage) is $7,410. His net worth (not including his home) is $21,000. Therefore, his debt-to-equity ratio is $7,410 divided by $21,000, or 0.35. Since this ratio is less than 1, Robert has not reached the upper limit of debt obligations.
Line of credit
The dollar amount that a lender makes available to a borrower
What are the two key concepts to remember when you borrow money?
The finance charge, and the annual percentage rate
Why is consumer credit important to our economy?
All economists now recognize consumer credit as a major force in the American economy. Any forecast or evaluation of the economy includes consumer spending trends and consumer credit as a sustaining force. To paraphrase an old political expression, as the consumer goes, so goes the U.S. economy. (p. 141)
What is a credit bureau?
An agency that collects information on how promptly people and businesses pay their bills.
Collateral
An asset pledged to ensure timely loan payments
How do changing economic conditions affect the use of financial services? Select financial services only on the basis of monetary factors?
As interest rates rise you are more likely to save and borrow less. When interest rates decline, spending and borrowing increase. See Exhibit 4-3 (p. 111) for additional information on the effect of interest rates on financial services use
What are the two types of consumer credit?
Closed-end and open-end are two types of consumer credit. With closed-end (or installment-credit, the borrower pays back a one-time loan in a specific number of payments in a specific period of time. With open-end credit, or revolving credit, the borrower is permitted to take loans on a continuous basis and is billed for partial payments periodically. The three most common types of closed-end credit are installment sales credit, installment cash credit, and single lump-sum credit. Examples of open-end credit include convenience credit, incidental credit, revolving credit, and credit cards. Only individual or family circumstances will dictate if one type of credit is better than another.
What are the major sources of: Medium Sized Loans
Commerical Banks, Savings and Loans, Credit Unions
What financial services are available through electronic banking systems?
Common electronic banking transactions include obtaining cash, point of purchase payment, direct deposit, preauthorized payments, and transfer of funds between checking, savings, and loans.
What is consumer credit?
Consumer credit refers to the use of credit for personal needs (except a home mortgage) by individuals and families.
What steps would you take if someone stole your identity?
Contact the credit bureaus and tell them to flag your file with a fraud alert. Contact the creditors and follow up in writing. File a police report and keep a copy of the report.
List two good reasons to borrow and two unnecessary reasons to borrow
GOOD REASONS A medical emergency. b. Borrowing for college education. BAD REASONS a. Borrowing for everyday living expenses. b. Borrowing to finance a luxury car.
Conditions
General economic conditions that affect your ability to repay a loan.
Louise McIntyre's monthly gross income is $2,000. Her employer withholds $400 in federal, state, and local income taxes and $160 in Social Security taxes per month. Louise contributes $80 per month for her IRA. Her monthly credit payments for VISA and MasterCard are $35 and $30, respectively. Her monthly payment on an automobile loan is $285. What is Louise's debt payments-to-income ratio? Is Louise living within her means? (LO5.3)
Louise's Gross Income = $2,000 Less: Income taxes = -400 Less: Social Security Tax = -160 Less: IRA contribution = -80 Net take-home pay = $1,360 Her monthly payments on VISA, MasterCard, and a car loan add up to $350 per month. Louise's debt payments to income ratio is 350 to 1,360, or 25.73 percent. This ratio exceeds the recommended 20 percent figure. Therefore, Louise is overextended. Her maximum monthly loan and credit card payments should not be over $272 (20 percent of $1,360).
Madeline Rollins is trying to decide whether she can afford a loan she needs in order to go to chiropractic school. Right now Madeline is living at home and works in a shoe store, earning a gross income of $820 per month. Her employer deducts a total of $145 for taxes from her monthly pay. Madeline also pays $95 on several credit card debts each month. The loan she needs for physical therapy school will cost an additional $120 per month. Help Madeline make her decision by calculating her debt payments-to-income ratio with and without the college loan. (Remember the 20 percent rule.) (LO5.3)
Madeline's debt payments-to-income ratio with the college loan is 31.85 percent; without the college loan it is 14.07 percent. According to the 20 percent rule, she cannot afford the college loan. However, after Madeline pays off her credit card debts, her debt payments-to-income ratio with the college loan will be 17.8 percent. Therefore, once she pays off her credit cards, she will be able to afford the loan. [ANSWER: $820 - $145 = $675; $95 + $120 = $215; $215 ÷ $675 = 31.85%; $120 ÷ $675 = 17.8%]
Brooke lacks cash to pay for a $600 washing machine. She could buy it from the store on credit by making 12 monthly payments of $52.74 each. The total cost would then be $632.88. Instead, Brooke decides to deposit $50 a month in the bank until she has saved enough money to pay cash for the washing machine. One year later, she has saved $642—$600 in deposits plus interest. When she goes back to the store, she finds that the washing machine now costs $660. Its price has gone up 10 percent— the current rate of inflation. Was postponing her purchase a good trade-off for Brooke? (LO5.4)
No, it was not a good trade-off for Brooke to postpone her purchase. By waiting one year, she had to pay more to buy the washing machine. Now she had saved $642, but the price of the washing machine has increased from $600 to $660. If she had used credit to buy the washing machine a year before, she would have paid only $632.88. However, it is possible that not incurring a debt and not being responsible for monthly payments were more important to Brooke than the money she would have saved if she had used credit.
What steps might you take if there is a billing error in your monthly statement?
Notify creditor in writing, and include any information that might support your case. Pay the portion of the bill that is not in question.
Closed-end credit
One-time loan paid back in a specified time in payments of equal amounts.
What are the major sources of: Inexpensive Loans
Parents, Family Members, Friends
What are the three major trade-offs you should consider as you take out a loan?
Term versus interest cost, lender risk versus interest rate, and cost of your loan.
Sidney took a $200 cash advance by using checks linked to her credit card account. The bank charges a 2 percent cash advance fee on the amount borrowed and offers no grace period on cash advances. Sidney paid the balance in full when the bill arrived. What was the cash advance fee? What was the interest for one month at an 18 percent APR? What was the total amount she paid? What if she had made the purchase with her credit card and paid off her bill in full promptly? (LO5.4) - Sidney's cash advance fee was $4.00. - At an 18% APR, she paid $3.00 interest for one month. - She paid a total of $207. - If Sydney had made the purchase with her credit card and paid off the bill in full promptly, she would have paid only $200
The answer is true if the card has a grace period, but if there is no grace period (and some cards don't offer one), she would have paid the $3 interest charge regardless and would have saved only on the cash advance of $4.
Capital
The borrower's assets or net worth
Character
The borrower's attitude toward his or her credit obligations
What are the major categories of financial services?
The major financial services are savings plans, payment services, credit plans (borrowing), and other services such as investments, tax assistance, financial planning, and trusts
Finance charge
The total amount paid to use the credit
What are the two general rules of measuring credit capacity? How is it calculated?
Two general rules for measuring credit capacity are: debt payments-to-income ratio, and debt-to-equity ratio. None of these methods is perfect for everyone; the limits given are only guidelines. Only you, based on the money you earn, your current obligations, and your financial plans for the future, can determine the exact amount of credit you need and can afford. You must be your own credit manager. Debt payments-to-income ratio is calculated by dividing your monthly debit payments by your net monthly income. The debt-to-equity ratio is calculated by dividing your total liabilities by your net worth
How might you protect your credit information on the internet?
Use a secure browser, keep records of online transactions, review your monthly statements; read the privacy and security policies, keep your personal information private, never give your password to anyone on line, don't download files sent by strangers.
What are the interest cost and the total amount due on a six-month loan of $1,500 at 13.2 percent simple annual interest? (LO5.4)
Using the simple interest formula: I = P × r × T = $1,500 * 0.132 * 1/2 year Interest = $99.00 Total amount due = $1,500 + $99 = $1,599.
What factors do consumers usually consider when selecting a financial institution to meet their saving and checking needs?
When selecting a financial institution, a person should consider the services available, convenience (location, hours, branch offices, banking by mail, ATMs), safety, personal service, rates charged, and interest paid to savers.