Chapter 14

Describe factors that affect credit worthiness and the ability to receive favorable interest rates including character (credit score), collateral, and capacity to pay.

As a rule, we should spend only what we earn and avoid borrowing. However, some purchases are very difficult to make without the use of credit and the benefits of making those purchases using credit may outweigh the costs in the long-run. For example, if someone cannot go to college without a student loan, the higher future income potential and lower risk of unemployment may make the student loan a wise idea. If someone lacks a reliable car to get them to a great job, the benefits of a low-interest car loan may outweigh the costs because of the higher income earned at the new job. The key is to be wise in borrowing. Do not borrow more than you need and make sure the payments are affordable given your income. If you want to secure a loan from a financial institution like a bank, your credit rating must be good. Credit-worthiness is a measure of a variety of factors used to determine whether a person will repay a loan. While there is no guarantee a person making $400,000 annually will pay a $2,000 loan, evaluation of their credit-worthiness indicates they have the income required to handle the loan. Annual earned income is a major factor in determining credit worthiness. If income is high, lenders believe the borrower can use some of that income for debt repayment. However, the amount of current debt is another big factor affecting credit-worthiness. Making $400,000 a year is less attractive to lenders if you already owe $500,000. The "Three C's of Credit" are character, capacity, and collateral. Since most lenders do not know potential borrowers personally, they evaluate a potential borrower's character using the information on the borrower's credit report. A credit report is available through three main private companies: Transunion, Equifax, and Experian. It details a person's borrowing and repayment history for the last seven years reported to the company's by a person's previous and current lenders. Potential lenders request credit reports on potential borrowers to assess the borrower's character and capacity. A potential borrower who has "paid as agreed" on all credit accounts has good credit character. The credit report also shows some aspects of capacity. While income is one factor in assessing capacity, the amount it takes to service current debt is also a concern. If debt to income ratio is high, the borrower may not be able to handle additional debt payments. Finally, collateral is something of value a borrower can use to back the loan if the borrower can no longer pay the scheduled payments. For example, a home mortgage is available to people with lower incomes because the bank can seize the home if the mortgage is not paid. Many people obtain a credit card to start building a positive credit history. To get low interest rates for borrowing and sometimes even to get a job, people need a good credit report and good credit score. In some cases, no credit history affects people negatively just as a poor credit history does. A credit score is a number calculated by the credit reporting companies based on a variety of factors. While the exact calculation is proprietary, the companies release general guidelines about how the score is calculated. Payment history, amount of open credit used, and the number of open credit accounts are some of the factors determining a credit score. By making small purchases and paying the entire amount each month, a potential borrower shows a lender how they use credit wisely. Using credit wisely and sparingly is essential to a healthy financial life. Some people find they are unable to make wise credit use decisions. Using credit cards impulsively, some find they are unable to pay the entire amount owed month and begin to accrue high amounts of interest on the unpaid balance. As the balance owed increases, it takes years to pay the loan for a small purchase. If borrowers have late payments, interest rates skyrocket and lenders charge late fees. Current law requires credit card companies to show borrowers the difference in total payments they will make if they pay only the minimum payment due versus paying the debt within three years.

Explain how changes in taxation can have an impact on an individual's spending and saving choices.

Government assesses taxes on individuals and firms in an economy to pay for public goods and services. Some common taxes paid by individuals include income, property, and sales tax. When the government increases taxes, individuals will have less of their income to save and spend. When government decreases taxes, individuals will have more income to save and spend.

Identify and explain the following types of taxes: income tax, corporate income tax, sales tax, FICA (Social Security, Medicare), unemployment, excise, estate, capital gains, gift, import, "sin taxes".

Income taxes, both corporate and individual are taxes on income (Federal, State or City) Sales tax is a tax on the sale of goods and services (State and local). FICA - Federal Insurance Contributions Act - is a tax levied on employers and employees for Social Security (income for retirees and senior citizens) and Medicare (healthcare for senior citizens). Social Security, as of 1997 6.2% of wages and salaries up to 128,400 in 2018, Medicare as of 1994 1.45% of all wages and salaries. Both are regressive taxes. Unemployment tax is paid by employers; excise - tax on goods; estate - (death) tax on total wealth; gift - money given away; import - on goods brought into country; "sin tax" is an excise tax on certain goods like tobacco or alcohol. License - grant a license to (someone or something) to permit the use of something or to allow an activity to take place.

Identify examples of local (city, county) government taxes and spending.

Local revenue is primarily from property and sales taxes, as well as fees for services. Local taxes go toward education, law enforcement, fire protection, public health and welfare, libraries, parks and recreation.

Briefly describe the process of paying individual income taxes.

Pay as you earn, tax withholding by your employer based on your W4 Form, once you receive your W2 Form from your employer, you complete the required tax form and file your tax return or form by April 15th. The Income tax is a progressive tax.

Explain the impact of property taxes on individuals and communities.

Property tax refers to a tax on real estate people own. The tax, levied by local governments like counties or cities, is on the value of the real estate. Periodic appraisals of a property's value indicate whether the tax on the property will rise or fall. Increases in property value are cause for celebration by those ready to sell their property. However, for those who wish to remain in their homes, increased property values translate to increases in property taxes. If property taxes increase drastically, lower income people may no longer be able to afford the taxes on their homes. Delinquent taxes accrue interest and fees increasing the total bill owed. Various entities can use the delinquent tax bill to start the foreclosure process even properties fully owned with no mortgage. For this reason, owners of previously low value properties can lose their homes as property values rise and they are unable to afford the tax bill. This is gentrification. Gentrification occurs when high-income property owners replace low-income property owners in an area. Since taxes assessed on the property's value are without regard for the income of the owner, these taxes are regressive.

Identify and explain the three types of tax structures, progressive, regressive, and proportional taxes.

Proportional tax is a tax structure for which the percentage of income paid in taxes is the same for all levels of income; a "flat tax" where everyone pays the same percentage, like ten percent on all income levels regardless of the amount of income. Sales tax is an example. Progressive tax is a tax structure for which the percentage of income paid in taxes increases as income increases, more taxes on the wealthy because they have more wealth. Federal income taxes are progressive. Regressive tax is a tax structure for which the percentage of income paid in taxes decreases as income increases. Sales tax and the tax on gasoline are examples..

What is a tax?

A tax is a payment to a local, state or national government. This money is used to operate the government.

Evaluate the costs and benefits of using credit.

Credit refers to borrowing money. People borrow money for a variety of reasons. When considering a loan, borrowers identify the benefits and the cost of using credit. If the benefits of using credit outweigh the costs, taking a loan is rational. If the costs of borrowing outweigh the benefits, the loan should be avoided.

Identify examples of state government taxes and spending.

Sales and income taxes provide states with the most revenue and state money goes to education, public safety, highways, public welfare.

Explain how an increase in sales tax affects different income groups.

Sales tax refers to a consumption tax levied on people when they make certain kinds of purchases, such as buying a book or eating out at a restaurant. Not all goods and services are subject to a sales tax; doctor visits, for example, are free of taxes. Like the different types of income taxes, a change to the sales tax affects different income groups in different ways. Since all consumers purchase essential goods like food, a high sales tax on food would affect poor people more than wealthy people because both groups will be paying the same tax rate for the same good. For this reason, economists usually classify sales tax as a regressive tax because it takes a greater percentage of income from a low-income person than from a high-income person. This is one reason why food is often not subject to a sales tax. However, food served at a restaurant typically is subject to a sales tax, since eating out is a luxury.

Define annual percentage rate and explain the difference between simple and compound interest rates, as well as fixed and variable interest rates.

The annual percentage rate (APR) is the annual rate charged for borrowing funds. Expressed as a percentage, APR represents the actual yearly cost of the borrowed funds over the full term of the loan. Interest rates on loans are fixed or variable. A fixed interest rate on a loan will not rise or fall during the term of the loan. Obtaining a fixed interest rate when rates are low is usually desirable. When rates are high, borrowers may choose a variable interest rate in the hope that rates will fall in the future. Sometimes, lenders will only offer fixed rates to their best customers. Lenders sometimes offer risky borrowers variable rates. If the borrower proves the ability to make the payments, the person can refinance for a fixed rate in the future. Interest is also simple or compound. Simple interest applies only to the original amount borrowed called the principal. Compound interest applies to both the principal of the loan as well as accrued interest on the principal. Compound interest makes a loan more expensive and is less desirable for borrowers than simple interest loans.

Explain the two principles regarding tax fairness.

The two principles of taxation are: "Benefit principle" of taxation is those who benefit from government services should pay for them, or people should pay taxes in proportion to the amount of services or benefits they receive; "Ability to pay principle" is people should be taxed according to their ability to pay regardless of how many services or benefits they receive. The wealthy should pay more!

Compare interest rates on loans and credit cards from different institutions.

Wise potential borrowers shop for the best interest rates on loans. While the exact rate offered to a borrower will vary with the borrower's character, capacity, and collateral, the internet allows borrowers to compare the best rates offered by different financial institutions.