Chapter 6: Introduction to Consumer Credit

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A few years ago, Michael purchased a home for $314,000. Today the home is worth $440,000. His remaining mortgage balance is $86,000. Assuming Michael can borrow up to 80 percent of the market value of his home, what is the maximum amount he can borrow?

Maximum loan amount =0.80 × Market value =0.80 × $440,000 =$352,000 Maximum loan available =Maximum loan amount − Current loan balance =$352,000 − 86,000 =$266,000

Louise's monthly gross income is $2,500. Her employer withholds $500 in federal, state, and local income taxes and $200 in Social Security taxes per month. Louise contributes $100 per month for her IRA. Her monthly credit payments for Visa, MasterCard, and Discover cards are $39, $34, and $30, respectively. Her monthly payment on an automobile loan is $376. (a) What is Louise's debt payments-to-income ratio? (Enter your answer as a percent rounded to 1 decimal place.) (b) Is Louise living within her means? Yes No

(a) Net income =Gross income − Taxes − IRA contribution =$2,500 − 500 − 200 − 100 =$1,700 Debt payments =Credit card payments + Auto loan payment =$39 + 34 + 30 + 376 =$479 Debt payments-to-income ratio =Debt payments / Net income =$479 / $1,700 =0.282, or 28.2% (b) Louise is not living within her means because her debt payments-to-income ratio exceeds 20 percent of her net income.

Robert owns a $190,000 town house and still has an unpaid mortgage of $142,000. In addition to his mortgage, he has the following liabilities: Liabilities Visa = $637 MasterCard = 517 Discover card = 483 Education loan = 994 Personal bank loan = 892 Auto loan = 4,580 Total = $8,103 Robert's net worth (not including his home) is about $30,400. This equity is in mutual funds, an automobile, a coin collection, furniture, and other personal property. (a) What is Robert's debt-to-equity ratio? (Round your answer to 2 decimal places.) (b) Has he reached the upper limit of debt obligations? Yes No

(a) The debt-to-equity ratio excludes both the value of a home and the mortgage on that home. Thus, these items are omitted from the following calculations. Total debt=$637 + 517 + 483 + 994 + 892 + 4,580 =$8,103 Debt-to-equity ratio=Total debt / Total equity =$8,103 / $(expression error) =0.27 (b) Robert's debt-to-equity ratio is less than the upper limit of debt obligations which is defined as a debt-to-equity ratio of 1.0.

What is your debt payments-to-income ratio if your debt payments total $398 and your net income is $1,000 per month?

Debt payments-to-income ratio =Debt payments / Net income =$398 / $1,000 =0.398, or 39.8%

Suppose that your monthly net income is $2,510. Your monthly debt payments include your student loan payment and a gas credit card. They total $753. What is your debt payments-to-income ratio?

Debt payments-to-income ratio =Debt payments / Net income =$753 / $2,510 =0.30, or 30%

Carl's house payment is $1,050 per month and his car payment is $416 per month. If Carl's take-home pay is $3,550 per month, what percentage does Carl spend on his home and car?

Loan payments-to-income ratio =Loan payments / Net income =($1,050 + 416) / $3,550 =0.4130, or 41.30%

The disposable income from your part-time job in 2019 was $16,700. In 2018, you borrowed $900 at 19 percent interest. You repaid your loan with interest in 2019. How much would you have available for spending in 2019?

Loan repayment =Principal + Interest =$900 + (0.19 × $900) =$1,071 Spending amount available in 2019 =Disposable income − Loan repayment =$16,700 − 1,071 =$15,629

Kim is trying to decide whether she can afford a loan she needs in order to go to chiropractic school. Right now Kim is living at home and works in a shoe store, earning a gross income of $1,300 per month. Her employer deducts $239 for taxes from her monthly pay. Kim also pays $185 on several credit card debts each month. The loan she needs for chiropractic school will cost an additional $152 per month. Help Kim make her decision by calculating her debt payments-to-income ratio with and without the college loan. (Remember the 20 percent rule.)

Net income =Gross income − Taxes =$1,300 − 239 =$1,061 Current debt plus college loan: Debt payments-to-income ratio =Debt payments / Net income =($185 + 152) / $1,061 =0.3176, or 31.76% Current debt without college loan: Debt payments-to-income ratio =Debt payments / Net income =$185 / $1,061 =0.1743, or 17.43% If Kim adds the college debt to her current credit card debt, her debt payments-to-income ratio will exceed the recommended 20 percent limit. However, if Kim can pay off her credit card debt, then the college loan is affordable as seen here: College loan only: Debt payments-to-income ratio =Debt payments / Net income =$152 / $1,061 =0.1433, or 14.33%

Drew's monthly net income is $2,700. What is the maximum he should use on debt payments?

The recommended maximum debt payments-to-income ratio is 20 percent. Thus, the maximum monthly debt payment amount is: Maximum monthly debt payment =0.20 × Monthly income =0.20 × $2,700 =$540


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