101-4 Cash Flow Management & Financing Flashcards
Current Ratio
Current Assets / Current Liabilities
Current assets: cash and cash equivalents
Current liabilities: current debts (those due within one year
Target: 1.0 to 2.0
Higher is preferable
Ratio >1 indicates the client can pay off existing, short-term liabilities with readily available liquid assets
Emergency Fund time frame
3-6 months
Cash and cash equivalents
Emergency Ratio
Liquid assets / non discretionary monthly expenses
Housing Payment Ratio
All monthly nondiscretionary housing costs (PITI) / monthly gross income
Target: Less than or equal to 28%
PITI: principal interest taxes and insurance
Total Payments Ratios
All monthly debt payments + housing costs / gross monthly income
Target: Less than or equal to 36%
Solvency Ratio
Total assets / total debt
Target: greater than or equal to 1.1
Savings Ratio
Savings per year / gross income
Target: 8-25% depending on age
Debt-to-income ratio
Annual debt payment / gross income
Target: less than or equal to 30%
Discretionary expense
Recurring or nonrecurring expense for an item that is either nonessential or more expensive than necessary
Examples: Vacations Club dues Entertainment Gifts
Nondiscretionary expense
Recurring or nonrecurring expense that is essential for an individual to maintain his lifestyle
Examples: Rent Mortgage payments Loan repayments Food Utilities Taxes
Emergency fund
An amount equal to 3 to 6 months of fixed and variable monthly expenses is considered adequate
Consumer debt ratio
The ratio of monthly consumer debt payments to monthly income
Net income = gross income - taxes
Does not include mortgage
Should not exceed 20%
Housing cost ratio
Should not exceed 28% of gross monthly income
Includes rent or monthly mortgage payment, principal and interest payments on the mortgage, property taxes, homeowners insurance premium
Total debt ratio
Includes monthly housing costs and consumer debt payments
36% of gross monthly income
Secured loan
A loan for which the creditor maintains a security interest in property, such as personal property, which serves as collateral for the debt
Unsecured (signature) loan
A loan for which the client merely promises to repay the debt in exchange for borrowed funds
In the event of default, lenders can take legal action but most often will attempt to settle the debt for less than the amount owed. However, this will negatively affect an individual’s credit rating.
Fixed rate loan
A loan with an interest rate that remains constant until paid in full
Initial interest rates are higher than those of variable (adjustable) rate loans
Variable (adjustable) rate loan
The interest rate on this type of loan adjusts at various intervals throughout loan term; thus, they are riskier
Short-term loan
A loan that is due in less than 1 year
Long-term loan
A loan due one year or more from a specified date
Installment loan
A loan for which the client borrows a single amount of money and repays the balance with interest at a stated interval
Single payment (bridge) loan
A loan which provides short-term, temporary financing which is repaid with interest in one lump sum at the end of the term
Example: for the purchase of one house and the subsequent sale of another
Conventional fixed-rate mortgage
Have a level interest rate for the term of the loan (the shorter the loan term, the higher the monthly payment) and a fixed payment amortization schedule
Adjustable rate mortgages (ARMs)
The initial rate and payment may change every month, quarter, year, 3 years, or 5 years
Interest rate changes are usually tied to a specific index such as the one-year LIBOR (London Inter-Bank Offer Rate)
Good for a client who wants lower initial monthly payments and does not anticipate remaining in the home for a long time
Federal Housing Administration (FHA) mortgage loans
Guaranteed by federal government
Very low initial down payment and, sometimes, a lower interest rate
Mortgage insurance
A policy that protects lenders against losses that result from defaults on home mortgages
Veterans Administration (VA) mortgages
Feature the same federal guarantee of repayment as that if FHA mortgages
For service members and veterans of the US armed services, their spouses, and other eligible beneficiaries
Interest-only mortgages
The homeowner tries to keep the mortgage payments at a minimum while hoping that the fair market value of the home will increase so that the principal amount will be paid off by the sale proceeds
Reverse mortgages
Special type of home loan where the payment stream is reversed (the lender pays the homeowner a stream of income secured by the considerable amount of equity in the home)
Available to borrowers age 62+
Home equity loans and lines of credit
Essentially second mortgages that use the current equity in the homeowner’s primary residence to provide money for home improvements and other purposes
A HELOC provides a set amount of credit from which funds may be drawn as needed
Borrowers make payments only on the amount they actually borrow, not the full amount available
Loan-to-value ratio (LTV)
The % of the value of the collateral real estate that is loaned to the borrower
The lower the LTV, the higher the borrower’s equity in the property
Prime loans
Mortgages with higher LTV ratios, made to borrowers with good credit
Subprime loans
Mortgages to borrowers of lower credit quality, or that have a lower-priority claim to the collateral in the event of default
Loan amortizations calculated using END mode
(E.g. mortgages, auto loans) calculated using end mode because the interest on the principal balance is accruing from payment to payment on the balance of the debt
