Cash Flow Management and Financing Strategies Flashcards
Consumer Debt Ratio (aka nonmortgage debt-to-income ratio)
Monthly Consumer Debt Payments / Monthly NET Income </= 20%
Typically includes debt for auto purchases and credit card purchases.
Housing Cost Ratio
Monthly house costs (rent or monthly PITI) / monthly gross income </= 28%
Total Debt Ratio
Total Monthly Debt / Monthly Gross Income </= 36%
Savings Rate
Annual Savings / Annual Gross Income (should be greater than or equal to 10%)
Emergency Fund Ratio
Current Assets / Monthly Non-Discretionary Expenses (3-6 months if one family income, and 3 months if 2 family income)
Retirement Plan Loans - Advantages
- Ease of Borrowing
- Lower Interest Rates
- Simplicity of repayments (often through payroll deduction)
- No effect on credit rating (not reported to credit rating agencies)
Retirement Plan Loans - Disadvantages
- No growth of borrowed amount (will not benefit from tax-deferred growth)
- Adverse tax treatment (loan repayments are made with after-tax dollars, unlike salary deferrals; must pay tax on income used to repay loan and distributions from their plans during retirement)
- Possible adverse effect on retirement savings
- Tax issues at separation from service (often balance is due when leaves employer, and if repayment cannot be made, income tax will be due on outstanding loan amount. In addition, 10% penalty may be assessed)
Snowball Debt Reduction Technique
Smaller balances paid off first
Avalanche technique
prioritizes high-interest debt paid off first
Credit Score Categories and Weightings
- Payment history - 35%
- Amounts owed (how much individuals owe relative to available) - 30%
- Length of credit history - 15%
- New credit (measures how many new accounts, which can lower score) - 10%
- Credit mix - 10%
Buying vs. Leasing Home
Buying vs. Leasing Automobile
prime mortgage
made to borrowers with good credit
subprime loan
mortgages to borrowers of lower credit quality or that have lower-priority claim to the collateral in event of default
Federal Housing Administration (FHA) mortgage loans
Federal government guarantees these and appeal to buyers who may not meet financial underwriting requirements for conventional home loan. Key feature is low initial down payment and sometimes lower interest rate.
Mortgage Insurance
Mortgage insurance is a policy that protects lenders against losses that result from defaults on home mortgages. FHA requirements include mortgage insurance primarily for borrowers making a down payment of less than 20%.
Veterans Administration (VA) Loans
Feature the same federal guarantee of repayment as that for FHA mortgages, but VA mortgages are for service members and veterans of the U.S. armed services, their spouses, and other eligible beneficiaries. An even more favorable attribute of the VA mortgage is that, in certain cases, no initial down payment is required; in other words, the entire purchase price can be borrowed. In addition, no mortgage insurance is required.
Conventional mortgage loan (conforming loans)
Made by commercial lenders in private sector. May me be called conforming loans because they conform to Fannie Mae and Freddie Mac $ limit requirements (ex. $484,350)
Jumbo loans/nonconforming loans
Loans above the Fannie Mac & Freddie Mac dollar limit
Graduated payment mortgage
Payable over a long time period, such as 30 years, and has a fixed interest rate. The payments are lower for the first few years of mortgage repayment (although they sometimes increase annually), then they adjust to a higher fixed payment that continues for the remainder of the loan.
Disadvantages of graduated payment mortgage
- higher payments during the second period of the loan than if the loan had been a standard fixed rate,
- higher interest costs, and
- negative equity accumulation in the early years of the loan because the payments during that period typically are not sufficient to pay the interest due (often called negative, or reverse, amortization, because the amount of the loan is increasing).
Reverse mortgage
What it is: A reverse mortgage allows homeowners age 62+ to convert home equity into income, helping them stay in their homes despite limited income.
Eligibility: Borrowers must be 62+, own a home with substantial equity, and have little to no debt on the property.
Loan Details: The lender makes payments based on home value and the borrower’s age. The homeowner retains title, but debt increases over time.
Repayment: The loan is repaid when the homeowner moves out, dies, or enters a nursing home, usually by selling the home. It’s a nonrecourse loan, so the repayment is limited to the home’s value.
Medicaid Impact: Homeownership doesn’t affect Medicaid eligibility unless the home is sold after 12 months of non-occupancy.
Responsibilities: Borrowers must pay property taxes, insurance, and maintenance costs. Failure to do so may trigger full loan repayment.
No Escrow: Unlike traditional mortgages, there’s no escrow for taxes or insurance.
Adjustable Rate Mortgage (ARM)
Interest and payment changes and tied to index. Often has cap limiting amount by which rate can change. Can allow for negative amortization to occur.
Client who wants lower initial monthly payment and doesn’t anticipate staying in home for long time could consider ARM.
Calculation to determine payback period for refinancing
Divide total closing costs by monthly savings from refinicing
