Chapter 2 - Budgeting and Consumer Lending

Question 1

What 3 essential questions does a cash flow statement answer to create a budget?

Answer 1

1. How much money is there?
2. Where does it come from?
3. Where does it go?

Question 2

What is a personal cash flow statement?

Answer 2

A record of a client’s cash flow over a specific period, usually one year. Consists of two main parts: net income received, expenses paid.

Question 3

What is the purpose of a cash flow statement?

Answer 3

Assess a client’s ability to increase their net worth by decreasing expenses.

Question 4

What are the 12 expenditure categories/clusters?

Answer 4

1. Housing
2. Groceries
3. Clothing
4. Transportation
5. Health care
6. Child or parental care
7. Personal grooming
8. Leisure
9. Education
10. Savings and investments
11. Debt reduction
12. Miscellaneous

Question 5

What are the 2 types of expenses?

Answer 5

Basic and discretionary.

Question 6

What are examples of discretionary expenses?

Answer 6

Flexible expenses that include leisure, private education, non-essential home renovation, savings and investments, some debt reduction and some miscellaneous items. Some basic expenses may be discretionary in the amount that the client spends.

Question 7

What is true of someone who spends most of their income on basic expenses rather than discretionary?

Answer 7

They will have a lowered ability to reduce their expenses.

Question 8

What are the 3 steps in creating a budget?

Answer 8

1. Record income, expenses, to determine cash flow and set a savings goal
2. Identify basic and discretionary expenses to determine which expenses can be cut, then adjust expenses accordingly
3. Review your budget monthly

Question 9

What are the 14 tips for making a good budget?

Answer 9

1. Set goals
2. Overestimate expenses, underestimate income
3. Know how much is in your account at all times
4. Make debt payment a priority
5. Pay yourself first
6. Trim your expenses
7. Share what you can
8. Keep separate accounts (spending vs savings)
9. Implement savings and investment plans for short and long term goals
10. Reduce insurance coverage
11. Pay with cash
12. Match funds
13. Save unexpected cash
14. Do not skimp on health care

Question 10

What are the two main reason that the consumer credit industry has gone through changes?

Answer 10

Changes in technology.

Changes to regulations.

Question 11

What are the 5 Cs of credit?

Answer 11

1. Character - client’s honesty, reliability, and intention to repay credit
2. Capacity - client’s ability to repay the loan
3. Credit - past credit history
4. Collateral - property that can be used to secure a loan
5. Capital - net worth

Question 12

Who determines credit history?

Answer 12

A credit bureau.

Question 13

What is a beacon score?

Answer 13

Another name for a credit score which is provided by credit-reporting agencies. It’s a numerical value based on a statistical analysis of the borrower’s information.

Question 14

What 4 types of information are generally included on a credit report?

Answer 14

1. Personal information
2. Account history
3. Inquiries
4. Public record information

Question 15

What is a debt service ratio?

Answer 15

Ratio of 2 numerical values selected from a borrower’s financial statements that are used as a guideline to help lenders evaluate a client’s financial situation.

Question 16

What is the GDS and TDS?

Answer 16

Gross debt service - all housing costs as a % of annual gross income.
Total debt service - all housing costs and other annual debt payments as a % of annual gross income.

Question 17

What is considered an acceptable GDS ratio?

Answer 17

Generally a ratio of 32% or less.

Question 18

What is considered an acceptable TDS ratio?

Answer 18

Generally a ratio of 40% or less.

Question 19

What are the pitfalls of the GDS and TDS ratios?

Answer 19

• Only highlight a client’s current situation, does not consider the future
• Do not provide information on a client’s short-term liquidity or long-term solvency
• Based on gross income, not net income
• Only applicable for average family incomes

Question 20

What is a charge account?

Answer 20

Account that allows customers to purchase goods and services on credit up to a specified limit with payment made at a later date. Typically have high fees and interest rates. Can be a charge card, open account credit, or conditional sales contract.

Question 21

What is the typical repayment on a line of credit?

Answer 21

Typically either a minimum monthly payment or a percentage of the limit.

Question 22

What is a HELOC?

Answer 22

Home-equity line of credit. Secured line of credit where a portion of a borrower’s equity in a home is used as collateral. Can borrow a larger amount (up to a maximum of 65% of the home’s value less any outstanding mortgage) at a lower interest rate.

If a client wishes to have a HELOC for 80% of a home’s value, the extra 15% must be done as a mortgage segment under the HELOC plan,

Question 23

What is a debt consolidation loan?

Answer 23

A way to consolidate multiple debts into one loan with one monthly payment at a lower interest rate.