An interest rate is a promissed rate of return, and there are many different interest rates as there are many different ways of lending or borrowing money.
Mortgage rate is the interest rate that home buyer pays on the loan when he/she takes to finance his/her home.
Commercial Loan rate is the rate charge by the bankson loans made to businesses.
The interest rate on any type of loan depends on a number of factors, but the three ost important ones are unit of account, its maturity, and its default risk.
The unit of account is the medium in which payments are denominated.
The maturity of a fixed-income instrument is the length of time until repayment of the entire amount borrowed.
Default risk is the possibility that some portion of the interest or the principal on a fixed-income instrument will not be repaid in full.
Friday, June 6, 2008
Thursday, June 5, 2008
Debt-management
Debt-management process is a systematic attmpt to analyze and deal with debt. This process can be broken into five steps:
Debt identification: consists of figuring out what the most important debt exposures are for the unit of analysis, either an individual or a household. To help in identifying debt exposures, it is a good idea to have a checklist that enumerates of all the entity's potential exposures and the realtionships among them.
Debt assessment: is the qualificaton of the costs associated with the debt that have been identified in the first step of debt identification.
Selection of debt-management techniques: there are three steps you can use to reduce debt;
Debt avoidance - a conscious decision not to e exposed to a debt
Loss prevention and control - actions taken to reduce or prevent likeelihood or severity of the loses
Debt transfer - trnsferring debt by going to the banks and asking fora loan to consolidate all of your debts into one that could offer the lowest interest rate and most convinient types of payments.
Implementation: following decision about how to handle the debt, one must decide to implement it. In other words, you have to take an action to consolidate and reduce yoour debt.
Review: debt-management is a dynamic process that needs to be reviewed every now and then. Review your debt often and review other available toold on the market to help you conslidate reduce you debt. You might find even a lower interest rate to consolidate yor debt, so you will transfer it from one to another instiution. Good luck!
Debt identification: consists of figuring out what the most important debt exposures are for the unit of analysis, either an individual or a household. To help in identifying debt exposures, it is a good idea to have a checklist that enumerates of all the entity's potential exposures and the realtionships among them.
Debt assessment: is the qualificaton of the costs associated with the debt that have been identified in the first step of debt identification.
Selection of debt-management techniques: there are three steps you can use to reduce debt;
Debt avoidance - a conscious decision not to e exposed to a debt
Loss prevention and control - actions taken to reduce or prevent likeelihood or severity of the loses
Debt transfer - trnsferring debt by going to the banks and asking fora loan to consolidate all of your debts into one that could offer the lowest interest rate and most convinient types of payments.
Implementation: following decision about how to handle the debt, one must decide to implement it. In other words, you have to take an action to consolidate and reduce yoour debt.
Review: debt-management is a dynamic process that needs to be reviewed every now and then. Review your debt often and review other available toold on the market to help you conslidate reduce you debt. You might find even a lower interest rate to consolidate yor debt, so you will transfer it from one to another instiution. Good luck!
Wednesday, June 4, 2008
About Debt - part 2
Risk Management
The process of formulating the benefit-cost trade-offs of risk reduction and deciding on the course of action to take is called risk management. People at times express regret at having taken costly measures to reduce risk. The appropriateness of a risk-management decision should be judged in the light of the information available at the time decision is made.
Types of risks
We distinguish among five major cateogries of risk exposure for households:
Sickness, disability and death: unexpected sickenss or accidental injuries can impose large costs on the people because of the need for treatment and care.
Unemployment risk: this is the risk of losing one's job.
Consumer-durable asset risk: this is the risk of loss arising from ownership of a house, car, or other consumer-durable asset.
Liability risk: this is the risk that others will have financial claim against you.
Financial-asset risk: this is the risk arising from holding different kinds of financial assets such as equities or fixed-income securities denominated in one or more currencies.
The process of formulating the benefit-cost trade-offs of risk reduction and deciding on the course of action to take is called risk management. People at times express regret at having taken costly measures to reduce risk. The appropriateness of a risk-management decision should be judged in the light of the information available at the time decision is made.
Types of risks
We distinguish among five major cateogries of risk exposure for households:
Sickness, disability and death: unexpected sickenss or accidental injuries can impose large costs on the people because of the need for treatment and care.
Unemployment risk: this is the risk of losing one's job.
Consumer-durable asset risk: this is the risk of loss arising from ownership of a house, car, or other consumer-durable asset.
Liability risk: this is the risk that others will have financial claim against you.
Financial-asset risk: this is the risk arising from holding different kinds of financial assets such as equities or fixed-income securities denominated in one or more currencies.
Tuesday, June 3, 2008
About Debt - part I
Most of the regular folks are broke and they do not have any cash in their pockets because they are in debt up to their eyeballs.
The only help they can look for are the commercial banks to help them consolidate their debts and give them lowest possible interest rates when repaying the loan.
According to a recent USA Today article about debt, 78% of Baby Boomers have mortgage debt, 59% have credit card debt, and 56% have car payments. If you want to lower your debt, it will take you a lot of discipline and courage to do so. However, it can be done.
Using a debt, we can buy a home, a car, or start a new business. I remember a finance professor telling us that debt was a two-edged sword, which would perfectly cut for you like a sharpest knife, but could also cut you and harm you.
Consider the Risk
Risk aversion id a characteristic of an individual's preferences in risk-taking situations. It is a measure of willingless to pay to reduce one's exposure to risk. In evaluating trade-offs between the costs and benefits of reducing risk, risk-averse people prefer the lower-risk alternatives for the same cost. For example, if you are generally willing to accept a lower expected rate of return on an investment because it offers a more predictable rate of return, you are risk averse. When choosing among investment alternatives with the same expected rate of return, a risk averse individual chooses the alternative with the lowest risk.
The only help they can look for are the commercial banks to help them consolidate their debts and give them lowest possible interest rates when repaying the loan.
According to a recent USA Today article about debt, 78% of Baby Boomers have mortgage debt, 59% have credit card debt, and 56% have car payments. If you want to lower your debt, it will take you a lot of discipline and courage to do so. However, it can be done.
Using a debt, we can buy a home, a car, or start a new business. I remember a finance professor telling us that debt was a two-edged sword, which would perfectly cut for you like a sharpest knife, but could also cut you and harm you.
Consider the Risk
Risk aversion id a characteristic of an individual's preferences in risk-taking situations. It is a measure of willingless to pay to reduce one's exposure to risk. In evaluating trade-offs between the costs and benefits of reducing risk, risk-averse people prefer the lower-risk alternatives for the same cost. For example, if you are generally willing to accept a lower expected rate of return on an investment because it offers a more predictable rate of return, you are risk averse. When choosing among investment alternatives with the same expected rate of return, a risk averse individual chooses the alternative with the lowest risk.
Monday, June 2, 2008
Compounding
We will begin this discussion of the time value of money with the concept of compounding. This is the process of going from today's value, or present value (PV), to future value (PV).
For instance, let's assume you put into the bank account $100 at an interest rate of 10% per year for 10 years.
PV = present value or starting amount in your bank account, which is $100.
i = interest rate per year or 10% in our case.
n = number of years the account will earn interest.
FV = future value of your money at the end of 10th year.
Now, let's calculate the future value of today's $100 at interest rate of 10% per year for 10 years.
FV = $100 X (1 + 10%)^10 years
FV = $100 X (1.10)^10
FV = $259.37
Therefore, after 10 years and initial saving of $100 at an interest rate of 10% per annum, you will end up having $259.37 in your account.
To calculate this copounded interest, please use this calculator provided for you.
For instance, let's assume you put into the bank account $100 at an interest rate of 10% per year for 10 years.
PV = present value or starting amount in your bank account, which is $100.
i = interest rate per year or 10% in our case.
n = number of years the account will earn interest.
FV = future value of your money at the end of 10th year.
Now, let's calculate the future value of today's $100 at interest rate of 10% per year for 10 years.
FV = $100 X (1 + 10%)^10 years
FV = $100 X (1.10)^10
FV = $259.37
Therefore, after 10 years and initial saving of $100 at an interest rate of 10% per annum, you will end up having $259.37 in your account.
To calculate this copounded interest, please use this calculator provided for you.
Sunday, June 1, 2008
Loan Amortization
Loan Amortization
Many loans, such as mortgage laons are repaid in equal periodic installments. Part of each payment is interest on outstanding balance and the other part is payment of the principal amount. After each payment, the outstanding balance is reduced by the amount of the principal paid. Therefore, the portion of interest is lower each period as the principal decrease with each period's payment.
For example, let's assume that you take a loan on $100,000 at an interest rate of 10% per year, repaid in 3 annual installments. First, we will calculate the annual payment by finding the PMT that has PV of $100,000 when discounted at 10% for 3 years;
PMT = -((PV(1+i)^n+FV)i)/(1-(1+i)^n)
PMT = -((-100,000(1.10)^3+0) X 0.10) / (1-(1.10)^3)
PMT = $40,211.48
This is the payment that needs to be paid in first year. How much of it is the interest and how much is the principal? Because, the interest rate is 10%, the interest portion of the first payment must be 10% X $100,000 or $10,000. The remainder of $40,211.48 or $30,211.48 is the payment of the original $100,000 of the principal amount. The remaining balance after the first payment is, therefore, $100,000-$30,211.48=$69,788.52. In the second year, how much of the $40,211.48 is interest and how much is the principal? We are left with $69,788.52. Because, the interest rate is 10%, the interest portion of the first payment must be 10% X $69,788.52 or $6,978.85. The remainder of $40,211.48 or $33,232.63 is the payment of the $69,788.52 of the principal amount left. The remaining balance after the second payment is, therefore, $69,788.52-$33,232.63=$36,555.89. The third and final year covers both the interest and the principal on this remaining $36,555.89.
Many loans, such as mortgage laons are repaid in equal periodic installments. Part of each payment is interest on outstanding balance and the other part is payment of the principal amount. After each payment, the outstanding balance is reduced by the amount of the principal paid. Therefore, the portion of interest is lower each period as the principal decrease with each period's payment.
For example, let's assume that you take a loan on $100,000 at an interest rate of 10% per year, repaid in 3 annual installments. First, we will calculate the annual payment by finding the PMT that has PV of $100,000 when discounted at 10% for 3 years;
PMT = -((PV(1+i)^n+FV)i)/(1-(1+i)^n)
PMT = -((-100,000(1.10)^3+0) X 0.10) / (1-(1.10)^3)
PMT = $40,211.48
This is the payment that needs to be paid in first year. How much of it is the interest and how much is the principal? Because, the interest rate is 10%, the interest portion of the first payment must be 10% X $100,000 or $10,000. The remainder of $40,211.48 or $30,211.48 is the payment of the original $100,000 of the principal amount. The remaining balance after the first payment is, therefore, $100,000-$30,211.48=$69,788.52. In the second year, how much of the $40,211.48 is interest and how much is the principal? We are left with $69,788.52. Because, the interest rate is 10%, the interest portion of the first payment must be 10% X $69,788.52 or $6,978.85. The remainder of $40,211.48 or $33,232.63 is the payment of the $69,788.52 of the principal amount left. The remaining balance after the second payment is, therefore, $69,788.52-$33,232.63=$36,555.89. The third and final year covers both the interest and the principal on this remaining $36,555.89.
Car Loan
Have you ever asked youself why wealthy people do not use debt as nearly as we are led to believe? Well, some say debt is dumb.
You are buying a car and thinking of taking a one-year loan of $1,000. Your APR of 12% per year (or 1% a month) is to be repaid in 12 months or 12 equal monthly payments. The monthly payment is $88.85.
The salesperson trying to sell you a car makes the following statement:
"Although the rate on this loan is 12% per year, it worked out to be a much lower rate. Because, the total interest payments over the year are only $66.19 and the loan is for $1,000, you will be only paying a true interest rate of 6.62% oer year."
What is the trick here?
The trick is here that with your first monthly payment, you are paying not only interest on the outstanding balance, you are also repaying part of the principal. The interest payment due at the end of the first month is 1% of $1,000 or $10. Because your monthly payment is $88.85, the other $78.85 is repayment of principal.
You are buying a car and thinking of taking a one-year loan of $1,000. Your APR of 12% per year (or 1% a month) is to be repaid in 12 months or 12 equal monthly payments. The monthly payment is $88.85.
The salesperson trying to sell you a car makes the following statement:
"Although the rate on this loan is 12% per year, it worked out to be a much lower rate. Because, the total interest payments over the year are only $66.19 and the loan is for $1,000, you will be only paying a true interest rate of 6.62% oer year."
What is the trick here?
The trick is here that with your first monthly payment, you are paying not only interest on the outstanding balance, you are also repaying part of the principal. The interest payment due at the end of the first month is 1% of $1,000 or $10. Because your monthly payment is $88.85, the other $78.85 is repayment of principal.
Saturday, May 31, 2008
Should you buy or rent?
Buy or Rent
If you are currently renting a house for $10,000 per year and have an option to buy it for $200,000, would you buy it?
Let's say that your tax rate is 35%, for income tax purposes. The maintenance and property taxes are esitated to be:
Maintenance $1,000
Property Tax $2,000
Total $3,000
These cost are currently included in the rent.
Let's assume that your objective is to provide yourself with housing at the lowest possible cost. Should you buy or continue to rent?
Because property taxes can be deducted from income for federal income tax purposes, the after tax outflow for property taxes per year is 0.65 X $2,000 = $1,300. If no date for selling a house ahs been specified, we can assume an infinite period.
First, we need to compute present value of the outflows, where period is 2 years, interest is 3%, future value is $0.00 and payment is $45,000. The present value of the outflows is $86,106.00.
Next, we compute the present value of the inflows or both periods; 2 and 43 years.
where period is 43 years, interest is 3%, future value is $0.00 and payment is $5,000, the present value of the inflows is $119,910, and where period is 2 years, interest is 3%, future value is $119,000 and payment is $0.00, the present value of the inflows is $113,026.
If you buy a house, then you will need to pay $200,000 immediatelly, and the expected after-tax cash outflow will consists of the maintenance and property tax expenses:
Cash outflow in Year n = $1,000 + $1,300 = $2,300
Let us assume there is no inflation and the real after tax rate equals (1 - tax rate) times the before-tax rate, which in our case is:
(1 - 0.03) X 3% = 0.7 X 3% = 2.1%
Because we are assuming that the property and maintenance costs are fixed in real terms, 2.1% should be a real interest rate. Therefore, we find the following:
Present Value of Owning = $200,000 + ($2,300 / 0.021) = $309,523.81 and
Present Value of Renting= $ 10,000 / 0.021 = $476,190.48
If Present Value of Renting is greater than Present Value of Owning, then it is better to own rather than rent, which is case in our example above.
For more info and calculators used, please visit Today's Smart Finance.
If you are currently renting a house for $10,000 per year and have an option to buy it for $200,000, would you buy it?
Let's say that your tax rate is 35%, for income tax purposes. The maintenance and property taxes are esitated to be:
Maintenance $1,000
Property Tax $2,000
Total $3,000
These cost are currently included in the rent.
Let's assume that your objective is to provide yourself with housing at the lowest possible cost. Should you buy or continue to rent?
Because property taxes can be deducted from income for federal income tax purposes, the after tax outflow for property taxes per year is 0.65 X $2,000 = $1,300. If no date for selling a house ahs been specified, we can assume an infinite period.
First, we need to compute present value of the outflows, where period is 2 years, interest is 3%, future value is $0.00 and payment is $45,000. The present value of the outflows is $86,106.00.
Next, we compute the present value of the inflows or both periods; 2 and 43 years.
where period is 43 years, interest is 3%, future value is $0.00 and payment is $5,000, the present value of the inflows is $119,910, and where period is 2 years, interest is 3%, future value is $119,000 and payment is $0.00, the present value of the inflows is $113,026.
If you buy a house, then you will need to pay $200,000 immediatelly, and the expected after-tax cash outflow will consists of the maintenance and property tax expenses:
Cash outflow in Year n = $1,000 + $1,300 = $2,300
Let us assume there is no inflation and the real after tax rate equals (1 - tax rate) times the before-tax rate, which in our case is:
(1 - 0.03) X 3% = 0.7 X 3% = 2.1%
Because we are assuming that the property and maintenance costs are fixed in real terms, 2.1% should be a real interest rate. Therefore, we find the following:
Present Value of Owning = $200,000 + ($2,300 / 0.021) = $309,523.81 and
Present Value of Renting= $ 10,000 / 0.021 = $476,190.48
If Present Value of Renting is greater than Present Value of Owning, then it is better to own rather than rent, which is case in our example above.
For more info and calculators used, please visit Today's Smart Finance.
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