Financing Strategies

Question 1

Long-term vs. short-term debt

Answer 1

• Short-term debt
  Short-term debt is consumer and auto debt
  Examples
• 3-year auto loan
• Personal lines of credit
• Credit card balances
• Long-term debt
  everything else
  Examples
• Home equity line of credit
• 30-year home mortgage

Question 2

Secured vs. unsecured debt

Answer 2

With a secured (also called collateralized) loan, borrowers pledge assets to repay the loan in the event of
default. For example, a mortgage uses the home as collateral and an auto loan uses the car as collateral.

Unsecured debt is not backed by an asset. With an unsecured loan, the clients borrow on their credit
worthiness, and no collateral is pledged. Sometimes referred to as a signature-only loan.

Question 3

Buy vs. lease/rent

Answer 3

Normally the higher the marginal tax bracket, the greater the advantage of owning a home. Also
consider the time frame. Short-time periods favor renting; long-time periods favor owning.

Buying
- One-time costs
* Down payment
* Closing costs
- Periodic costs
* Mortgage
* Property tax
* Homeowners insurance
* Utilities
* Maintenance
-Advantages
* Potential tax deductions if
itemizing (mortgage interest
and up to $10,000 of property
tax)
* Home equity
* No capital gain on sale if under exclusion amount

Renting
- One-time costs
* Security deposit
* Sometimes first and last
month’s rent
- Periodic costs
* Rent
* Renters insurance
-Advantages
* Landlord responsible for
maintenance
* More flexible if moving
frequently
* Often cheaper than buying

Question 4

Buy vs. lease a car- Considerations

Answer 4

Buying
- Monthly payments: Higher
- Ownership: Own Car can sell
- Warranty: normally limited warranty
- Depreciation: Depreciates

Leasing
- Monthly payments: Lower
- Ownership: No resale value
- Warranty: always under warranty
- Depreciation: Does not depreciate

Question 5

Fixed-Rate Mortgage

Answer 5

Payments and interest are fixed over the period of repayment (typically 15 or 30 years).

Question 6

Adjustable-Rate Mortgage (ARM)

Answer 6

Interest rates fluctuate with interest rates in the economy. As interest rates vary, payments change.
There are limits as to how much and how frequently the rates may change. Adjustable-rate mortgages generally carry a lower initial interest rate than fixed-rate mortgages because of their greater degree of uncertainty.

Question 7

Biweekly payments

Answer 7

Payments are due every 2 weeks in an amount equal to one-half the monthly payment, resulting in the
mortgage being paid off faster and with less total interest.

Question 8

Balloon payments

Answer 8

Payments are based on a long-term mortgage at a given interest rate. For example, after a 5-year period, the unpaid balance must be either paid off or refinanced.

Question 9

Federal Housing Administration (FHA)

Answer 9

While the government does not originate mortgage loans, it may guarantee them through insurance issued by the FHA. This insurance reduces the risk to the lender because if the borrower defaults, the FHA will make the loan good. This guarantee makes mortgage money available to low- and middleincome individuals who lack the necessary down payment or who may not be able to meet other requirements necessary to obtain conventional mortgage financing.

Question 10

Veterans Administration Loans (VA)

Answer 10

This is a similar program to the FHA except it is available only to veterans. The requirements for veterans, especially the amount of the initial down payment, are less stringent than required under
conventional mortgage financing.

Question 11

Mortgage Calculations - Interest for Life of Loan

Answer 11

Step 1: Calculate payments PMT (end mode).
Step 2: Calculate total payments and subtract the principal. PMT * #of payments - principal

Question 12

Mortgage Calculations - Principal and interest for less than the life of the loan (first year)

Answer 12

Step 1: Calculate payments (use end mode)
Step 2: Calculate total payments for the year. PMT *12
Step 3: Round step 2 answer down to nearest 100 to estimate interest
Step 4: Multiple step 3 by tax bracket
Step 5: Subtract approximate total payments for the year by step 4.

Question 13

Mortgage Calculations - Principal and interest for less than the life of the loan ( past first year)

Answer 13

Step 1: Calculate payments (use end mode)
Step 2: Amortization
- Set P/YR
- Enter N, I/YR, and PV
- Calculate PMT
- 1 INPUT 120 (10 yrs)
- Gold, AMORT
- Hit = to rotate through values

Question 14

Statement of financial position mortgage reporting

Answer 14

Some mortgage-related questions involve changes in net worth. Paying down mortgage principal (not
interest) results in an increase in net worth (because it is a decrease in liabilities).

Question 15

Qualified residence interest rules

Answer 15

The Tax Cuts and Jobs Act (TCJA) limited the amount of qualified residence interest that is deductible.
The aggregate amount of acquisition indebtedness and the aggregate amount of home equity indebtedness may not exceed $750,000 for married filing jointly and single filers, and $375,000 each for married filing separately. Existing primary mortgages up to $1 million are grandfathered. Interest
attributable to debt over these limits is nondeductible personal interest. Home equity loans must be
used to improve the home in order to be deductible. Home equity loans not used for home improvement prior to TCJA are not grandfathered.

Question 16

Refinancing Cost-benefit analysis

Answer 16

The costs of refinancing are similar to the costs of obtaining an original mortgage. When evaluating
whether a client should refinance a mortgage, the financial planner should consider two key issues:
length of time expected to stay in the home and cash flow capacity.
Reasons to refinance a mortgage
* To obtain a lower interest rate
* To consolidate debt
* To change the term of the loan (shorter or longer)
* To raise extra cash

Question 17

Reverse mortgage

Answer 17

A reverse mortgage is a means of accessing equity in a home. Funds may be received as a lump sum,
ongoing payments, or as a line of credit.
- Repayment is triggered upon the death of the individual owner (longest living spouse), the conclusion of a term of years, or it can be triggered by certain events, such as absence of the elder homeowner from the home for a minimum of 1 year.
If an older homeowner with a reverse mortgage enters a nursing home, owning a residence is not a barrier to Medicaid eligibility. However, if the home is sold to satisfy a reverse mortgage lender,
remaining cash proceeds are not protected and will cause the loss of Medicaid eligibility.

• Generally, these payments will not be counted as income for Medicaid eligibility as long as they are spent within the same months that they are received. However, the unspent balance from a lump-sum reverse mortgage loan could put a borrower over the allowable asset limits for Medicaid or Supplemental Security Income (SSI) eligibility. Even if the reverse mortgage is received as monthly payments, the payments could accumulate and push asset amounts over eligibility limits. In addition,
  payments from reverse annuity mortgages may be counted as income for SSI whether or not they are
  spent within the month they are received. Individual state rules may vary.

Question 18

General rules for a reverse mortgage

Answer 18

• A reverse mortgage is only available to homeowners 62 years and older living in condominiums and single-family homes.
• There are no income qualifications.
• The borrowers retain title to the property and can continue to live in and own the home for as long as they choose.
• There are no monthly mortgage payments during the life of the loan.
• Proceeds are tax-free and can be used for any purpose. They may be paid out as a lump sum, in monthly payments, as a line of credit, or a combination.
• The loan amount depends on the borrower’s age, appraised value of the home, current interest rates, and the type of reverse mortgage selected.
• A reverse mortgage is not repaid until the borrower moves out of the home permanently.
• The repayment amount cannot exceed the value of the home, regardless of the loan balance.
• Once the loan is repaid, any remaining equity is distributed to the borrower or the borrower’s estate.
• The home does not have to be owned free and clear to qualify for a reverse mortgage.