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University of Guelph
Marketing and Consumer Studies
MCS 2100
Jian Zhou

MCS*2100 DE Chapter 3 Summaries - Kyle Brennan Planning you Tax Strategy Taxes and Financial Planning  Taxes on purchases – sales tax. Food items and prescription drugs are exempt to sales to reduce economic burden on poor.  Taxes on property – real estate major source of revenue for local governments. Increasing rates are large concern to homeowners.  Taxes on wealth – “Capital Gains Tax”, Sales of assets (stock or bond), transferring ownership asset, gifts or inheritance.  Taxes on earnings – supports a number of social benefit programs. Pension plans, Employment insurance. Tax is withheld by employer. Filing your Federal/Provincial Income Tax Return  Who must file? All residents of Canada for any year they have balance of taxes owing. Income Tax Fundamentals  Step 1: Determining total income o Employment income o Net Business income o Investment income o Taxable capital gains o Other income (corporate pension plans, RRSPs)  Step 2: Calculating Net income o Net income – total income less deductions. o Deductions – expenses that taxpayers are allowed to deduct from total income. Common permitted deductions are:  Contributions to deferred income plans  Union and professional dues  Child care expenses  Disability Supports  Moving Expenses  Others: Spousal and child support, interest paid on loans the proceeds of which are used to earn taxable investment incomes, employment expenses (ex. travel).  Step 3: Calculating Taxable Income o Security options deduction – equals one half of stock option benefit included under employment income. o Capital gains deduction – equals to one half of the eligible capital gains exemption. o Net capital losses – prior years can be carried forward indefinitely and used to offset any taxable gains. o Others: employee home relocation, employment with Canadian Forces, and carry forward from non-capital losses from prior years.  Step 4: Calculating Federal Taxes Owing o 0 to 37,178$ 15% tax rate o 37,179 to 74,357 $ 22% tax rate o 74,358 to 120,877 $ 26% tax rate o Over 120,887 $ 29% tax rate o Marginal Tax rate – rate you pay on the next dollar of taxable income earned. o Average Tax rate – total tax due divided total taxable income.  Step 5: Calculating Net Federal Tax o Two Types of Tax Credits.  Non-Refundable tax credits (most common, subtracted from total amount of taxes owed, never reduce net federal tax below zero)  Refundable tax credits o Personal credits – spousal, dependants, age and disability reduce payable income tax directly by how much you apply to each situation. o Calculate the non-refundable tax credit by determining the maximum applicable amount. The government pre-sets some of these. When these are determined, it is calculated by multiplying the amount b the lowest marginal tax rate.  Making Tax Payments o Source withholding – tax withheld from payment is considered to have been paid by you to the tax authorities. End of the year your T4 is used to report your annual earnings and amounts deducted. o Reductions of source withholding – must prove you are paying more withholding tax then necessary. o Installment payments – Tax payments must be paid in installments if the difference between your payable taxes and the amount you have had withheld at source is more than 2000$ in both the current and either the two preceding years.  Deadlines and Penalties th o File taxes by April 30 each year. (balance owing due) o If you or your spouse has business income it is June 15 o Penalties – 5% on balance, plus 1% of unpaid balance for each month your return is late. Tax Planning Strategies  How should you receive income? o Small business owner – pay themselves a salary or receive remuneration in the form of dividends only worth it after 250,000$ income.  Tax Free Saving account o 5000$ annually, amounts withdrawn are free of tax o Any unused room can be carried forward o Important for Canadians with below average incomes, and those with high income that want to save more than the 20,000$ max RRSP.  Tax Deferral techniques o RRSP, RPP, IPP, DPSP.  Income Splitting techniques o Making contribution to spouses RRSP o Splitting the CPP benefits with spouse o High income spouse pay for living expenses, lower income invests income. o Opening a RESP o Setting up a trust investment  Ensuring your Portfolio is Tax Efficient o Whether the interest on a loan made for an investment purposes can be deducted from taxable income. If proceeds of a loan are invested in assets that generate taxable dividends, interests, or rents, then the interest paid on the loan is tax deductible.  Tax issues important to students o Report scholarships, fellowships, bursaries, grants and RESPS. o Deductions – Moving expense, child care expenses, interest paid on student loan o Non-refundable tax credit – tuition and textbooks.  Changing tax strategies o Consider changes in personal situation and your income level. Tax Assistance and the Audit Process  Tax information sources o Tax Publications o The internet  Tax preparation software and electronic filing o Electronic filing most popular  Tax preparation services o Most people do their own tax return. Helps improve your understanding of your financial situation Definitions: 1. Excise Tax – tax imposed on specific goods and services (ex – gasoline) 2. Average Tax Rate – Total tax due divided by total income [Line 435/Line 150 x 100] 3. Employment income – Remuneration received for personal effort. 4. Investment income – Income from property, including income in the form of interest, dividends, and rents net of expenses. 5. Marginal tax rate – The rate of tax paid on the next dollar of taxable income 6. Net business income – Net income from an activity that is carried out for profit, after expenses are deducted. 7. Net income – Total income reduced by certain deductions, such as contributions to an RRSP or RPP. 8. Tax audit - A detailed examination of your tax return by the Canadian Revenue Agency 9. Tax credit – An amount subtracted directly from the amount of taxes owing 10. Tax evasion – The use of illegal actions to reduce ones taxes 11. Tax planning – The use of legitimate methods to reduce one’s taxes. 12. Taxable capital gains – Net gains from the sale of capital assets such as stocks, bonds, and real estate. One-Half of net capital gains are taxable. 13. Taxable income – The net amount of income. After allowable deductions, on which income tax is computed. Chapter 4 The Banking Services of Financial Institutions LO 1- Analyze factors that affect selection and use of financial services. Financial Needs for short term needs -Daily purchases -Living expense payments -Emergency funds Cash Availability Savings Chequing Credit Cards -Cheque cashing -Regular savings -Regular chequing -All purpose cards -ATM's account -Online payments -Cash advances. -Traveller's cheques -Money market -Automatic payments -Foreign currency account -Cashier‟s cheques exchange -Money orders Financial Needs for long term goals -Major purchases -Long term financial security Savings Credit Services Investment Services Other Services -Guaranteed -Cash loans for autos, -Registered -Insurance (auto, Investment education, and other Retirement Savings home, life, health) Certificates (GIC's) purposes Plan (RRSP) -Trust service -Canada Savings -Mortgages -Brokerage Service -Tax preparation Bonds (CSB) -Home equity loan (full service or -Safety deposit boxes discount) -Budget Counselling -Investment advice -Estate planning -Mutual funds Common mistakes involved with managing current cash needs include: -Overspending due to impulse buying and credit cards -Having insufficient liquid assets (available cash) to pay current bills. -Using savings or borrowing to pay current expenses -Failure to invest unneeded funds in an interest-earning savings account or other investment plan for long-term goals. Quick cash sources In order to get cash in an emergency situation you can use a savings account, redeemable GIC, or mutual fund. A bank overdraft or credit card will also supply you with cash but most likely at high interest rates. The best way is too have a personal line of credit already set up in case of an emergency. Financial Services: Savings- (time deposits) include money in savings accounts and investment certificates Payment Services- the ability to transfer money to other parties, eg. Chequing accounts and demand deposits. Borrowing- credit cards, cash loans, mortgages. Other Financial Services- Trusts- a legal agreement that provides for the management and control of assets by one party for the benefit of another. eg. RESP Direct Deposit- having a paycheck directly deposited into a bank account. Automatic Payments- bills paid through the direct withdrawal from a bank account. ATM's- can be expensive with frequent use as they can charge fees for each transaction. Methods of Payment 1. Point of Sale Transaction- debit card or credit card payment. 2. Stored Value Cards- prepaid cards for purchasing specific merchandise, some are reloadable others disposable. 3. Smart Cards- (electronic wallets) look like ATM cards but have microchip which stores prepaid amounts for buying goods and services, also stores data about account balance, transaction history, insurance info, and medical history. 4. Electronic Cash- SecurNat offered by National Bank of Canada allows you to pay online purchases from National Bank approved merchant with a credit card. Opportunity Costs of Financial Services -Higher long-term returns may result in low liquidity capability. -Minimum balance accounts can tie up extra money that could be earning interest otherwise. As a general rule when the interest rates are rising us long term loans to take advantage of low interest rates and select short-term savings instruments to take advantage of the higher interest rates when they mature. Furthermore when interest rates are falling you should use short-term loans to take advantage of lower interest rates when you refinance loans. Should also select long- term savings instruments to lock in earnings at current higher interest rates. LO 2- Compare the types of financial institutions. Types of Financial Institutions Deposit type Non-deposit type -Chartered banks -Life insurance companies -Trust companies -Investment Companies -Credit unions/cuisses popularise -Mortgage and loan companies -Pawnshops -Cheque-cashing outlets. Interest Rates Prime Rate The rate the banks charge their most creditworthy corporate and retail clients. Bank Rate The rate a central bank charges for loans to national banks (eg. the rate the Bank of Canada charges the Bank of Montreal) 91-day T-bill rate The yield on 91-day government treasury bills 30-yr T-bond rate The yield on 30 year government treasury bonds 5-yr mortgage rate The amount individuals pay to borrow for the purchase of a home 5-yr term deposit - The amount that individuals receive for 5-year term deposits rate Savings deposit rate The amount that individuals receive for regular savings deposits. Deposit Type Institutions The division referred to as the 'four pillars' separated banks, trust companies, insurance companies, and investment dealers. But in 1992 was revoked by Canadian government allowing them to compete more directly with one another. Chartered Banks- a financial institution that offers full range of financial services to individuals, businesses and government agencies. Schedule I banks- full service domestic banks, including the big six banks (RBC financial, CIBC, BOM, Scotia bank, TD Canada Trust, and National Bank of Canada), smaller Canadian owned banks, and other non-bank financial institutions. Schedule II banks- subsidiaries of foreign banks in Canada that have restrictions on asset growth as well as on lending activities that are a function of their local capital base rather than that of the parent base. Focus on corporate loans. Schedule III banks- branches of foreign institutions that have been authorized to bank in Canada. Trust Companies- offer a broad range of financial services similar to those provided by banks. They are also the only corporations allowed to act as a trustee in charge of property, stocks and bonds. Credit Unions and Caisses Populaires- user owned, non-profit, co-operative financial institution, usually offer credit cards, mortgages, home equity loans, direct deposit, cash machines, safety deposit boxes and investment services. Non-deposit Institutions Life insurance companies- main purpose is to provide financial security for dependants Investment companies- (mutual funds) offers banking-type services. Common one being the money market fund which is a combination savings-investment plan in which the investment company uses your money to purchase a variety of short term financial instruments. Your earnings are based on the interest the investment company receives. Mortgage and Loan Companies- provide real estate mortgage loans as well as financing opportunities for individuals and small businesses. Finance and Leasing Companies- extend loans and leases to both individual and businesses and are categorized by the type of loan or lease they offer. (Eg. Consumer loan companies vs. finance companies that serve the corporate sector.) Pawnshops- makes loans based on the value of tangible possessions. Used to get cash fast. Cheque-Cashing Outlets- cash cheques for a fee anywhere from 1-20 percent of the cheque value. Online Banking Benefits Concerns -Time and money savings -Potential privacy, security violations -Convenience for transactions, comparing rates -ATM fees can become costly -No paper trails for identity thieves -Difficulty depositing cash, cheques -Transfer access for loans, investments -Over spending due to ease of access -Email notices of due dates -Online scams, "phishing" and email spam LO 3-Compare the costs and benefits of various savings plans. Types of Savings Plans Type of Alternative Benefits Drawbacks Regular Savings Low minimum balance. Ease Low rate of return accounts/passbook accounts of withdrawal. Insured to $100,000 per financial institution GIC's Guaranteed rate of return for Possible penalty for early time of GIC. Insured withdrawal. Minimum deposit Interest-earning chequing Chequing privileges. Interest Possible service charge for accounts earned. Insured to $100,000 going below minimum balance. Cost for printing cheques; other fees may apply Money market accounts Favourable rate of return Higher min balance than (based on current interest regular savings accounts. No rates). Allows some cheque interest or service charge, if writing below a certain balance. Money market funds Favourable rate of return Min balance. Not insured (based on current interest rates) Canada Savings Bonds Rate of return varies with No interest paid if redeemed (CSB's) current interest rates. Low min before 3 months. deposit. Regular or compound interest. Government guaranteed Term Deposits and GIC's Term deposits- a deposit made for a specified term in exchange for a higher rate of return. Can be redeemed before maturity by earning a reduced interest rate (paying penalty). Guaranteed Investment Certificates' (GIC's)- are term deposits made for longer periods of time. Usually 1-5 years. Interest Earning Chequing Accounts Canada Savings Bonds (CSB's)-developed from victory bonds. Sold only once a year in 6-month period October to April. They have a fixed interest rate for first year and subject to guaranteed minimum. Rates can be adjustable in later years. CSB's can be cashed at any time for face value plus earned interest. Can get regular interest bond or compound interest bond. -Regular interest bond pays out interest earned once a year, and denominations for this bond range from $300 to $10000 and must be purchased with cash. -Compound interest bond reinvests earned interest automatically until redemption or maturity. Denominations range from $100 to $10000 and can be paid with cash, through a monthly payment plan with financial institution, or through a payroll savings plan. -There is also a 3rd bond: the Canada Premium Bond (CPB) which is sold at same time as others but has higher interest rates because it can only be redeemed on the anniversary date and the 30 days following. LO 4- Identify the factors used to evaluate different savings plans. Rate of Return- (yield) the percentage of increase in the value of savings as a result of interest earned. Compounding- the more frequent the compounding rate is the higher the return will be. Effective Annual Rate (EAR)- formula that calculates effective return, takes compounding into account. EAR= [1+k/m] - 1 m= # of compounding periods in a year k= rate of return quoted for a year Inflation Money that is being earned in a savings account should always be compared to the inflation rate to ensure that you are not actually losing money by letting it sit there. The real rate of return is the investment's EAR subtract the inflation rate. Real Rate of return = EAR - inflation rate. Tax Considerations- Taxes also decrease the amount of interest actually earned on savings. If in 26% tax bracket federally, you would do 1- 0.26= 0.74 then multiply this value by yield on savings account (6.25%) 0.74*0.0625 = 0.046 therefore your after tax return would be 4.6%. Then if inflation was 3% over that year. The real after tax return is 4.6%-3% = 1.6%. Liquidity- refers to the ease in which you can access cash or convert investments into cash with minimal loss of principal. Safety- most savings plans are insured through the federal government. The CDIC protects eligible deposits up to a maximum of $100,000 per person including principal and interest. Restrictions and Fees-always be sure to look into the hidden fees and restrictions that banks apply to their savings accounts, such as minimum balances, transaction fees and interest rates. LO 5- Compare the costs and benefits of different types of chequing accounts. Types of Chequing Accounts 3 categories: regular chequing accounts, activity chequing accounts, and interest-earning chequing accounts. Regular Chequing Accounts-have monthly service charges that can be avoided by maintaining a minimum balance. Some banks will also waive the service charge if there is a certain balance in savings account. Activity Accounts- charges a fee for each cheque written and sometimes a fee for each deposit, in addition to a monthly charge. No minimum balance is required. It's most appropriate for people who write only a few cheques each month and are unable to maintain the required minimum balance. Interest-Earning Chequing Accounts- usually require a minimum balance. If the account balance goes below this amount you may not earn interest and may incur a service charge. Evaluating Chequing Accounts Restrictions- the most common limitation on chequing accounts is the amount you must keep on deposit to earn interest or avoid a service charge. Fees and Charges- most financial institutions require a minimum balance or else will incur a service charge. Interest- frequency of compounding and overall rate. Special Services- some banks offer 24 hour ATM and home banking services. Also overdraft protection is a useful service to avoid a service charge for exceeding the available funds in the chequing account that would normally result in a bounced cheque. It automatically gives a loan to a chequing account to cover cheques written in excess to the available funds. Other Payment Methods Personal cheque is the most common but can also use a certified cheque which is just a personal cheque with a guaranteed deposit, can also purchase a money order. These three methods allow you to make a payment that the recipient knows is valid. Travellers cheques allows you to make payments away from home, they require you to sign each cheque twice, first when you purchase them and then again to identify yourself you sign them again when you cash them. Prepaid travellers cards allow travellers to get local currency from an ATM. MCS*2100 Personal Financial Management Chapter 5 Summary - Intro to consumer credit Credit- An arrangement to receive cash, goods, or services now and pay for them in the future Consumer Credit- The use of credit for personal needs (except a home mortgage) Using credit to purchase goods and services may allow consumers to be more efficient or more productive or to lead more satisfying lives. There are many valid reasons for using credit. “Shopaholics” and young adults are those most vulnerable to misusing credit. Post-secondary students are a prime target for credit card issuers. Advantages of Credit: -Enjoy things now and pay later -Helpful in emergency situations -Credit cards are more convenient and safer to use than cash Disadvantages of Credit: -Temptation to overspend -Failure to repay can cause loss of income or valuable property -Credit costs money (interest) Types of Credit Consumer Loan- One-time loans that the borrower repays in a specified period of time with a pre- determined payment schedule Revolving Credit- a line of credit that loans are made on a continuous basis and the borrower is billed periodically for at least partial payment Credit Limit- The dollar amount, which may or may not be borrowed, that a lender makes available to the borrower Interest- A periodic charge for the use of credit Personal Line of Credit- A pre-arranged loan from a bank for a maximum specified amount Credit Cards Costs: -Late or overdue payments -Membership fees -Charges from exceeding the credit limit Benefits: -You can get a short term no interest loan if you pay the full balance each month -Several rewards type services offered through the issuers -Emergency availability What to do when stolen: -Call the issuer and report it stolen -Have the card cancelled immediately -Ask for a new account # and credit card to be sent to you Home equity line of credit- A personal line of credit based on the current market value of your home less the amount still owed on the mortgage Credit Bureau- A reporting agency that assembles credit card and other information about consumers Credit Reporting Legislation- Fair credit reporting act- Applicable in Columbia, Ontario, BC, Nova Scotia, and PEI Character- The borrower’s attitude towards credit obligations Capacity- The Borrower’s financial ability to meet credit obligations Capital- The borrower’s assets or net worth Collateral- A valuable asset that is pledged to ensure loan payments Conditions- The general economic conditions that can affect a borrower’s ability to repay a loan Credit (from Latin credo translation. "I believe") is the trust which allows one party to provide resources to another party where that second party does not reimburse the first party immediately (thereby generating a debt), but instead arranges either to repay or return those resources (or other materials of equal value) at a later date. The resources provided may be financial (e.g. granting a loan), or they may consist of goods or services (e.g. consumer credit). Credit encompasses any form of deferred payment.[1] Credit is extended by a creditor, also known as a lender, to a debtor, also known as a borrower. Chapter6Summary Sources of Consumer Credit  Credit costs money o Weigh benefits of buying an item on credit versus waiting until you have saved enough money to pay cash  Ask yourself; o Do I need a loan? o Can I afford a loan? o Can I qualify for a loan? What Kind of Loan should you seek?  Inexpensive Loans o Parents and Family members are often the course of the least expensive loans o Financial assets held by a lending institution  Ex. GIC or the cash value of a whole life insurance policy  Medium-priced loans o Chartered banks, trust companies, and credit unions  Expensive loans o Finance companies, retailers (such as car or appliance dealers), and banks through credit cards  Student loans o Inexpensive loans to finance education beyond high school are available from the government of Canada o Interest rates lower than commercial rates because they are subsidized by the federal government  Government student loan programs o Canada Student Loans Programs (CSLP) – federal program  Open to full-time and part-time students o Provincial programs The Cost of Credit Effective Cost of Borrowing  Effective Annual Interest Rate (EAR) depends on o The quoted annual percentage rate o How frequent interest is compounded o Whether interest is charged on a discount basis (up front) o Whether any other charges are incurred such as service charges, credit-related insurance premiums, or appraisal fees  The annual percentage rate (APR) is the percentage cost of credit on a yearly basis o May be compounded more frequently o Thus the effective annual interest rate may be higher than annual percentage rate  The higher the compounding frequency, the higher the EAR  EAR is calculated as: o E A R = (1 + APR/m) - 1  Where m is the number of times per year interested in compounded o Ex. Borrow $100 and bank quotes you an APR of 6%, compounded semi-annually o EAR=(1+0.06/2) – 1 o =0.0609x100=6.09% Tackling the trade-offs Term VS. Interest Cost  Longer term means the smaller monthly payments but you pay more in interest  Ex. Buying a car for $7,500, placed down payment of $1,500, need to borrow $6,000 APR, Term of Loan Monthly Total Amount Total Interest Compounded Payment Repaid Cost Monthly Creditor A 14% 36 months $205.07 $7,382.52 $1,382.52 Creditor B 14% 48 months $163.96 $7,870.08 $1,870.08 Creditor C 15% 48 months $166.98 $8,015.04 $2,015.04 Lender Risk VS. Interest Rate  To reduce the lender’s risk you can… o Accept a variable interest rate o Provide collateral to secure a loan o Make a large payment up front o Have a shorter term Calculating you loan Payments  Fixed-rate instalment loan o Pay off over a pre-determined period of time o Payment represents blend of interest and principal o Ex. Peter buying a car, $5,000 loan at a fixed rate of 9%, compounded monthly (refer to time value of money discussion in Chapter 1 and the formula in exhibit 1B-4 on page 46) ( )   5000 = PMT [11.4349]  PMT = 5000 ÷ 11.4349 = 437.26  Floating rate personal line of credit o Variable interest rate tied to lender’s prime rate o Compounded daily o Payments not fixed o At risk if interest rates rise o Takes longer to repay if only paying minimum required o o o Ex .Peter has $5000 line of credit, prime rate is 6% and peter pays 3% above prime. Month Beginning Interest Principal Total Payment Ending Loan Loan Balance Charge Reduction Balance 1 5000 36.99* 250 286.99 4750 2 4750 35.14 237.50 272.64 4512.50 3 4512.50 33.38 225.63 259.01 4286.87 *Calculated as: 5000 x 0.000246575 x 30 Financial Planning calculations Cost of carrying credit card balances  Adjusted balance method o Creditors add interest after subtracting payments made during the billing period  Previous Balance method o Creditors give you no credit for payments made during the billing period  Daily balance method (fairest method) o Creditors add your balances for each day in the billing period and then divide by the number of days in the period Cost of credit and expected inflation  Expected inflation o Borrowers and lenders are less concerned about dollars, present or future, than about the goods and services those dollars can buy  i.e. purchasing power o generally lenders seeking to protect their purchasing power, add the expected rate of inflation to enable you to repay the loan with cheaper dollars Avoid the minimum monthly payment trap  minimum monthly payment is the smallest amount you can pay and still be a cardholder in good standing o is not the total amount due o the longer you take to repay the more interest you will incur Credit Insurance  ensures the payment of your loan in the event of death, disability, or loss of property  three types of credit insurance; o credit life, (most commonly purchased type of credit insurance) o credit accident and health (also called credit disability insurance) and, o credit property Managing your debt  A sudden illness or loss of job may make it impossible to repay your debts  Contact your creditors at once to work out a modified payment arrangement  Your vehicle can be repossessed if you default on your payments and you could incur added costs so it is better to sell yourself and repay the debt  Debt counseling services are available but be sure to investigate the company Warning signs of debt problems  Emotional problems such as the need for instant gratification  The use of money to punish such as a husband who buys a new car without consulting his wife, who, in turn, buys a diamond watch to get even  The expectation of instant comfort  Keeping up with the joneses  Overindulgence of children  Misunderstanding or lack of communication among family members  The amount of the finance charges  You continually go over your credit limit  You use your credit card as a necessity rather than a convenience  You borrow money to make it from one pay cheque to the next  Your wages have been garnished to pay outstanding debts  You pay only interest or service charges monthly and don’t reduce your total debt  You are pressured or threatened by creditors  Utility services are cut off for unpaid bills The serious consequences of debt  Loss of job due to garnishment of wages  Neglecting health and educational needs of family members  Alcoholism or drug abuse  Marital difficulties  Neglect of children  For more information visit the Government of Canada’s office of the Superintendent of Bankruptcy at http://www.ic.gc.eic/site/bsf-osb.isf Chapter 7- The Finances of Housing Traditional Perception of housing cost- although this does not completely apply today traditionally housing should cost between 25-30% of year expenses or 2.5 times yearly income. Evaluating Housing Alternatives Renting apartment, renting house, owning new house, owning previously owned house, owning condominium, owing co-operatively, and owning mobile home. All of which has advantages and disadvantages. Housing Rental Activities 1. The search- geography, costs, talk with locals 2. Before signing a lease- lease start cost and facilities, 3. Living in a rental property- upkeep of property, respect other tenants, contact owners for repairs 4. At the end of the lease- clean apartment, require any deductions from deposit to documented 3 main advantages of renting Mobility- a change of location is significantly easier when renting, fewer responsibilities- renters do take on responsibilities like rent and utilities but usually do not have to worry about many maintenance and tax costs associated with home ownership, and lower initial costs. 3 disadvantages of renting Few financial benefits- renters are subject to rent increases, which they have little control and do not see any financial gains, Restricted Lifestyle- renters sharing dwelling generally have to abide by rules like noise policies and other restrictions, Legal Details- a lease that outline all the legal responsibilities of the tenant. The Home Buying Process Step 1: Determining Home Ownership Needs What are the benefits of home ownership? 1. Pride of ownership- having a place to call one’s own is a primary motive of many homebuyers. 2. Financial benefits- a potential benefit is increases in the value of the property. If the dwelling is your principle residence increases in value are not subject to taxes. Homeowners are able to borrow against the equity in their homes. 3. Lifestyle Flexibility- homeowners are able to do what they want to their home unlike renters. Drawbacks of homeownership 1. Financial uncertainty- saving for the down payment as home prices increase. Obtaining a mortgage. Changing property values can affect your financial investment. 2. Limited mobility- selling a home quickly can be a challenge and costly. 3. Higher living costs- homeowners are responsible for the maintenance and repairs. 4. Higher property taxes Assess Types of Housing Available Single family dwellings, multi-unit dwellings, manufactured homes, mobile homes, and building a home. Consider Forms of Home Ownership 1. The most common form of home ownership is one in which an individual or a couple is the sole owner of an entire property. 2. Condominiums- an individually owned housing unit in a building with several such units. Condos consist of two part the first is the part that is individually owned by each tenant and is paid and maintained by the individual. The second part is the common areas like lobbies and hallways that are owner by all the members of the condo. These areas are paid for jointly and generally maintained by an outside company. 3. Co-operative Housing- co-ops are member owned communities where residents make decisions on how the co-op operates. A co-op is governed by directors and members. Two types non-for profit and for profit. Determining Amount of Down Payment  Minimum amount for a down payment 5%. Large down payments make financing easier.  First time homebuyers can use up to $25,000.00 of pension plan funds towards the purchase of a home.  Making a 20% down payment qualifies you for a conventional mortgage  High ratio mortgages are for anyone paying less that 20% down payment of the appraised value of the home.  Federal law requires you have mortgage insurance if your mortgage represents 80% or more of the total purchase price in order to protect the lender. Calculate Your Affordable Home Purchase Price Lenders generally use two ratios to determine the amounts associated with your mortgage. The Gross Debt Service (GDS) and the Total Debt Service (TDS). GDS- is your monthly shelter costs as a percentage of your gross monthly income. Most lenders recommend you spend no more than 30 to 32 percent of your gross income on shelter costs. TDS- is your monthly shelter costs plus any outstanding debt payments and obligations (credit cards, car payments etc.) as a percentage of your gross monthly income. Most lenders recommend you spend no more than 40% of your gross income on shelter and non-shelter financial obligations. Calculations: GDS = ((PI + T + H)/ GI) x 100% TDS = ((PI + T + H + D)/ GI) x 100% PI= monthly principal and interest payments on mortgage T= monthly property taxes H= monthly heating costs D= monthly debt service payments GI= monthly gross income Step 2: Find and Evaluate a Property to Purchase Selecting a Location  Location, location, location is important to remember  Zoning laws of the area are restrictions on the property in an area Using a Real Estate Agent The main services real estate agents provide: 1. Presenting your offer to the seller 2. Negotiating a settlement price 3. Assisting you in obtaining financing 4. Representing you at the closing Real estate agents can also make recommendations about insurance, lawyers home inspectors etc. Conducting a Home Inspection Have a certified professional come to the home before purchase to inspect the home for potential problems that may arise down the road. The home inspector will ensure 4 aspects of the house are sufficient and report on any problems including; interior construction, interior design, exterior facilities, and exterior construction. Step 3: Price the Property Determining the Home Price The main factors to consider are recent selling prices in the area, current demand for housing, the length of time the home has been on the market, the owner’s need to sell, financing options, and features and condition of the home. If your initial offer is accepted then you have a valid contract if not then negotiating the purchase price begins. Step 4: Obtain Financing The Application Process 3 steps: 1. After completing the mortgage application, a meeting between the lender and borrower is scheduled. The borrower presents evidence of employment, income, ownership of assets and amounts of existing debts. 2. The lender obtains a credit report and verifies other aspects of the borrowers application and financial assets. 3. The mortgage is either approved or declined and indicates the maximum amount you qualify for. Evaluating Different Interest and Payment Options Fixed Rate Mortgages- allow the borrower the opportunity to lock into a specific rate of interest for a period of time generally 1, 3 or 5 years. In Canada fixed mortgages are compounded semi annually. However payments are generally made monthly, weekly, or bi weekly. Variable Mortgage Rate- has an interest rate that increases or decreases during the life of the loan. When mortgage rates are high many people choose variable rates in hopes of the rates coming down. A rate cap is a limit on the increases and decreases in the interest rate charged on an adjustable rate mortgage. Split or Multi-Rate Mortgages-This type of mortgage allows you to split the borrowed amount into three to five parts, each of different maturity and interest rates. Options for Paying Back Your Mortgage- most mortgage lenders offer options to your payment plan that will allow you to speed up your payment schedule through; accelerated mortgage payments, double up on monthly payments, or make lump sum payments directly reducing the principal. Second Mortgages- aka a home equity loan allows the homeowner to borrow on the paid up value of the home. Refinancing- the process of obtaining a new mortgage on a home to get a lower interest rate. Step 5: Close the Purchase Transaction  Before the closing do a walk through of the building to ensure everything is up to your standards  The closing involves a meeting among the buyer, seller and notary or representatives of party to complete the transaction  The closing cost also referred to as the settlement costs, are the fees and charges paid when a real estate transaction is completed.  Types of closing costs are insurance costs to protect against unforeseen errors in the inspection, the deed-recording fee, etc.  An escrow account is money usually deposited with the lending instituition for the payment of property taxes and homeowner’s insurance. Selling Your Home Preparing Your Home for Selling When selling your home you want to ensure that you present it in a way that will entice prospective buyers. Clean, well lite, smelling nice are good ways to provide the buyer with a good image of the home. Determining the Selling Price An appraisal of the home will give you an accurate price and will help to determine its appropriate value. Chapter8 Homeandautomobileinsurance Insurance and Risk Management: An introduction - You purchase insurance to control the effects of uncontrollable financial risk inherent to life and living (and for that matter even death) What is insurance? - Insurance: protection against possible financial loss o One thing in common;  They give peace of mind that comes from knowing that money will be available to meet the needs of your survivors, pay medical expenses, protect you home and belongings, and cover personal or property damage - Insurance company: a risk-sharing firm that assumes financial responsibility for lossess that may result from an insured risk o Insurer: an insurance company - Policy: a written contact for insurance o Premium: the amount of money a policy-holder is charged for an insurance policy  Insured: a personal covered by an insurance policy  Policyholder: a person who owns an insurance policy Types of risk - Insurance companies offer financial protection against such dangers and losses bu promising to compensate the insured for a relatively large loss in return for the payment of a much smaller but certain expense called the premium o Risk: change or uncertainty of loss; may also mean “the insured” o Peril: the cause of possible loss o Hazard: a factor that increases the likelihood od loss through some peril - The most common risks are classified as; o Personal risk: the uncertainties surrounding loss of income or life due to pre-mature death, illness, disability, old age, or unemployment o Property risk: the uncertainties of direct or indirect losses to property due to fire, eindstorm, accidents, theft, and other hazards o Liability risks: loss posibiltites due to neglect resulting in bodily harm or property damage to others  Pure risk: a risk in which there is only a chance of loss; also called insurable risk  They are accidental un unintentional risks for which the nature of financial cost of the loss can be protected - Speculative risk: a risk in which there is a chance of either loss or gain o Ex. gambling – legally defined as uninsurable Risk Management Methods - Risk management: is an organized strategy of protecting assets and people o Long range planning process - Insurance is not the only method of dealing with risk; in some situations other methods may be less costly 1. Risk Avoidance  You can avoid the risk of an automobile accident by not driving to work  People avoid that risk by not smoking or by not walking through high-crime areas 2. Risk reduction  You can reduce the risk of injury in an auto accident by wearing a seat belt  You can reduce the risk of illness by eating a balanced diet and exercising 3. Risk assumption  Taking on responsibility for the loss or injury that may result from a risk  Makes sense to assume the risk when the potential for loss is small  Self-insurance: the process of establishing a monetary fund to cover the cost of a loss  Does not eliminate the risks; it provides a means for covering losses 4. Risk shifting  Most common method of dealing with risk is to shift, or transfer, it to an insurance company or some other organization  Insurers, in their turn, usually insure themselves through what is known as re-insuring Planning an insurance program - All people have their own needs and goals, many of which change over the years, a personal insurance program should be tailored to those changes o In the early years of marriage – property insurance o When you have children - life and disability insurance, adequate health insurance o High income – children’s education, more life insurance to match the higher standard of living, revised health insurance o Old with no dependents – retirement and health coverage benefits - Steps in developing an insurance program 1. Set insurance goals o Goal is to minimize personal, property, and liability risks  Covering the basic risk means providing a financial resource to cover costs resulting from a loss o Income, age, family size, lifestyle, experience, and responsibilities influence the goals you set , and the insurance you set, and the insurance you buy must reflect those goals o A basic risk management plan should include  Potential loss of income but to the premature death, illness, accident, or unemployment of a wage earner  Potential loss of income and extra expense resulting from the illness, disability, or death of a spouse  Additional expenses due to the injury, illness, or death of other family members  Potential loss of real or personal property due to fire, theft, or other hazards  Potential loss of income, savings, and property due to personal liability 2. Develop a plan to reach your goals o Planning is a sign of maturity, a way of taking control of life instead of letting life happen to you  You need good information 3. Put your plan into action o Obtain financial and personal resources, budget them, and use them to reach your risk management goals o The best risk management plans have flexibility – allows you to respond to changing life situations o To put your risk management plan to work, you must answer  What should be insured  For how much  What kind of insurance should I buy  From whom 4. Review you results o Evaluate your plan periodically  The needs of a single person differ from those of a family, a single parent, a couple, or a group of unrelated adults living in the same household Property and liability insurance - Major disasters have caused catastrophic amount if property loss - Since most people invest large amounts of money in their homes and motor vehicles, protecting these assets from loss is a great concern - The price you pay for a home and automobile insurance may be viewed as an investment in financial protection against those losses o Property and liability insurance offer protection from financial loss that may arise from a wide variety of situations - Main risks related to homes and automobiles o Property damage and loss o You responsibility for injuries to others or damage to the property of others Potential property loss - Property owners face two basic types of risk o Physical damage; caused by such hazards as fire, wind, water, and smoke o Loss of use; due to robbery, burglary, vandalism, or arson Liability protection - A person may be judged legally responsible for injuries or damages - Liability: legal responsibility for the financial cost of another person’s losses or injuries o Negligence: failure to take ordinary or reasonable care in a situation - Strict liability: a situation in which a person is held responsible for intentional or unintentional actions - Vicarious liability: a situation in which a person is held legally responsible for the action of another person Principles of home and property insurance - Homeowners insurance: coverage for a place of residence and its associated financial risks Homeowners insurance coverages - A homeowners policy provides coverages for the building and other structures, additional living expenses, personal property, replacement value of your home, personal liability and related coverages, and specialized coverages - Building and other structures o The main component - Additional living expenses o If damage from a fire or other event prevents the use of your home, additional living expense coverage pays for the cost of living in a temporary location while you home is being repaired - Personal property o Typically, a home insurance policy will cover damages or destruction of the contents of you home o Two ways to calculate;  As a percentage of the total value of your insurance coverage  Limit coverage – normally 70 to 80 percent of the limit on the dwelling  As an itemized basis that lists and values all the contents of your home  Allows you to list and value all the items that you wish to protect and ensures adequate coverage o Recommend that you keep your list of items in a safety deposit box o Personal articles endorsement: additional property insurance to cover the damage or loss of a specific item of high value  Requires a detailed description, periodic appraisals to verify the current value o Personal property coverage usually provides protection against the loss or damage of articles taken with you when away from the home as well as for contents of your vehicle  On vacation or used while at school  Property that you rent is insured while in your possession o In the event of damage or loss of property, you must be able to prove both ownership and value  Household inventory: a list or other documentation of personal belongings, with purchase dates and cost information  Can include photographs and video  Make sure that closet and storage areas are photographed open o Be sure to indicate the value of the objects - Replacement value of your home o The replacement value of your home for insurance purposes is not its current market value, principally because that type of valuation includes the value of the land, foundation, which are unlikely to be affected by typical disasters  Solely bases on the replacement value of your homes structure o A professional appraisal will usually give you both the depreciated value and the replacement value of the structure of your home  Depreciated value: a reduction in the value of an object, based upon its age and the percentage it has decreased each year o While replacement value offers you better protection than depreciated value coverage, you are required to rebuild the house in order to receive a settlement from the insurance company o With depreciated value coverage, your compensation is in the form of cash and you can decide whether to rebuild or not - Personal liability and related coverages o The component of homeowners policy protects you form financial losses resulting from legal action or claims against you or family members due to damages to the property of others  Includes the cost of legal defence o Umbrella policy: supplementary personal liability coverage; also called personal catastrophe policy o Voluntary medical payments: home insurance that pays the cost of minor accidental injuries on one’s property  Minor injuries on your property and minor injuries caused by you, family, pets away from home  Allows fast processing of small claims, generally up to $5000 o Should you or your family accidently damage another person’s property the voluntary damages of homeowner’s insurance will pay for these minor mishaps  Payments are made regardless of fault - Specialized coverages o Most common insurance is general o Rider: an addition of coverage to a standard insurance policy  Insurance riders and policies can be purchased to cover just about anything, but something to keep in mind is that the costs of insurance are bound to rise whenever risk increases Tenants insurance - For people who rent, home insurance coverage include personal property protection and related coverages o The building owners property insurance does not cover tenants personal property unless the building owner can be proven liable - Tenants insurance is relatively inexpensive and provides protection from financial loss due to many of the same risks covered in homeowners policies - Tenants Legal Liability o Under any liability policy, you are not protected for loss to property in you care or control o If you case damage to your apartment or unit because of fire, smoke, explosion, or water damage, you can be held liable for it  Portion of your policy responds to this type of loss Home insurance types - There are two types of policies o Named perils: a policy in which only those perils that are specially listed will be covered should a loss occur  The consumers suffers a loss to their property, they must should that the cause of the lass was one of the perils named in order for the loss to be covered o All risk: a policy in which any event that causes loss or damage to the insured property is covered unless it is specifically excluded  Most personal property policies do not cover, for example, damage to business or agricultural property, damage cause by wars, floods, or earthquakes or intentional damage - The more extensive the coverage, the higher premium you pay - Manufactured housing units and mobile home usually qualify for insurance cover with conventional policies o The cost of mobile home insurance is most heavily affected by location and by the method used to attach housing unit to the ground - Home insurance policies include coverage for o Credit card fraud, cheque forgery, and counterfeit money o The cost of removing damaged property o Emergency removal of property to protect it from damage o Temporary repairs after a loss to prevent further damage o Fire department charges in areas with such fees Exclusions - Exclusions are like small print o Companies use exclusions to help limit the risk they assume for the policy holder Home insurance cost factors - Financial losses cause by fire, theft, wind, and other risks amount to billions of dollars each year Deductibles - Before an insurance company pays you any amount of your claim, you will be asked to pay a deductible o Deductible: a fixed sum of money that is stipulated by your policy - The higher deductible you agree to pay, the lower the premium on your policy will be o This is for three reasons  Since you share more of you risk with the insurance company, it needs to pay less  It is generally agreed that people are more careful if the costs of being careless are higher  A higher deductible means that the insurance company deals with fewer claims, thus saving administration fees o Can also be your personal advantage as the effect of a higher deductible is to lower the premium coast per dollar of insurance and, thus, raise the amount of coverage - The rule is that your deductible should total no more that 3% of your net worth How much coverage do you need? - Your insurance protection should be based on the amount needed to rebuild or repair your house, not the amount you paid for it o Most insurance policies have had a built-in inflation clause that increases coverage as property values increase - Co-insurance clause: a policy provision that requires a homeowner to pay for part of the losses if the property is not insured for the specified percentage of the replacement value - Most companies suggest full coverage - If your are financing a home, the lending institution will require you to have property insurance in an amount that covers its financial investment o Personal belongings are generally covered up to an amount ranging from 55 to 75 percent of the insurance amount on the dwelling - Insurance companies base claim settlements on one of two methods: o Actual cash value (AVC): a claim settlement method in which the insured receives payment based on the current replacement cost of damaged or lost item, less depreciation  Your settlement amount is determined by take the current cost and subtracting the years of depreciation o Replacement value: a claim settlement method in which the insured receives the full cost of repairing or replacing a damaged or lost item  In order to receive the replacement value, the item must be replaced with an item of like kind and quality and for the same use Factors that affect home insurance 1. Location of the home o The location of the residence affects insurance rates  Efficiency of the fire department, distance from the fire station, the available water supply, frequency of thefts 2. Type of structure o A brick house would cost less to insure than a similar house made of wood  However earthquake coverage is more expensive for a brick home than for a wood dwelling o Age and style o Source of heat o Roof 3. Coverage amount and policy type o The policy you select and the financial limits of coverage affect the premium you pay  The comprehensive form of homeowners policy costs more than a tenants policy o The deductible amount in your policy also affects the cost of your insurance  The most common deductible amount is $300 Reducing home insurance costs - Home insurance discounts o Most companies offer incentives that reduce home insurance costs  Lower if you have smoke detectors or a fire extinguisher  Deterrents to burglars – deadbolt locks or an alarm system - Company differences o You can save up to 25% on home owner’s insurance comparing companies o Don’t select a company on the basis of price alone  Consider service and coverage and reputation Automobile insurance coverages - Potential damages associated with the risks of owning and operating an automobile can be very large, so much so that they may prove to be disastrous for your wealth and financial future - All provinces and territories require minimum automobile insurance coverage - Policies protect you from three major financial risks o Risk of the injury or death to you as owner and your financial risks o Possibility of damages, destruction, or theft o Third-party liability – the possibility that you will held financially liable if you and your car injure someone else - Every jurisdiction has minimum insurance laws because of the tremendous social and financial risks that are associated with automobiles - You should note that in areas where your insurance is publicly provided, you can expect to pay just one price for coverage and he it in just one place o If the insurance is provided privately through an insurance company, you will find a number of competing suppliers and the price you will be asked to pay may vary - 2001 to 2003, auto insurance rates increased by 20% in provinces with private insurers o Caused by growth in high injury claims - In a tort-based system, as in the province of British Columbia, injured parties are allowed to take the at-fault to court for the full amount of their damages - No-fault insurance: an automobile insurance program in which drivers involved in accidents collect medical expenses, lost wages, and related injury cost from their own insurance companies o Fault is determined in every accident for the purpose of premium calculation o Allows you to collect payment from your own insurance company for bodily injury, and to claim damage to you own automobile no matter who is at fault in accident  If you are at fault, you insurance premiums may increase o This type of system is intended to provide faster settlement of claims and reduce the cost associated with taking legal action  Ontario had a partial no-fault system the still allows suits in situations involving serious injury or death Motor vehicle coverages - Bodily injury liability o Bodily injury liability: coverage for the risk of financial loss due to legal expenses, medical costs, lost wages, and other expenses associated with injuries caused by an automobile accident for which the insured was responsible  The automobile owners policy covers both the owner and people who drive the vehicle with the owner’s permission  In cases where the owner is uninsured, your policy will be needed to settle the claim - Accident benefits o Accident benefits: Automobile insurance that covers medical expenses for people injured in ones car  Cover income replacement, medical rehabilitation and attendant care expenses, and death and funeral costs for people who were injured in your automobile, including yourself  These benefits are available if the related costs are the result of an automobile accident, regardless of fault - Uninsured motorist’s protection o Uninsured motorist coverage: automobile insurance coverage for the cost of injuries to a person and member of his or her family caused by a driver with inadequate insurance or by a hit-and-run driver  Typically through collision and comprehensive damage - Collision o Collision: automobile insurance that pays for damage to the insured’s car when it is involved in an accident  The insurance company’s right to recover the amount it pays for the loss from the person responsible for the loss is called subrogation - Comprehensive physical damage o Comprehensive physical damage: automobile insurance that covers financial loss from damage to a vehicle caused by a risk other than c collision, such as fire, theft, glass breakage, hail, or vandalism  Certain articles in your vehicle, such as some radios and stereo equipment, may be excluded from this insurance  These types of articles may be protected by the personal property coverage of your home Other automobile insurance coverages - Towing and emergency road service coverage pays for the cost of breakdowns and mechanical assistance o Beneficial on long trips on long trips or during inclement weather - Purchasing duplicate coverage as part of your automobile insurance could be waste of money - You can also purchase waiver of depreciation coverage for new vehicles o If you are in an accident, the insurance company will calculate the value of your loss based on the vehicle’s retail value Automobile insurance costs - Premiums reflect the amounts insurance companies pay for injury and property damage claims o Your automobile insurance is directly related coverage amount and such factors as the vehicle, your place of residence, and your driving record Amount of coverage - How much coverage do I need? o Affect the amount you pay for insurance - Legal concerns o Every province had laws that mandate automobile liability insurance coverage o Third-party liability (minimum of $200000) accident benefits, and uninsured motorists coverage are mandatory in order to operate a motor vehicle in Canada  Driving without it can result in criminal charges o You may prefer to carry more insurance  If you feel that your net worth is large enough for the liability risk of losing it to be too great, you will want to get more coverage o The prudent amount of coverage that is now commonly sought by Canadian drivers is $1000000 Automobile insurance premium factors - Several factors influence the premium you pay or automobile insurance - Make and style of car o The type of car you drive generally does not affect the premium you pay for third-party liability insurance  Does affect the cost of coverage for physical damage to your car - Use of the vehicle o What you use your vehicle for has an impact on your premium  Pleasure/business/farming/distance driven to work/use for the deliveries or carrying passengers - Rating territory o Rating territory: the place of residence used to determine a person’s automobile insurance premium  Geographic locations have different cost - Driver classification o You are compared with other drivers to set your automobile insurance premium o Driver classification: a category based on the drivers age, gender, material status, driving record, and driving hobbits; used to determine automobile insurance rates  Young drivers and those over 70 have more frequent and severe accidents  As a result they pay a higher premium  Poor driving record increases your insurance costs o The number of claims you file with your insurance company also affects your premiums - Provincial differences o The factors used for determining the rate of your insurance premium will vary among provinces High-risk-driver insurance - Some drivers have accident records or other characteristics that make them very high-risk and thereby unacceptable to standard insurance companies o Creating an insurance pool that assigns high-risk cases to companies in proportion to their share of automobile insurance in each province  The result if that no company receives more than its fair share of bad risks and insurance is available to all drivers - High-risk pool: consists of people who are unable to obtain automobile insuranc
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