# Money Management

## Simple Interest

### Learning Objectives

After completing this section, you should be able to:
1. Compute simple interest.
2. Understand and compute future value.
3. Compute simple interest loans with partial payments.
4. Understand and compute present value.
There is truth in the phrase “You need to have money to make money.” In essence, if you have money to lend, you can lend it at a cost to a borrower and make money on that transaction.
When money is borrowed, the person borrowing the money (borrower) typically has to pay the person or entity that lent the money (the lender) more than the amount of money that was borrowed. This extra money is the interest that is to be paid. Interest is sometimes referred to as the cost to borrow, the cost of the loan, or the finance cost.
This idea also applies when someone deposits money in a bank account or some other form of investment. That person is essentially lending the money to the bank or company. The money earned by the depositor is also called interest. The interest is typically based on the amount borrowed, or the principal.
The pairing of borrower and lender can take various forms. The borrower may be a consumer using a credit card or taking out a loan from a bank, the lender. Companies also borrow from lending banks. Someone who invests in a company’s stock is the lender in this case; the company is essentially the borrower.
In this section, we examine the basic building block of interest paid on loans and borrowed credit and also the returns on investments like bank accounts, simple interest.

### Compute Simple Interest

Let’s get some terminology understood. Interest to be paid by a borrower is often expressed as an annual percentage rate, which is the percent of the principal that is paid as interest for each year the money is borrowed. This means that the more that is borrowed, the more that must be paid back. Sometimes, the interest to be paid back is simple interest, which means that the interest is calculated on the amount borrowed only.
The length of time until the loan must be paid off is the term of the loan. The date when the loan must be paid off is when the loan is due. The day that the loan is issued is the origination date. We’ll put this terminology to use in the following examples. Note that in this section we will use letters, called variables, to represent the different parts of the formulas we’ll be using. This will help keep our formulas and calculations manageable.

### Simple Interest Loans with Integer Year Terms

Calculating simple interest is similar to the percent calculations we made in Understanding Percent and Discounts, Markups, and Sales Tax, but must be multiplied by the term of the loan (in years, if dealing with an annual percentage rate).
When the annual interest rate, the principal, and the number of years that the money is borrowed is known, the interest to be paid can be found and from there the total to be repaid can be calculated.

### Simple Interest Loans with Other Lengths of Terms

In the previous example and Your Turn exercise, the loans were paid back in one payment after an integer number of years. However, there are also loans lasting a length of time not equal to an integer number of years (like 1, 2, or 3 years or more), but in a number of months (like 4 months, 18 months, and so on). What model would apply to these situations?
When the loan is paid back after a term that is not an integer number of years but is instead a number of months, the term of the loan, or time, , is expressed as a fraction of the year. So for a 2-month loan, the time, in years, is 2/12 = 1/6. For a 5-month loan, the time in years is 5/12. For an 18-month term, the term in years is 18/12 = 1.5.
Those examples dealt in months. However, some loans are for days only (45 days, 60 days, 120 days). In such cases, we find the daily interest rate. The fraction we will use for the daily interest rate is the interest rate (as a decimal) divided by 365. This may be referred to as Actual/365. In order to find the term of the loan, divide the number of days in the term of the loan by 365.

### Understand and Compute Future Value

Money can be invested for a specific amount of time and earn simple interest while invested. The terminology and calculations are the same as we’ve already seen. However, instead of the total to be paid back, the investor is interested in the total value of the investment after the interest is added. This is called the future value of the investment.
You may have noticed that for these problems, the future value was rounded down. When the future value is paid, the amount is typically rounded down.
A certificate of deposit (CD) is a savings account that holds a single deposit (the principal) for a fixed term at a fixed interest rate. Once the term of the CD is over, the CD may be redeemed (cashed in or withdrawn) and the owner of the CD receives the original principal plus the interest earned. The deposit often cannot be withdrawn until the term is up; if it can be withdrawn early, there is often a penalty imposed to do so.

### Paying Simple Interest Loans with Partial Payments

In every example above, there was one payment for the loan, or one withdrawal for the investment. However, for many loans (house, car, in-ground swimming pool), the loan will be paid back in two or more payments. Such a payment is called a partial payment, because they only pay off part of the loan.
When a partial payment is made, some of the payment pays for the principal, but the rest of the payment pays for interest on the principal. When making the first partial payment, the interest is calculated on the principal for the time between the origination date of the loan and the date of the payment. If another partial payment is made, the interest is calculated based on the remaining principal and the time between the previous partial payment and the current partial payment date.

### Remaining Balance

The previous examples demonstrated how to determine the interest paid in a partial payment. Using this, we can determine the remaining balance after a partial payment.
Step 1: determine the amount of the payment, , that is applied to interest, .
Step 2: subtract the amount paid in interest from the payment, . This is the amount applied to the balance.
Step 3: subtract the amount applied to the balance (the value obtained in Step 2) from the balance of the loan, . This is the remaining balance after the partial payment.

### Loan Payoff

Finally, we will determine the amount to be paid at the end of the loan. To do so, we apply the formula for the loan payoff to the remaining balance. However, the length of time for that remaining balance is the time between the partial payment and the day the loan is paid off.
Step 1: Determine the remaining balance after the partial payment.
Step 2: Calculate the number of days between the partial payment and the date the loan is paid off. This will be the time  in the payment formula.
Step 3: Calculate the amount to be paid at the end of the loan, or the payoff amount, using , where  is the remaining balance and  is the time found in Step 2.

### Repeated Partial Payments

Car loans and mortgages (loans for homes) are paid off through repeated partial payments, most often monthly payments. Since car loans are often 3 to 6 years, and mortgages 15 to 30 years, calculating each individual monthly payment one at a time is time consuming and tedious. Even a 3-year loan would involve applying the above steps 36 times! Fortunately, there is a formula for determining the amount of each partial payment for monthly payments on a simple interest loan.

### Understand and Compute Present Value for Simple Interest Investments

When finding the future value of an investment, we know how much is deposited, but we have no idea how much that money will be worth in the future. If we set a goal for the future, it would be useful to know how much to deposit now so an account reaches the goal. The amount that needs to be deposited now to hit a goal in the future is called the present value.
Understanding what this tells you is important. When you find the present value, that is how much you need to invest now to reach the goal , under the conditions (time and rate) at which the money will be invested.

### Check Your Understanding

### Key Terms

1. Interest
2. Principal
3. Annual percentage rate
4. Simple interest
5. Term
6. Due
7. Origination date
8. Payoff amount
9. Future value
10. Partial payment
11. Present value

### Key Concepts

1. Interest is money that is paid by a borrower for the privilege of borrowing the money.
2. Simple interest is computed by substituting the principal, interest rate, and number of years into the formula
3. The payoff for a loan is the amount of principal remaining on a loan plus the interest that accumulated on the loan since the last payment.
4. The future value of an investment yielding simple interest is the original principal plus the interest earned on the investment.
5. When making a partial payment, some of the payment pays off all the accumulated interest, while the remainder of the payment is applied to the principal of the loan.
6. Finding the present value of an investment is used to determine how much should be invested now in order to achieve a specific goal.

### Formulas


# Money Management

## Compound Interest

### Learning Objectives

After completing this section, you should be able to:
1. Compute compound interest.
2. Determine the difference in interest between simple and compound calculations.
3. Understand and compute future value.
4. Compute present value.
5. Compute and interpret effective annual yield.
For a very long time in certain parts of the world, interest was not charged due to religious dictates. Once this restriction was relaxed, loans that earned interest became possible. Initially, such loans had short terms, so only simple interest was applied to the loan. However, when loans began to stretch out for years, it was natural to add the interest at the end of each year, and add the interest to the principal of the loan. After another year, the interest was calculated on the initial principal plus the interest from year 1, or, the interest earned interest. Each year, more interest was added to the money owed, and that interest continued to earn interest.
Since the amount in the account grows each year, more money earns interest, increasing the account faster. This growth follows a geometric series (Geometric Sequences). It is this feature that gives compound interest its power. This module covers the mathematics of compound interest.

### Understand and Compute Compound Interest

As we saw in Simple Interest, an account that pays simple interest only pays based on the original principal and the term of the loan. Accounts offering compound interest pay interest at regular intervals. After each interval, the interest is added to the original principal. Later, interest is calculated on the original principal plus the interest that has been added previously.
After each period, the interest on the account is computed, then added to the account. Then, after the next period, when interest is computed, it is computed based on the original principal AND the interest that was added in the previous periods.
The following example illustrates how compounded interest works.

### Determine the Difference in Interest Between Simple and Compound Calculations

It is natural to ask, does compound interest make much of a difference? To find out, we revisit Abena’s CD.

### Understand and Compute Future Value

Imagine investing for 30 years and compounding the interest every month. Using the method above, there would be 360 periods to calculate interest for. This is not a reasonable approach. Fortunately, there is a formula for finding the future value of an investment that earns compound interest.

### Understand and Compute Present Value

When investing, there is often a goal to reach, such as “after 20 years, I’d like the account to be worth $100,000.” The question to be answered in this case is “How much money must be invested now to reach the goal?” As with simple interest, this is referred to as the present value.

### Compute and Interpret Effective Annual Yield

As we’ve seen, quarterly compounding pays interest 4 times a year or every 3 months; monthly compounding pays 12 times a year; daily compounding pays interest every day, and so on. Effective annual yield allows direct comparisons between simple interest and compound interest by converting compound interest to its equivalent simple interest rate. We can even directly compare different compound interest situations. This gives information that can be used to identify the best investment from a yield perspective.
Using a formula, we can interpret compound interest as simple interest. The effective annual yield formula stems from the compound interest formula and is based on an investment of $1 for 1 year.

### Check Your Understanding

### Key Terms

1. Compound interest
2. Effective annual yield

### Key Concepts

1. Compound interest means that the interest earned during one period will earn interest in later periods. Essentially, the amount of the principal grows from period to period.
2. The important values in computing compound interest are the interest rate, the principal, the length of time the investment, and the number of times the investment is compounded.
3. Compound interest has minimal impact early, but later has a very large impact.
4. You can determine how much to invest today in order to reach a goal for some time later.
5. Compound interest can be translated into an effective annual yield, which allows for comparison between investment options.

### Videos

1. Compound Interest
2. Compare Simple Interest to Interest Compounded Annually

3. Compare Simple Interest and Compound Interest for Different Number of Periods Per Year

### Formulas


# Money Management

## Making a Personal Budget

### Learning Objectives

After completing this section, you should be able to:
1. Create a personal budget with the categories of expenses and income.
2. Apply general guidelines for a budget.
“That doesn’t fit in the budget.”
“We didn’t budget for that.”
“We need to figure out our budget and stick to it.”
A budget is an outline of how money and resources should be spent. Companies have them, individuals have them, your college has one. But do you have one?
Creating a realistic budget is an important step in careful stewardship of your financial health. Designing your budget will help understand the financial priorities you have, and the constraints on your life choices. You want to have enough income to pay not only for the necessities, but also for things that represent your wants, like trips or dinner out. You also may want to save money for large purchases or retirement. You do not want to just get by, and you do not want the problems associated with overdue balances, rising debt, and possibly losing something you have worked hard to obtain.
While creating a budget may seem intimidating at first, coming up with your basic budget outline is the hardest part. Over time, you will adjust not only the numbers, but the categories.

### Creating a Budget

You should view creating a budget as a financial tool that will help you achieve your long-term goals. A budget is an estimation of income and expenses over some period of time. You will be able to track your progress, which will help you to prepare for the future by making smart investment decisions.
There are several budget-creating tools available, such as the apps Good budget and Mint, and Google Sheets. Getting started, though, begins well before you find an app. The following are steps that can be used to create your monthly budget.
1. Track your income and expenses Review your income and expenses for the past 6 months to a year. This will give you an idea of your current habits.
2. Set your income baseline Determine all the sources of income you will have. This income may from paychecks, investments, or freelance work. It even includes child support and gifts. Be sure to use income after taxes. This allows you to determine your maximum expenditures per month.
1. Determine your expenses Review your bills from the past 6 months. You should include mortgage payments or rent, insurance, car payments, utilities, groceries, transportation expenses, personal care, entertainment, and savings. Using your credit card statements and bank statements will help you determine these amounts. Be aware that some of the expenses will not change over time. These are referred to as fixed expenses, like rent, car payments, insurance, internet service, and the like. Other expenses may vary widely from month to month and are appropriately called variable expenses, and include such expenses as gasoline, groceries.
1. Categorize your expenses These categories may be housing, transportation, or food, for broad categories, or may get more specific, where you categorize car payments, car insurance, and gasoline separately. The categories are your choices. Be sure to account for the cost of maintaining a vehicle or home. The more specific you are, the better you’ll understand your spending needs and habits.
2. Total your monthly income and monthly expenses and compare These values should be compared. If your expenses are higher than your income, then adjustments have to be made. Decisions of what to do with any extra income is part of the planning process also.
3. Make plans for unplanned expenses Ask anyone, an unexpected car repair can ruin a carefully crafted budget. Have a plan for how you can be ready for these random expenses. This often means creating a cushion in your budget.
4. Use your budget to make decisions and adjust for any changes Your budget is a changeable document. Add to it when you wish, refer to it when special purchases are to be made. Keeping your budget up to date helps accommodate changes in income and expenses.
In this section, we will focus on income and expenses. One of the easiest ways to manage a budget is to create a table, with one column containing income sources, another with income values, a third with expense categories, and a last containing expenses. An example is shown in .
Using the budget process, we can make decisions on adding expenses to the budget. To do so, check the cushion of the budget to see if there is room in the budget for the new expense.

### The 50-30-20 Budget Philosophy

It isn’t clear, obvious, or easy to decide how much of your income to allocate to various categories of expenses. Many people pay their bills and then consider all the leftover money to be spending money. However, when developing your own budget, you may want to follow the 50-30-20 budget philosophy, which provides a basic guideline for how your income could be allocated. Fifty percent of your budget is allotted to your needs, 30% of your budget is allotted to pay for your wants, and 20% of your budget is allotted for savings and debt service (paying off your debts).
Knowing what expenses are necessary and what expenses are wants is important, since wants and needs are often confused. The following are necessary expenses that represent basic living requirements and debt services. This list isn’t complete: mortgage/rent, utilities, car, car insurance, health care, groceries, gasoline, child care (for working parents), and minimum debt payments. The 50-30-20 budget philosophy suggests that 50%, or half, your income go to these necessities.
Wants, though, are things you could live without but still wish to have, such as Amazon Prime, restaurant dinners, coffee from Starbucks, vacation trips, and hobby costs. Even a gym membership or that new laptop are wants. Creating the room to afford these wants is important to our mental health. Not budgeting for things we want will negatively impact our quality of life.
The remaining 20% should be set aside, either in retirement funds, stocks, other investments, an emergency fund (recommendations are that an emergency fund have 3 months of income), and perhaps extra spent to pay down debt. This 20% is very useful for addressing those unexpected costs, such as repairs or replacement of items that no longer work. Without budgeting this cushion, any expense that is a surprise can cause us to miss necessary payments.
The list of necessary expenses was not complete. There are other expenses that could be included.

### Necessary Expenses and Expenses that are Wants

For some people, an expense will be necessary while the same expense for someone else will be a want. A good example of this is internet service. Many people consider internet service as a need, especially those who work from home or who are not able to leave their homes. One could also call internet service a need if they have children in school. For others, internet service is a want. If a person’s job doesn’t require them to be online, if they are not in school, if they do not have kids, then internet service can be dropped. There are public options for internet service. One could even use their phone as a hot spot.
Cars often fall into the category of need, but could also fall into the want category, depending on where and how you live. Bikes, public transportation, and walking are all options that could replace a car. This would then remove the cost of gasoline and car insurance.
Another consideration when deciding if an item on your budget is a need or a want is about your choices and priorities. A car is a need for many. But the need for a car is not the same as the need for a specific car. If you choose to buy a car with payments that exceed your budgeted amount for the car, then that car is a want. The amount you exceed the budget now belongs in the want category.
The same can be said for housing. If you want an apartment that costs $1,250 per month, but your budget only allows for an apartment that costs $900, then $350 of the rent is a want.
The point of that is to carefully consider if an expense is a need as opposed to a want.
When your expenses exceed your income, you may want to change how you budget your income to line up with these guidelines. This may mean cutting back, finding less-expensive living arrangements, finding a less-expensive (and more fuel-efficient) car, or sacrificing some specialty groceries. Using these guidelines keeps your financial life manageable.
Better still, they can guide you as you begin your life after graduation.

### Check Your Understanding

### Key Terms

1. Budget
2. Necessary expenses
3. Fixed expenses
4. Variable expenses
5. 50-30-20 budget philosophy

### Key Concepts

1. A budget is a set of guidelines for how to allocate your income.
2. Budgeting helps to plan for many of life’s expenses
3. Budgets are used to compare income to expenses. When expenses exceed income, changes have to be made.
4. Budgets can help evaluate the affordability of life changes.
5. One guideline for setting a budget is the 50-30-20 budget philosophy. The guidelines suggest that 50% of income is allocated to necessary expenses, 30% to expenses that wants, and 20% to savings and other debt reduction.

### Videos

1. Creating a Budget
2. 50-30–20 Budget Philosophy


# Money Management

## Methods of Savings

### Learning Objectives

After completing this section, you should be able to:
1. Distinguish various basic forms of savings plans.
2. Compute return on investment for basic forms of savings plans.
3. Compute payment to reach a financial goal.
The stock market crash of 1929 led to the Great Depression, a decade-long global downturn in productivity and employment. A state of shock swept through the United States; the damage to people’s lives was immeasurable. Americans no longer trusted established financial institutions. By October 1931, the banking industry’s biggest challenge was restoring confidence to the American public. In the next 10 years, the federal government would impose strict regulations and guidelines on the financial industry. The Emergency Banking Act of 1933 created the Federal Deposit Insurance Corporation (FDIC), which insures bank deposits. The new federal guidelines helped ease suspicions among the general public about the banking industry. Gradually, things returned to normal, and today we have more investment instruments, many insured through the FDIC, than ever before.
In this section, we will first look at the different types of savings accounts and proceed to discuss the various types of investments. There is some overlap, but we will try to differentiate among these financial instruments. Saving money should be a goal of every adult, but it can also be a difficult goal to attain.

### Distinguish Various Basic Forms of Savings Plans

There are at least three types of savings accounts. Traditional savings accounts, certificates of deposit (CDs), and money market accounts are three main savings account vehicles.

### Savings Account

A savings account is probably the most well-known type of investment, and for many people it is their first experience with a bank. A savings account is a deposit account, held at a bank or other financial institution, which bears some interest on the deposited money. Savings accounts are intended as a place to save money for emergencies or to achieve short-term goals. They typically pay a low interest rate, but there is virtually no risk involved, and they are insured by the FDIC for up to $250,000.
Savings accounts have some strengths. They are highly flexible. Generally, there are no limitations on the number of withdrawals allowed and no limit on how much you can deposit. It is not unusual, however, that a savings account will have a minimum balance in order for the bank to pay maintenance costs. If your account should dip below the minimum, there are usually fees attached.
Having your savings account at the same bank as your checking account does offer a real advantage. For example, if your checking account is approaching its lower limit, you can transfer funds from your savings account and avoid any bank fees. Similarly, if you have an excess of funds in your checking account, you can transfer funds to your savings account and earn some interest. Checking accounts rarely pay interest.
There are some weaknesses to savings accounts. Primarily, it is because savings accounts earn very low interest rates. This means they are not the best way to grow your money. Experts, though, recommend keeping a savings account balance to cover 3 to 6 months of living expenses in case you should lose your job, have a sudden medical expense, or other emergency.
Around tax time, you will receive a 1099-INT form stating the amount of interest earned on your savings, which is the amount that must be reported when you file your tax return. A 1099 form is a tax form that reports earnings that do not come from your employer, including interest earned on savings accounts. These 1099 forms have the suffix INT to indicate that the income is interest income.
Savings accounts earn interest, and those earnings can be found using the interest formulas from previous sections. The final value of these accounts is sometimes called the future value of the account.

### Certificates of Deposit, or CDs

We discussed certificates of deposit (CDs) in earlier sections. CDs differ from savings accounts in a few ways. First, the investment lasts for a fixed period of time, agreed to when the money is invested in the CD. These time periods often range from 6 months to 5 years. Money from the CD cannot be withdrawn (without penalty) until the investment period is up. Also, money cannot be added to an existing CD.
Certificates of deposit have features similar to savings accounts. They are insured by the FDIC. They are entirely safe. They do, though, offer a better interest rate. The trade-off is that once the money is invested in a CD, that money is unavailable until the investment period ends.

### Money Market Account

A money market account is similar to a savings account, except the number of transactions (withdrawals and transfers) is generally limited to six each month. Money market accounts typically have a minimum balance that must be maintained. If the balance in the account drops below the minimum, there is likely to be a penalty. Money market accounts offer the flexibility of checks and ATM cards. Finally, the interest rate on a money market account is typically higher than the interest rate on a savings account.

### Return on Investment

If we want to compare the profitability of different investments, like savings accounts versus other investment tools, we need a measure that evens the playing field. Such a measure is return on investment.

### Annuities as Savings

In Compound Interest, we talked about the future value of a single deposit. In reality, people often open accounts that allow them to add deposits, or payments, to the account at regular intervals. This agrees with the 50-30-20 budget philosophy, where some income is saved every month. When a deposit is made at the end of each compounding period, such a savings account is called an ordinary annuity.
The formula for the future value of an ordinary annuity is , where  is the future value of the annuity,  is the payment,  is the annual interest rate (in decimal form),  is the number of compounding periods per year, and  is the number of years.

### Compute Payment to Reach a Financial Goal

The formula used to get the future value of an ordinary annuity is useful, finding out what the final amount in the account will be. However, that isn’t how planning works. To plan, we need to know how much to put into the ordinary annuity each compounding period in order to reach a goal. Fortunately, that formula exists.
With this formula, it is possible to plan the amount to be saved.

### Check Your Understanding

### Key Terms

1. Savings account
2. 1099 form
3. Certificate of deposit
4. Money market account
5. Return on investment
6. Ordinary annuity

### Key Concepts

1. There are three main types of savings accounts, saving accounts, certificates of deposit (CD), and money market accounts.
2. Savings account are very risk free, and so yield low interest rates.
3. The differences in the three types of savings accounts relate to their convenience.
4. Savings account typically have a lower interest rate that money market accounts, which typically have lower interest rates than CDs.
5. Ordinary annuities more accurately reflect how we save, in that money is deposited repeatedly over time.
6. Spreadsheet software, such as Google Sheets, have built in functions that can be used to quickly calculate both the future value of an ordinary annuity account, but also the payment necessary to reach a goal using an ordinary annuity.

### Videos

1. Return on Investment, ROI
2. Future Value Using Google Sheets

### Formulas


# Money Management

## Investments

### Learning Objectives

After completing this section, you should be able to:
1. Distinguish between basic forms of investments including stocks, bonds, and mutual funds.
2. Understand what bonds are and how bond investments work.
3. Understand how stocks are purchased and gain or lose value.
4. Read and derive information from a stock table.
5. Define a mutual fund and how to invest.
6. Compute return on investment for basic forms of investments.
7. Compute future value of investments.
8. Compute payment to reach a financial goal.
9. Identify and distinguish between retirement savings accounts.
You can save your money in a safe or a vault (or worse, under the mattress!), but that money does not grow. It would be hard to save enough for retirement that way. What can be done to increase the value of the money you already have?
The answer is to invest it. Use the money that you have to earn more money back. For instance, as we saw in Methods of Savings, you can save it in a bank. Or, to reach loftier goals, invest in something more likely to grow, such as stocks.
A great example of this is Apple stock. Anyone who bought stock in Apple Inc. (formerly Apple Computer, Inc.) in 1997 and held onto the shares earned a lot of money. To be more specific, $100 worth of Apple shares bought in 1980, when it was first sold to the public, was valued at $67,564 in 2019, or 676 times more! Perhaps you have heard a story like that, of an investment opportunity taken that paid off, or the story of an investment opportunity missed. But such stories are the exceptions.
In this section, we’ll investigate bonds, stocks, and mutual funds and their comparative strengths and weaknesses. We close the section with a discussion of retirement savings accounts.

### Distinguish Between Basic Forms of Investments

Bonds, stocks, and mutual funds tend to offer higher returns, but to varying degrees, come with higher risks. Stocks and mutual funds also vary in how much they earn. Their predicted rates of return on investment are not guaranteed, but educated guesses based on market trends and historical performance.
We will use the methods and formulas we learned earlier to evaluate these forms of investment.

### Bonds

Bonds are issued from big companies and from governments. Selling bonds is an alternative to an institution taking a loan from a bank. The funds from the selling of bonds are often used for large projects, like funding the building of a new highway or hospital.
Bonds are considered a conservative investment. They are bought for what is known as the issue price. The interest is fixed (does not change) at the time of purchase and is based on the issue price of the bond. The interest rate is often referred to as the coupon rate; the interest paid is often called the coupon yield. The interest paid is often higher than savings accounts and the risk is exceptionally low. The bond is for a fixed length of time. The end of this time is the maturity date of the bond.
There are several types of bonds:
1. Treasury bonds are issued by the federal government.
2. Municipal bonds are issued by state and local governments.
3. Corporate bonds are issued by major corporations.
There are other types of bonds available, but they are beyond the scope of this section.

### Stocks

Stocks are part ownership in a company. They come in units called shares. The performance and earnings of stocks is not guaranteed, which makes them riskier than any other investment discussed earlier. However, they can offer higher return on investment than the other investments. Their value grows in two ways. They offer dividends, which is a portion of the profit made by the company. And the price per share can increase based on how others see that value of the company changing. If the value of the company drops, or the company folds, the money invested in the stock also drops.
Most stock transactions are executed through a broker. Brokers’ commissions can be a percentage of value of the trades made or a flat fee. There are full-service brokers who charge higher commission rates, but they also offer financial advice and perform the research that you may not have the time or the expertise to do on your own. A discount broker only executes the stock transactions, buying or selling, so they charge lower rates than full-service brokers. There are also brokers that offer commission-free trading.
An important thing to remember is that stocks might provide a very large return on investment, but the trade-off is the risk associated with owning stocks.

### Reading Stock Tables

Information about particular stocks is contained in stock tables. This information includes how much the stock is selling for, and its high and low values form the past year (52 weeks). In a newspaper, the stock table may look like this:
The symbols and abbreviations are defined here:
The formulas for yield and price to earnings is a good way to measure how much the stock returns per share. Their values are calculated in the stock table, but deserve attention here.
It should be noted that the price of a stock increases and decreases every moment, and so these value change as the share price changes.
The stock table information is now, and has been, available online, from websites such as cnn.com/markets, markets.businessinsider.com/stocks, and marketwatch.com. The same information is available from these sites as from the newspaper listings, but are often accessed one stock at a time.  shows the stock table for Lowe’s on September 7, 2022.
Other key data is further down on the website, and is shown in , below.
Notice that the 52-week high and low are now shown as the 52-week range. However, you get additional information, including the stock performance over the past 5 days, past month, past 3 months, the year to date (YTD), and over the past year. You can also read the number of shares outstanding, the expected date for the dividend (EX-DIVIDEND DATE), and importantly for the P/E ratio, the earning per share (EPS).
As mentioned, stocks earn money in two ways, through dividends and increase in share price.

### Mutual Funds

A mutual fund is a collection of investments that are all bundled together. When you buy shares of a mutual fund, your money is pooled with the assets of other investors. This pooled money is invested in stocks, bonds, money market instruments, and other assets. Mutual funds are typically operated by professional money managers who allocate the fund's assets and attempt to produce capital gains or income for the fund's investors.
A key benefit of mutual funds is that they allow small or individual investors to invest in professionally managed portfolios of equities, bonds, and other securities. This means each shareholder participates proportionally in the gains or losses of the fund. The performance of a mutual fund is usually stated as how much the mutual fund’s total value has increased or decreased. Since there are many different investments inside the mutual fund, the risk is reduced significantly, compared to direct ownership of stocks. Even so, mutual funds historically perform well and can earn more than 10% annually.
The investments that make up a mutual fund are structured and maintained to match stated investment objectives, which are specified in its prospectus. A prospectus is a pamphlet or brochure that provides information about the mutual fund. Before buying shares of a mutual fund, consult its prospectus, consider its goals and strategies to see if they match your goals and values and also research any associated fees.

### Return on Investment

As in Methods of Savings, the formula for return on investment is . As indicated before, this formula does not take into account how long the investment took to reach its current value. It depends only on the initial value, , and the value at the end of the investment, .
As mentioned, the ROI does not address the length of time of the investment. A good way to do that is to equate the ROI to an account bearing interest that is compounded annually.
The annual return is the average annual rate, or the annual percentage yield (APY) that would result in the same amount were the interest paid once a year.
We apply this to the previous example.
In  and Your Turn, the annual return was lower than the interest rate of the investment. This is because the interest from a bond is simple interest, but annual yield equates to compounded annually.
You should see that the annual return is equal to the annual compounded interest that was assumed for the stocks.

### Compute Payment to Reach a Financial Goal

As in Methods of Savings, determining the payment necessary to reach a financial goal uses the payment formula for an ordinary annuity, . If dealing with mutual funds or stocks, an assumed annual interest rate, compounded, will be used. This value is often determined through research and informed speculation.

### Retirement Savings Plans

We close this section by investigating the three main forms of retirement savings accounts: traditional individual retirement accounts (IRAs), Roth IRAs, and 401(k) accounts. Each has distinct characteristics that are suited to different investors’ needs.

### Individual Retirement Accounts

A traditional IRA lets you contribute up to an amount set by the government, which may change from year to year. For example, the maximum contribution for 2022 is $6,000; $7,000 over age 50. Anyone is eligible to contribute to a traditional IRA, regardless of your income level. Your money grows tax-deferred, but withdrawals after age 59½ are taxed at current rates. Traditional IRAs also allow you to use the contribution itself as a deduction on a current year tax return.
Roth IRAs allow contributions at the same levels as traditional IRAs, with a maximum $6,000 for 2022; $7,000 over age 50. However, to be eligible to make contributions, your earned income must be below a certain level. A Roth IRA allows after-tax contributions. In other words, the contribution itself is not tax-deductible, as it is with the traditional IRA. However, your money grows tax-free. If you make no withdrawals until you are age 59½, there are no penalties. IRAs pay a modest interest rate.
In either case, IRA deposits have to be from earned income, which in effect means if your earned income is over $6,000 ($7,000) then you can deposit the maximum.

### 401(k) Accounts

Your employer may offer a retirement account to you. These are often in the form of a 401(k) account. There are traditional and Roth 401(k) accounts, which differ in how they are taxed, much as with other IRAs. In the traditional 401(k) plans, the money is deposited before tax is assessed, which means you do not pay taxes on this money. However, that means when money is withdrawn, it is taxed. These accounts are similar to mutual funds, in that the money is invested in a wide range of assets, spreading the risk.
One of the perks some employers offer is to match some amount of your contributions to the 401(k) plan. For instance, they may match your deposits up to 5% of your income. This is an instant 100% return on the money that was matched.
401(k) plans with matching funds provide great value, as their rates of return are high compared to savings accounts, and are less risky that stocks since such funds invest across many investment vehicles. The next example demonstrates the power of constant deposits into a 401(k) plan that has some employer match.

### Check Your Understanding

### Key Terms

1. Bonds
2. Maturity date
3. Stocks
4. Dividend
5. Mutual fund
6. Prospectus
7. Issue price
8. Shares
9. Stock table
10. Individual retirement account
11. Roth IRA
12. 401(k)

### Key Concepts

1. There are many different investments with different returns and risks.
2. Bonds are loans form the purchaser to the entity selling the bond.
3. Bonds have some tax benefits, low to no risk, and a low return.
4. Stocks represent part ownership in a company. As such, stock holders share in the profits, and losses, of the company.
5. Information, including price, P/E, yearly highs and lows, and dividend amount can be found in online stock tables available on many websites.
6. Mutual funds represent collections of professionally administered investment vehicles. Have shares in a mutual fund has lower risk than ownership of stocks.
7. Retirement accounts employ some of the same strategies as mutual funds, in that they spread the risk and are professionally managed.
8. IRAs and Roth IRAs differ on when taxes are paid on the money, and who can use them. Roth IRAs have income limits while traditional IRAs do not.

### Videos

1. Bonds
2. Reading Stock Summary Online
3. Mutual Funds
4. 401(k) Accounts

### Formulas


# Money Management

## The Basics of Loans

### Learning Objectives

After completing this section, you should be able to:
1. Describe various reasons for loans.
2. Describe the terminology associated with loans.
3. Understand how credit scoring works.
4. Calculate the payment necessary to pay off a loan.
5. Read an amortization table.
6. Determine the cost to finance for a loan.
New car envy is real. Some people look at a new car and feel that they too should have a new car. The search begins. They find the model they want, in the color they want, with the features they want, and then they look at the price. That’s often the point where the new car fever breaks and the reality of borrowing money to purchase the car enters the picture. This borrowing takes the form of a loan.
In this section, we look at the basics of loans, including terminology, credit scores, payments, and the cost of borrowing money.

### Reasons for Loans

Even if you want a new car because you need one, or if you need a new computer since your current one no longer runs as fast or smoothly as you would like, or you need a new chimney because the one on your house is crumbling, it’s likely you do not have that cost in cash. Those are very large purchases. How do you buy that if you don ’t have the cash?
    You borrow the money.
And for helping you with your purchase, the company or bank charges you interest.
Loans are taken out to pay for goods or services when a person does not have the cash to pay for the goods or services. We are most familiar with loans for the big purchases in our lives, such as cars, homes, and a college education. Loans are also taken out to pay for repairs, smaller purchases, and home goods like furniture and computers.
Loans can come from a bank, or from the company selling the goods or providing the service. The borrower agrees to pay back more than the amount borrowed. So there is a cost to borrowing that should be considered when deciding on a purchase bought with credit or a borrowed money.
    Even using a credit card is a form of a loan.
Essentially, a loan can be obtained for just about any purchase, large or small, that has a cost beyond a person’s cash on hand.

### The Terminology of Loans

There are many words and acronyms that get used in relation to loans. A few are below.
APR is the annual percentage rate. It is the annual interest paid on the money that was borrowed. The principal is the total amount of the loan, or that has been financed. A fixed interest rate loan has an interest rate that does not change during the life of the loan. A variable interest rate loan has an interest rate that may change during the life of the loan. The term of the loan is how long the borrower has to pay the loan back. An installment loan is a loan with a fixed period, and the borrower pays a fixed amount per period until the loan is paid off. The periods are almost uniformly monthly. Loan amortization is the process used to calculate how much of each payment will be applied to principal and how much is applied to interest. Revolving credit, also known as open-end credit, is how most credit cards work but is also a kind of loan account. (We will learn about credit cards in Credit Cards) You can use up to some specified value, called the limit, any way you want, and as long as you pay the issuer of the credit according to their terms, you can keep borrowing from this account.
These and other terminologies can be researched further at Forbes.

### Calculating Loan Payments

Loan payments are made up of two components. One component is the interest that accrued during the payment period. The other component is part of the principal. This should remind you of partial payments from Simple Interest.
Over the course of the loan, the amount of principal remaining to be paid decreases. The interest you pay in a month is based on the remaining principal, just as in the partial payments of Simple Interest.
The payment of the loan has to be such that the principal of the loan is paid off with the last payment. In any period, the amount of interest is defined by the formula above, but changes from period to period since the principal is decreasing with each payment. The trick is knowing how much principal should be paid each payment so that the loan is paid off at the stated time. Fortunately, that is found using the following formula.

### Reading Amortization Tables

An amortization table or amortization schedule is a table that provides the details of the periodic payments for a loan where the payments are applied to both the principal and the interest. The principal of the loan is paid down over the life of the loan. Typically, the payments each period are equal. Importantly, one of the columns will show how much of each payment is used for interest, another column shows how much is applied to the outstanding principal, and another column shows the remaining principal or balance .

### Cost of Finance

There are often costs associated with a loan beyond the interest being paid. The cost of finance of a loan is the sum of all costs, fees, interest, and other charges paid over the life of the loan.

### Check Your Understanding

### Key Terms

1. Fixed interest rate
2. Variable interest rate
3. Installment loan
4. Loan amortization
5. Revolving credit
6. Amortization table
7. Cost of finance

### Key Concepts

1. There are many reasons for a loan, but primarily it is taken out for a large expense when cash is not available.
2. Each payment for an installment loan consists of an interest portion and a principal portion.
3. There is a formula to calculate the payment necessary to pay off a loan in installments.
4. Amortization schedules, or tables, show how each payment is applied to principal and interest. It also includes other details such as remaining balance and total interest paid.
5. Loans often have other fees associated with them such as origination fees or application fees. The total of the interest paid and the fees is the cost of finance.

### Video

1. Credit Scores Explained
2. Reading an Amortization Table

### Formula


# Money Management

## Understanding Student Loans

### Learning Objectives

After completing this section, you should be able to:
1. Describe how to obtain a student loan.
2. Distinguish between federal and private student loans and state distinctions.
3. Understand the limits on student loans.
4. Summarize the standard prepayment plan.
5. Understand student loan consolidation.
6. Summarize and describe benefits or drawbacks of other repayment plans.
7. Summarize possible courses of action if a student loan defaults.

### Obtaining a Student Loan

All college students are eligible to apply for a loan regardless of their financial situation or credit rating. Federal student loans do not require a co-signer or a credit check. Most students do not have a credit history when they begin college, and the federal government is aware of this. However, private loans will generally require a co-signer as well as a credit check. The co-signer will assume responsibility for paying off the loan if the student cannot make the payments.
The first step in applying for student loans is to fill out the FAFSA (Free Application for Student Aid). FAFSA determines financial need and what type of loan the student is qualified to obtain. For students who are still dependents on their parent’s taxes, the parents also fill out the FAFSA, as their wealth and income impacts what the dependent student is eligible for. Students who cannot demonstrate financial need will also be helped by applying with FAFSA, as it will help guide them to the type of loan most appropriate. The FAFSA must be submitted each year.
As soon as an offer letter from the college is received, the student should start the application process. The college will determine the loan amount needed. Also, there are limits on the amount a student can borrow. There are both yearly limits and aggregate limits. See the table later in this section that outlines the loan limits per school year and in the aggregate.
If the student receives a direct subsidized loan, there is a limit on the eligibility period. The time limit on eligibility depends on the college program into which the student enrolls. The school publishes how long a program is expected to take. The eligibility period is 150% of that published time. For example, if a student is enrolled in a 4-year program, such as a bachelor’s degree program, their eligibility period is 6 years, as 1.50(4) = 6. Therefore, the student may receive direct subsidized loans for a period of 6 years.

### Types and Features of Student Loans

Once a tuition statement is received, and all the non-loan awards are analyzed that are applicable to the costs of college (such as scholarships and grants), there still may be quite of bit of an expense to attend college. This difference between what college will cost (including tuition, room and board, books, computers) and the non-loan awards received is the college funding gap.
There are several loan types, which basically break down into four broad categories: subsidized loans, unsubsidized loans, PLUS loans, and private loans. These loans are meant to fill the college funding gap.
Federal subsidized loans are backed by the U.S. Department of Education. These loans are intended for undergraduate students who can demonstrate financial need. Subsidized federal loans, including Stafford loans, defer payments until the student has graduated. During the deferment, the government pays the interest while the student is enrolled at least half-time. These loans are generally made directly to students. However, there are restrictions on how the money can be used. It can only be used for tuition, room and board, computers, books, fees, and college-related expenses. Interest rates are not based on the financial markets but determined by Congress. Federal loans are backed by the Department of Education.
Federal unsubsidized loans, including unsubsidized Stafford loans, are available for undergraduate and graduate students who cannot demonstrate financial need. If the student meets the program requirements, they are automatically approved. The student is not required to pay these loans during their time in college (enrolled at least half-time). However, the interest rate is generally higher and there is no deferment period, as with subsidized loans. Interest begins accruing as soon as the money is disbursed.
Parent Loans for Undergraduate Students (PLUS) are federal loans made directly to parents. They are available even if parents are not deemed financially needy. A credit check is performed and approval is not automatic. The limit to what parents can borrow from a PLUS loan each year is still the college funding gap, but the aggregate of the PLUS loans does not have a limit. This means the PLUS loan can cover whatever is left in the funding gap once all other aid and loans are applied. Payments do not begin until the student is out of school, but interest begins to accrue the moment funds are disbursed. Because the parents take out the loan, the parents are responsible for paying back the loan.
Private student loans are backed by a bank or credit institution and require a credit check, and interest rates are variable. As private loans are not subsidized by the government, no one pays the interest but the borrower. The student does not have to start repaying the loan until after graduation, but interest starts to accrue immediately. This loan has fewer repayment options, more fees and penalties, and the loan cannot be discharged through bankruptcy. Many students need a co-signer to acquire a private loan. Like PLUS loans, private student loans can cover whatever is left in the funding gap once all other aid and loans are applied
Student loans, in general, have a term of 10 years, that is, the loans are paid back over 10 years. This can vary, but 10 years is the standard.

### Limits on Student Loans

As mentioned earlier, there are limits to how much a student can borrow, per year and in total. The following table shows a general breakdown of the amounts the federal government and private lenders will lend. Amounts are based on level of need and whether the student is a dependent or an independent student. Independent students include those who are at least 24 years old, married, a professional, a graduate student, a veteran, a member of the armed forces, an emancipated minor, or an orphan. The amounts shown are as of this writing in 2022.
Check out this Edvisors page on the limits of student borrowing to learn more!
Putting this all together, we have a way to determine the student loans needed for a student to attend college.
1. First, determine the funding gap. If the student or family can cover the gap, then no loans are necessary.
2. Second, determine how much in federal subsidized and unsubsidized student loans can be taken out. If the total federal loans available is more than the funding gap, no other loans are needed.
3. Third, if the federal subsidized and unsubsidized loans do not cover the gap, PLUS and private student loans can be taken out to cover the remainder of the gap.
At each step, if the student and family can cover some or all of the gap, they can do so without taking out a loan.

### Student Loan Interest Rates

Student loans are first and foremost loans. Students will pay them back and will pay interest. In the fall of 2022, the federal student loan interest rate was 4.99%. Private student loans rates ranged between 3.22% and 13.95%. Finding the lowest interest rate you can helps with the payments, and especially helps if the loan is not federally subsidized. Remember, if the loan is not federally subsidized, the student is on the hook for the interest that is accumulating with the loan.

### Interest Accrual

The interest on student loans begins as soon as the loan is disbursed (paid to the borrower). When the loan is federally subsidized, the government pays that interest for the student. This means the loan for a subsidized loan of $3,000 is still a loan for $3,000 when the student graduates. However, if the loan is not federally subsidized, the student is responsible for the interest that accrues on the loan. The $3,000 loan from year 1 of college is now a loan for more due to that added interest. The interest on that loan grew while the student was in college. The formula for growth of the loan’s balance is the same as compound interest formula from Compound Interest, .

### The Standard Repayment Plan

There are various repayment plans available. The one most likely to apply to a student loan is the standard repayment plan, which is available to everyone. Borrowers pay a fixed amount monthly so the loan is paid in full within 10 years. Consolidated loans, discussed later in this section, also qualify for the standard repayment plan, and may allow the payoff period to range from 10 to 30 years. Direct subsidized and unsubsidized loans, PLUS loans, and federal Stafford loans are eligible.
Since these are loans, they are paid back with interest. As with most installment loans, their payments are due monthly. The formula for paying back these loans is the same as the formula used for paying loans in The Basics of Loans:
Using that formula, we can calculate how much the payment is for a student loan. Remember that all loan payments are rounded up to the next penny.

### Student Loan Consolidation

When a student graduates, they may have multiple different student loans. Keeping track of them and paying them off separately can be a burden. Instead, these loans can be consolidated into a single loan. If they are federal loans the combination is called federal consolidation. Combining private loans is often referred to as refinancing. Refinancing, or private consolidation, can be used to combine both private and federal student loans. Be aware that consolidated federal loans may still be subject to the rules and protections that govern subsidized loans. Refinancing loans, private or federal, are no longer subject to those rules and guidelines. Check out this Experian article about consolidation and refinancing for more deatil.
In consolidation of federal direct student loans, the interest rate is the weighted average of the interest rates on the subsidized loans. This means the interest rate remains the same. However, if the term is extended, then the student will pay back more over time than if they did not extend the loan term.
In refinancing, it is possible to obtain a lower interest rate on the student loans, which may lower how much is paid per month and lower the total paid back over time. These monthly payments are calculated using the same formula as for any other loan payment, . The term of the refinanced loan may also be changed, which would also impact the payment per month.
In either case, consolidating or refinancing, the monthly financial burden on the student can decrease. However, if the term is extended, the total amount repaid may increase.

### Other Repayment Plans

There are various other repayment plans available to students. Plans other than the standard repayment plan typically require the student to meet certain criteria. The following plans are independent of student income, but may make early payments easier.
1. Graduated repayment plans are plans where the amount of payments gradually increases so that the loan is paid off in 10 years, or within 10 to 30 years for consolidated loans. Payments start off small and increase approximately every 2 years. Almost all loan types are eligible, including direct subsidized and unsubsidized loans, Stafford loans, PLUS loans, and consolidated loans.
2. Extended repayment plans are available to the direct loan borrower if the outstanding direct loans are over $30,000. The payments, fixed or graduated, are designed so that the loans are satisfied within 25 years. Eligible loans include both direct subsidized or unsubsidized loans, Stafford loans, PLUS loans, and consolidated loans.
If student earnings are such that the standard, graduated, or extended repayment plans are unaffordable, then one can make payments that are based on their discretionary income. Discretionary income is federally defined to be the difference between (adjusted) gross income and 150% of the poverty guideline for location and family size. This discretionary income then depends on where one lives (contiguous United States or Hawaii or Alaska) and how many dependents one has. If married, a spouse’s income will be included in the adjusted gross income. Understanding discretionary income is necessary to understand how income driven payments plans work.
The following plans all depend on discretionary income.
1. Pay As You Earn (PAYE) repayment plans have monthly payments that are 10% of discretionary income based on a student’s updated income and family size. If a borrower files a joint tax return, their spouse’s income and debt may also be considered. Eligible loans include direct subsidized and unsubsidized loans, PLUS loans made to students, and some consolidated loans. These loans are forgiven (student does not pay the remaining balance) after 20 years of monthly payments if they were direct federal student loans.
2. Revised Pay As You Earn (REPAYE) repayment plans have payment amounts that are based on income and family size and calculated as 10% of discretionary income. Eligible loans include direct subsidized and unsubsidized loans, direct PLUS loans, and some consolidated loans. These loans are forgiven, that is, the student does not pay more, after 20 or 25 years, provided they were direct federal student loans.
3. Income-Based Repayment (IBR) plans sound like a few of the others and there are similarities in all of them. The payments are either 10% or 15% of discretionary income, but this plan is meant for those with a relatively high debt. Every year, income and family size must be updated, and payments are calculated based on those figures. Eligible loans include direct subsidized and unsubsidized loans, Stafford loans, and PLUS loans made to students, but not PLUS loans made to parents.
4. Income-Contingent Repayment (ICR) plans have payments that are either 20% of discretionary income or whatever would be paid if a student were on a fixed payment plan for more than 12 years, whichever is less. Eligible loans include direct subsidized and unsubsidized, PLUS loans to students, and consolidated loans.
There are many similarities among these repayment plans, and it is easy to misunderstand the nuances of each. Therefore, be careful entering into any type of repayment contract until you fully understand all the details and repercussions of the plan you choose. For more detail, see this nerdwallet article "Income-Driven Repayment: Is It Right for You?" to learn more!
Using income to determine payments initially seems excellent. However, if there is no forgiveness at the end of the loan, then the income driven payment plans can cause problems. For one, your payment may not be sufficient to cover the interest rate of your loans. In that case, your loan balance actually increases as you make your payments. Eventually, you are paying for not only your original loan balance, but interest that has been growing and compounding over time. Also, if the loan term is extended, you may pay more, perhaps a lot more, money over time. You may find yourself in the position of paying these loans for decades.
With those possible drawbacks, great care must be taken to avoid large problems down the line.

### Student Loan Default and Consequences

The first day a payment is late, the account becomes delinquent. After 90 days, this delinquency is reported to the credit bureaus, and goes into default. This is serious, as now a credit score is affected, meaning that it will be harder to buy a car, a home, get a credit card, or a cell phone. Even renting an apartment may be a task not easily overcome. The default rate for students who do not complete their degree is three times higher than for students who do.
Further, defaulting on a student loan may mean that the borrower loses eligibility for repayment plans, as the balance and any unpaid interest may become due immediately, and any tax refunds may be withheld and applied to the loan, and wages may be garnished. One should immediately contact your loan servicer and try to make other arrangements for repayment if this situation becomes apparent, as different repayment plans are available, if actions are taken quickly.
There are several options that may be open to avoid defaulting. One is called rehabilitation, or is the process in which a borrower may bring a student loan out of default by adhering to specified repayment requirements, and the other is consolidation. Certain criteria must be met to enter these programs.
Both of these options are detailed, including the criteria required for eligibility, on the studentaid.gov loan management page.
Professionals advise hiring an attorney if one of these paths is chosen.

### Check Your Understanding

### Key Terms

1. FAFSA
2. College funding gap
3. Subsidized loan
4. Unsubsidized loan
5. Parent loan for undergraduate students
6. Private student loan
7. School-channel loan
8. Direct-to-consumer loan
9. Standard repayment plan
10. Federal consolidation
11. Refinancing
12. Private consolidation
13. Graduated repayment plan
14. Extended repayment plan
15. Discretionary income
16. Pay as you earn (PAYE) repayment plan
17. Revised pay as you earn (REPAYE) repayment plan
18. Income-based (IBR) repayment plan
19. Income-contingent (ICR) repayment plan
20. Delinquent
21. Default
22. Rehabilitation

### Key Concepts

1. The FAFSA must be filled out each year that a student wishes to borrow for.
2. A student’s funding gap determines how much they need in loans to pay for college.
3. Federal subsidized student loans defer payments until after graduation and interest does not accrue on these loans.
4. Unsubsidized student loans defer payment until after graduation but interest begins accruing as soon as the loan finds are disbursed.
5. There are both yearly and aggregate limits for student loans to prevent over-borrowing, among other reasons.
6. Federal direct loans have a low interest rate set by the government, but other student loans have varying rates of interest set by the banks.
7. The standard repayment plan lasts 10 years and is made up of monthly payments.
8. Consolidating or refinancing student loans merges many student loans into one loan.
9. If only federal loans are consolidated, the interest rate is the same as the individual loans, currently set at 4.99%.
10. If other loans are refinanced together, the interest rate may be lower with the new loan.
11. Other repayment plans are available. Such a plan may have payment that start small and grow as the loan is paid off, or it may have a longer term, or may be based on the discretionary income of the student.
12. Being delinquent on a student loan is a precursor to being in default. Making payments in a timely fashion allows the student to avoid this situation.

### Video

1. Types of Student Loans
2. Repayment Plans

### Formula


# Money Management

## Credit Cards

### Learning Objectives

After completing this section, you should be able to:
1. Apply for a credit card armed with basic knowledge.
2. Distinguish between three basic types of credit cards.
3. Compare and contrast the benefits and drawbacks of credit cards.
4. Read and understand the basic parts of a credit card statement.
5. Compute interest, balance due, and minimum payment due for a credit card.
It can be difficult to get along these days without at least one credit card. Most hotels and rental car agencies require that a credit card is used. There are even a number of retailers and restaurants that no longer accept cash. They make online purchasing easier. And nothing contributes more to a good credit rating than a solid history of making credit card payments on time.
Being granted a credits card is a privilege. Used unwisely that privilege can become a curse and the privilege may be withdrawn. In this section, we will talk about the different types of credit cards and their advantages and disadvantages. The more knowledge a cardholder has about the credit card industry, the better able credit accounts can be managed, and that knowledge may cause major adjustments to a cardholder’s lifestyle.
All credit cards are not equal, but they all represent consumers borrowing money, usually from a bank, to pay for needs and “wants.” As such, they are a type of loan, and your repayment may include interest. (You might want to review Section 6.8, which discusses loans and repayment plans.)
There are many institutions and credit cards to choose from. Use caution as you shop around for a credit card that suits you. Your top concern is likely the interest rates on purchases and cash advances. But be careful to also read the small print regarding charges for late payments, and other fees such as an annual fee, where the credit card charges you (the cardholder) a fee each year for the privilege of using the cards. Many cards charge no such fee, but there are many that charge modest to heavy fees. Make sure to understand rules for reward programs, where the credit card issuer grants benefits based on one’s spending. Finally, once one applies for and is granted a credit card, pay attention to the credit limit the bank offers. Once a company is owed that much money, use of the card for purchases should be curtailed until some of the debt is paid off.

### Types of Credit Cards

There are basically three types of credit cards: bank-issued credit cards, store-issued credit cards, and travel/entertainment credit cards. We will look at all three and explain the good and the bad qualities of each.

### Bank-Issued Credit Cards

Perhaps the most widely used credit card type is the bank-issued credit card, like Visa or MasterCard (and even American Express and Discover cards). These types of cards are an example of revolving credit, meaning that additional credit is extended before the previous balance is paid—but only up to the assigned credit limit. Bank-issued cards are considered the most convenient, as they can be used to purchase anything, including apparel, furniture, groceries, fuel for automobiles, meals, hotel bills, and so on, just as if paying with cash. The interest rates on bank-issued credit cards are usually lower than those for other credit cards we’ll discuss, and the credit limits are generally higher. Currently, bank-issued cards have an average 20.09% APR.

### Store-Issued Credit Cards

Store-issued credit cards are issued by retailers. One can hardly walk into a store these days without being offered a discount on purchases if one applies for the store credit card. These cards can only be used in that store or family of stores that issues the card. However, if a store credit card is associated with Visa, MasterCard, or American Express, then the card might be used the same way that the bank-issued cards are used. This is called cobranding. The logo of the bank-issued card will be present on the store card. Many stores offer both types. Like other credit cards, they may come with an annual fee.
Store credit cards usually charge higher interest rates than bank-issued cards. Currently, store credit cards have an APR (annual percentage rate) of 24.15%. Any rewards offered by store credit cards are usually limited to purchases made in their own store, and it typically takes longer to accumulate enough rewards or points to redeem them, whereas cobranded credit cards offer opportunities to earn rewards on all purchases, regardless of whether purchases are made in the issuing store or not.
Store credit cards usually offer lower credit limits, at least in the beginning. After being proved to be a responsible credit card owner, credit limits can be raised. Nevertheless, store credit cards are a good choice for those new to the credit card industry. If on-time payments are consistently made, it is an excellent way to get started building a credit history.

### Travel/Entertainment Cards, or Charge Cards

This is the third type of credit card. The travel and entertainment cards, also known as charge cards, first and foremost offer very high limits or unlimited credit, but they must be paid in full every month. They generally charge high annual fees and impose expensive penalties should a payment be late. On the other hand, they typically have longer grace periods and offer many and various kinds of rewards.
Check out this nerdwallet article about the differences between a charge card and a credit card.

### Credit Card Statements

Cardholders usually receive monthly statements and have 21 days to pay the minimum amount due. The statements itemize and summarize activity on the credit card for that statement’s billing period. The billing period for a credit card is generally a month long, but typically does not start and end on the first and last days of the month. The statement will include the current balance, interest rate, the minimum payment due, and the due date. Be aware, different companies produce statements that are laid out differently. The information will be clearly labeled though.
The due date is a top concern. Missing a due date is one of the worst things a cardholder can do financially, and this is by far the biggest downfall of owning a credit card. Not only is the cardholder subject to late fees, but when a payment is late more than once there is a high probability that the cardholder will be negatively reported to the credit bureaus, which can quickly erode a credit score.  shows an excerpt from an actual statement from a Chase Bank Visa card, based on the current $668.25 balance.
Specifically pay attention to the late payment penalty and minimum payment warning statements. stating that if no other purchases are made and you continue making only the minimum payment, it will take 19 months to pay off the balance and you will pay $754.00. You can’t say you were not warned.
It is critical that you examine your statement every month because it is always a possibility that your account may have been compromised. If you should notice fraudulent charges on your statement, notifying the credit card company is often enough to have those charges researched by the company and removed. The card with the fraudulent charges will be canceled and a new card with a new account number will be sent to you.

### Compute Interest, Balance Due, and Minimum Payment Due for a Credit Card

Computing all of these values depends on understanding and computing the average daily balance on a credit card. Once that is known, the interest, balance due, and minimum payment can be found.
Above all else, if you pay off the entire balance each month, interest is not charged.

### Average Daily Balance

Most credit card companies compute interest using the average daily balance method.
To find the average daily balance on your credit card, determine the balance on the card each day of the billing period (often that month), and take the average. One process to find that average daily balance follows these steps:
1. Start with a list of transactions with their dates and amounts.
2. For each day that had transactions, find the total of the transactions for the day. Expenditures are treated as positive values, payments are treated as negative values.
3. Create a table containing each day with a different balance. The balance is the previous balance plus the day’s total transactions.
4. Add a column for the number of days those balances until the balance changed.
5. Add a column that contains the balances multiplied by the number of days until the balance changed.
6. Find the sum of that last column.
7. Divide the sum by the number of days in the billing period (often the number of days in the month). This is the average daily balance.

### Calculating the Interest for a Credit Card

The interest charged for a credit card is based on the daily interest rate of the card, the number of days in the billing cycle, and the average daily balance on the card.

### Calculating the Balance of a Credit Card

The balance, or sometimes balance due, on a credit card is the previous balance, plus all expenses, minus all payments and credits, plus the interest on the card. As stated before, if the card was paid off, there is no interest to be paid.
The next example puts all those steps together.

### Minimum Payment Due

The minimum payment due is the smallest required amount to be paid on a credit card to avoid late fees and penalties, such as an increased interest rate. The calculations for this may differ from card to card. They also depend in the balance of the credit card. General guidelines for minimum payment due are:
1. For larger balances (usually over $1,000), the minimum payment will be some percentage of the balance due.
2. For moderate balances (between $25 and $1,000), the minimum would be a specified dollar amount. $25 seems to be a common value.
3. If the balance is small (under $25 for instance), then the minimum payment is the balance.
Those are just guidelines. Individual cards may vary in these values.
Minimum payments should only be paid if money is short in a given month. The length of time to pay off a credit card using minimum payments is quite long, and results in paying a lot of interest. It is strongly discouraged.
Check out this nerdwallet article about minimum payments for more!

### Check Your Understanding

### Key Terms

1. Reward program
2. Annual fee
3. Credit limit
4. Bank-issued credit card
5. Store-issued credit card
6. Travel and entertainment cards
7. Charge cards
8. Billing period
9. Balance
10. Minimum payment
11. Average daily balance

### Key Concepts

1. Credit cards can be a flexible way to pay for almost anything, but can become a financial hazard if used unwisely.
2. When deciding which credit card to apply for, evaluate the interest rate, fees (annual and late), reward programs and credit limit. Be sure they meet your criteria.
3. Paying off the balance of your credit card every month will control your spending and will never result in paying interest.
4. Credit card statements hold all important information about your credit card, including payment, balances, charges and billing cycle dates.
5. Although the minimum payment is attractive precisely because it is so small, paying only the minimum results is a long payoff term and higher interest costs.

### Video

1. Choosing a Credit Card
2. Reading Credit Card Statements

### Formula


# Money Management

## Buying or Leasing a Car

### Learning Objectives

After completing this section, you should be able to:
1. Evaluate basics of car purchasing.
2. Compute purchase payments and identify the related interest cost.
3. Evaluate the basics of leasing a car.
4. Identify and contrast the pros and cons of purchasing versus leasing a car.
5. Investigate the types of car insurance.
6. Solve application problems involving owning and maintaining a car.
There are people who don’t need a car and won’t purchase one. But for many people, whether or not to have a car is not a question. Having a car is a basic necessity for these people.
Obtaining a car can be daunting. The models, the features, the additional costs, and finding funding are all steps that need to be taken. One of the big decisions is whether to buy the car or to lease the car. This section will address some of the issues associated with each option.

### The Basics of Car Purchasing

The biggest questions you will answer before purchasing a car are, what do you want and what do you need?
Does it have to be new? Does it have to be a make and model you are familiar with? Does it have to have assisted driving? What other details are important to you? For a new vehicle, every feature beyond standard features comes with additional cost, which leads to the question that constrains all of your decisions about a car. How much can you afford to spend on a car?
What you can afford must include insurance costs (discussed later in this section) and maintenance and upkeep. Once you have this in mind, you can search for a car that matches, as closely as possible, what you want and can afford. Most, if not all, dealers have websites that you can search through to identify the car you want. If new cars are not affordable, used cars cost less but come with the wear and tear of use.
The sticker price of the car, called the manufacturer’s suggested retail price (MSRP), or the negotiated price you arrive at, isn’t the end of the cost to buying a car. There are many fees that accompany the purchase of the car, and perhaps even sales tax. These include but aren’t necessarily limited to the following:
1. the title and registration fee, which includes registering your car with the state, getting the license plate, and assigning the title of the car to the lender. This cannot be avoided.
2. a destination fee, which covers the cost of delivering the vehicle to the dealer
3. a documentation fee, sometimes referred to a processing fee of handling fee, is the cost of all the paperwork the dealer did to get you the car
4. a dealer preparation fee, which is for washing the car and other preparation of that sort. You should try to negotiate that out of the cost of the dealer tries to charge for that
5. extended warranties and maintenance plans, which help cover some of the costs of caring for the car.
6. Sales tax.
You could pay for these immediately, but they are often added to the financing of the car, meaning they become part of the principal of your loan.
One way to bring down payments on a car is to provide a down payment or a trade in. This is money applied to the purchase price before financing happens. Be warned, the sales tax applies to the full purchase price! If you reduce the amount financed, the payments respond by going down. This often becomes part of the negotiating process.
When purchasing a car, the total cost to obtain the car is not the only factor in your monthly price. You will also pay an interest rate for the loan you obtain. The interest rate you will get is dependent on your credit score (see The Basics of Loans). But you can choose from different lenders. The dealership will likely offer to finance your car loan. Frequently, dealerships offer special financing with very low rates. This is to help move inventory, and may indicate their desire to make sales. This might make negotiating easier. Even if the dealership offers financing, check with your bank or credit union to determine the interest rates they are offering. To reduce your payments, choose the lowest rate you can find.

### Purchase Payments and Interest

Whether or not you buy a new car or a used car, if you finance the purchase, you are taking out a loan. The interest rates available for used cards are frequently higher than those for new cars. These loan payments work exactly the same way as other loans do as far as payments are concerned. The payment function comes from The Basics of Loans. The difference between financing a new car or a used car is that financing a new car typically comes with a lower interest rate and a longer term that financing a used car.

### The Basics of Leasing a Car

Leasing a car is an alternative to purchasing a car. It is still a loan, and acts like one in many respects. They typically last either 24 months or 36 months, though other terms are available. Leases also come with mileage limits, frequently 10,000, 12,000, or 15,000 miles per year. When the lease is over, the car is returned to the dealer. At that time there may be fees that have to be paid, such as for damage to the car or for extra miles driven over the limit.
There are two components to lease costs. One is the monthly payment for the lease. The other is the fees for leasing, These often are paid before the lease is complete. These include:
1. a down payment, which is your initial payment that is applied to the price of the car. It reduces the amount you finance, much the same as when you purchase a car. It is recommended that this be negotiated away.
2. the acquisition fee, sometimes called the bank fee. This is the money charge for the company to set up the lease. It is essentially a paperwork fee. It is not likely that this can be negotiated.
3. a security deposit, which might be required. It is about the same as 1 month’s payment for the lease. The deposit is returned to you if the car is in good shape at the end. This can be negotiated away.
4. disposition fees, which cover the cost the company will incur when they take your car back and are typically between $200 and $450.
5. the title, registration, and license fees, just as with the purchase of a car.
6. sales tax, which will likely be applied. The sales tax only covers the depreciated portion of the car (more on depreciation later) in many states. Since this depends on the state in which the car is leased, you should determine the sales tax rules for where you lease the car.
As you can imagine, this can come to a fairly high dollar amount.
You have some obligations when you lease a car. You must keep the car in good condition, cleaned, maintained, and free of anything more than minor damage. If the car is in poor condition when the car is returned, you will be responsible for the cost to bring the car to an acceptable condition. You are also expected to keep the mileage under its limit. If you go over, you will pay 10 to 25 cents per mile over.

### Lease Payments

Lease payments are similar to regular loan payments, but have some other details. Calculating a lease payment involves knowing the following values:
1. The price of the car. This is the cost you would pay for the car after applying all discounts, incentives, and negotiations.
2. Residual Value. This is the manufacturer's estimate of the car's value after a set period of time. The residual value is expressed as a percentage of the manufacturer’s suggested retail price (MSRP).
3. Months. This is the length of the lease. Most leases are either 24- or 36-month leases, but other terms are available.
4. Monthly Depreciation. The monthly depreciation is the difference between the price of the car and the residual value, divided by the number of months of the lease, and represents the monthly loss of value of the car while it’s being used.
5. Money Factor (MF). This is the interest rate, but expressed in a different way for a lease. Converting from the money factor to the annual percentage rate (APR) is done by multiplying the MF by 2400. Naturally, converting an APR to a MF is done by dividing the APR by 2400.
Once the values above are found, the payment for the lease can be calculated.

### Comparing Purchasing and Leasing

When deciding to buy or lease a car, the differences between the two options should be carefully evaluated. The following is a list of points of comparison between the two.
1. The payments for a lease are likely less than the payment for purchasing.
2. When leasing, you get a new car after the lease term is over, typically 24 or 36 months. Buying the car means the same car is driven until it is re-sold and a new one bought. Essentially, leasing a car is equivalent to renting a car.
3. The leased car is new, so all warrantees are in force and you drive the car during its best years. When the car is purchased, it may be kept past its warrantees and may be driven until it is quite old.
4. Each time you lease a new car, all the fees and taxes must be paid again. When buying a car, these fees are only paid once.
5. Leasing contracts carry restrictions on the mileage you can drive per year, and going over incurs more cost at the end of the lease. Buying the car means no such mileage limits.
6. When leasing, you are obligated to keep the vehicle in good condition and maintained according to the dealer’s schedule. Some dealerships will even pay for oil changes over the life of the lease. When the car is purchased, the upkeep schedule is the choice of the owner.
7. When a car is purchased and kept for long enough, the warranty expires and the owner is responsible for all maintenance items and repairs. The warrantee for a car won’t expire during the lease term.
8. When a new car is purchased and the loan is paid off the car is still owned by the buyer and may be traded in when a new car is to be purchased. When leasing, the car is returned to the dealer when the lease term is over.
When deciding between the two, you are choosing between these features. If you aren’t willing to drive an older car or deal with the upkeep that accompanies an older car, you may want to lease. This means you will need to pay those beginning costs each time the lease is up. If you want to own the car after the payments are over, then you may want to buy a car. This means you are paying for all the upkeep after the warrantees expire, but you have no limits on mileage and own the car at the end. It really depends on your preferences.

### Car Insurance

Car insurance is meant to cover costs associated with accidents involving cars. Most states (all except New Hampshire and Virginia) require some insurance. Without insurance, the state may not let you get a license for your car or register your car. Your state’s requirements can be hard to follow. Fortunately, insurance companies and brokers will make sure your insurance is sufficient for your state and will warn you if you try to not meet the requirements. Of course, they may offer more than what is sufficient, so it is your responsibility to determine how much coverage you want, as long as the minimum insurance requirements are met. The cost of insurance should be accounted for when evaluating the affordability of buying or leasing a car.
Whether your car is leased or owned, you do need insurance. This contributes to the cost of having the vehicle. Leasing or owning makes no difference to the insurance company you choose, because they are insuring you based on what you are driving, your driving record, and other information about you including where you live and your age. These insurance policies have many components that address different costs that can come from auto accidents. This may make details confusing, and you may not realize what you are paying for until you must use it. Here is a brief outline of the different components of auto insurance, many of which are required by the state that issues your driver’s license.
1. Liability insurance is mandatory coverage in most states. Liability insurance covers property damage and injuries to others should you be found legally responsible for an accident. You are required to have the minimum amount of coverage, as determined by your state, in both areas.
2. Collision insurance is insurance covering the damage caused to your car if involved in an accident with another vehicle.
3. Comprehensive insurance is an extra level of coverage if involved in an accident with another vehicle and covers other things like theft, vandalism, fire, or weather events as outlined in your policy. There is a deductible assigned to each type of insurance, an amount that you pay out of pocket before your comprehensive coverage takes effect. Comprehensive insurance is often required if you lease or finance the purchase of a vehicle.
4. Uninsured or underinsured motorist insurance: If you are hit by an uninsured or underinsured motorist, this insurance will help pay medical bills and damage to your car.
5. Medical payments insurance is mandatory in some states and helps pay for medical costs associated with an accident, regardless of who is at fault.
6. Personal injury protection insurance is coverage for certain medical bills and other expenses due to a car accident. Other covered expenses may include loss of income or childcare, depending on your policy.
7. Gap insurance is designed to cover the gap between what is owed on the car and what the car is worth in the event your car is a total loss.
8. Rental reimbursement insurance is coverage for a rental car while your car is under repair resulting from an accident.
You can also purchase other special insurance policies, such as classic car insurance, new car replacement insurance, and sound system replacement insurance, to name a few. It is important that you determine exactly what you need, as insurance policies can be expensive and vary according to your age, driving history, and where you live.

### Maintaining a Car

Cars are not a buy it and forget it item. They require upkeep, which adds to the cost of owning the car. Tires, brakes, and wipers need replacing. Oli changes, inspections, so many things other than gasoline. Below is a list of some maintenance requirements for cars, along with cost and roughly how often they should happen.
When designing a budget, these expected costs should be accounted for. Extra money per month should be saved in addition to this budget category, to handle unanticipated, and perhaps very costly, repairs.

### Check Your Understanding

### Key Terms

1. Title and registration fees
2. Destination fee
3. Documentation fee
4. Dealer preparation fee
5. Extended warranty
6. Down payment
7. Acquisition fee
8. Security deposit
9. Disposition fees
10. Liability insurance
11. Collision insurance
12. Comprehensive insurance
13. Uninsured or underinsured motorist insurance
14. Medical payment insurance
15. Personal injury insurance
16. Gap insurance
17. Rental reimbursement insurance

### Key Concepts

1. There are many factors to consider when choosing to buy or lease a car.
2. The cost of the car is increased by a number of fees and sales tax.
3. There are advantages to buying a car and advantages to leasing a car. The decision between the two depends on the preference of the buyer.
4. Insurance covers costs associate with accidents. It is made up of various components.
5. The costs of owning a car, including insurance and maintenance, should be a part of the budgeting process.
6. Budgeting for unexpected repairs can ease the stress of encountering large repair bill.

### Formula