Ch 7 To 9 Sum. Principle 1: The Risk-Return Trade-Off This principle affects the cost of credit for both the borrower and the lender. Fixed-rate loans generally cost more for the borrower than variable-rate loans because the lender is bearing more risk and therefore demands a higher return. Borrower strategies to reduce the risk for the lender (e.g., strong credit rating, variable interest rate, short loan term, collateral, and larger down payment) reduce costs associated with the loan. Principle 6: Taxes Bias Personal Finance Decisions Taxes may affect the cost of borrowing as well as the decision to use savings for a planned purchase. The tax deduction for interest paid on home equity credit loans and student loans, within applicable restrictions, offers a cost advantage. The after-tax lost return, or the true earnings after taxes are paid on future earnings on savings, must be considered when determining whether to borrow or use savings for a purchase. Principle 9: The Best Protection is Knowledge Knowledge of credit costs can save a lot of money, as is very apparent with short-term ï¿½fee-financing,ï¿½ applied to payday loans. Consumers using these loans should consider the applicable interest rate that the fee represents.

Loan costs should persuade consumers to look for another source of financing, or better yet, to control their spending and avoid the need altogether. Unfortunately, those using payday loans often have no other lending alternatives and may not control their finances to include even a small emergency fund. REVIEW 1. A single-payment, or balloon, loan is paid back in one lump-sum payment on the date of loan maturity. The balloon payment is the total of the amount borrowed and all interest charged for the life of the loan, generally less than one year. In contrast, an installment loan is repaid through a series of smaller payments. A bridge loan, such as a single payment balloon loan, provides short-term funding until longer-term or additional financing is available. The name, bridge or interim loan, refers to the fact that this loan fills an interim time or bridges the need for financing from one time period to another, when another loan is available. The subsequent financing would pay off the bridge loan. 2. Collateral, or an asset identified as security for a loan, differentiates a secured from an unsecured loan. An unsecured loan, because it has no available collateral for repossession in the event of loan default, carries a higher interest rate.

As explained by Principle 1, the lender requires a higher return in exchange for the greater risk of having only the borrowerï¿½s promise to pay. In contrast, with a secured loan the collateral could be repossessed, therefore offering more ï¿½safetyï¿½ for the lender and a lower interest rate for the borrower. 3. Variable or adjustable interest rate loans subject the consumer to fluctuations in the current market interest rates, which could mean higher or lower payments over the life of the loan. Loan rates are typically tied to the prime rate or the rate on Treasury securities, often plus some margin. Consumers are protected by periodic caps on interest rates as well as a lifetime cap that establishes a maximum rate over the life of the loan. A loan with the interest rate tied to longer-term market rates typically offers more rate stability than one tied to shorter-term rates, as the latter tend to change more often.

When shopping for these loans, consumers should compare: ï¿½ the interval between rate adjustments (e.g., monthly, quarterly, annually); ï¿½ the volatility of the market interest rate on which the loan rate is based (e.g., 6-month Treasury bill rate or the 20-year Treasury bond rate); ï¿½ periodic rate cap or maximum amount the rate can change in one adjustment interval; and ï¿½ lifetime cap or maximum amount the rate can increase over the life of the loan. Convertible loans offer the borrower the benefit of a lower variable-rate loan with the option to convert to a fixed rate loan at specified future dates. Although not as commonly available, convertible loans offer initially lower costs and the option to convert to a fixed rate loan, although it could be at a rate higher than that available when the loan was initially established. 4. The following clauses deal with consumer default on a loan contract: ï¿½ Acceleration clause declares the entire balance of the loan due immediately if one payment is missed. The collateral will be repossessed and sold if funds are not available to pay off the loan.

ï¿½ Deficiency payments clause establishes the right of the creditor to bill the consumer for the difference in the amount of the outstanding loan balance (plus collection, selling, and legal costs) and the amount generated through the repossession and sale of the collateral. ï¿½ Recourse clause establishes what additional actions the lender can take to seek repayment in case of default. Attachment of wages to secure a portion of the debtorï¿½s salary is a common recourse. An insurance agreement clause requires the purchase of credit life insurance to repay the loan in the event of the borrowerï¿½s death. This clause adds, sometimes tremendously, to the cost of the loan because credit life insurance is a very expensive type of life insurance that mainly benefits the lender. 5. Home equity credit loans/lines offer two distinct advantages. First, the loans generally carry a lower interest rate than other consumer loans. Second, the interest paid (within limits) is tax deductible. The consumer saves money initially by paying less interest on the loan, when compared to competing consumer loans, and later through tax savings equal to the marginal tax bracket percent multiplied by the amount of interest paid.

Because the consumerï¿½s built-up equity in the home is the collateral for a home equity loan, the home is at risk should the consumer default. This is a major disadvantage. Other disadvantages focus on the loss of financial flexibility. Those dollars can't be used for other purposesï¿½they are committed to repay debt. Future debt repayment of any kind commits future income and reduces flexibility. 6. Students have two options for financing their education: Federal Direct Loans and Stafford Loans. Both of these options have borrowing limits that increase with academic level succession and interest rates that are capped at 8.25 percent. These loans also defer payment during enrollment and for six months after graduation. Parents also have two options for financing the childï¿½s education: PLUS Direct and PLUS Loans. With these loans, the available amount of financing depends on the total budgeted cost of education minus any other financial aid received, so the total amount available may be more than the Federal Direct or Stafford Loans offer. Whereas the student version loans are capped at 8.25 percent and repayment is deferred until six months after graduation, the parental versions are capped at 9.00 percent over the life of the loan, but loan repayment is not deferred. 7.

Only home equity and student loans offer tax advantages for the borrower. As noted in Chapter 4, home equity interest (with restrictions) is an itemized deduction. Student loan interest appears on the tax form as an adjustment to income (with income restrictions). Both reduce the annual tax liability of the borrower. The typical auto loan offers no tax advantage, although a knowledgeable consumer could use a home equity loan to purchase a car, thereby making the interest tax deductible. But, if the consumer should default, the home, and not the auto, is the security for the loan. 8. All costs associated with a loan (e.g., interest, loan processing fees, credit check fees, and any required insurance fess) make up the finance charges. APR, or annual percentage rate, is a federally required, standardized calculation of the approximate true cost of borrowing. It compares the cost of all finance charges over the life of the loan to the loan amount. APR represents the annualized true simple percentage cost of the loan. 9. Payday loans are typically short-term loans, used by consumers to cover expenses between paychecks. These loans have a fee that can sometimes be equal to paying 800 percent interest, on an annualized basis.

This is a major disadvantage, offset only by the fact that people with poor credit can typically qualify. Because the loan costs are assessed as ï¿½feesï¿½ and not interest, and the true interest rate is so high, some states have exempted payday lenders from laws that limit interest rates. Consider Principle 1 from the perspective of the lender. Other states chose to protect consumers by banning payday lenders. 10. Both the simple interest method and the discount method are used to calculate interest on a single-payment loan. Comparison of the APR for $10,000 borrowed for 6 months at 12 percent (with no additional finance charge fees) using the simple interest method (12.0 percent) and the discount method (13.64 percent) reveals that the simple interest method is preferable. The discount method APR is larger because the interest is deducted before the loan is received. This means the principal amount actually received is smaller than the stated principal of the loan. 11. With a simple interest loan, interest is paid only on the unpaid balance. With the add-on method, interest is paid on the original principal over the entire life of the loan, yielding an APR almost twice the stated interest rate.

When borrowing $5,000 for one year at 14 percent (with no additional finance charges), the APR for the simple interest method is 14.0 percent while the APR with the add-on method is 24.91 percent. If the loan is repaid early, the simple interest method offers the debtor greater savings than the add-on method. Fortunately the simple interest method is most commonly used, and consumers should always shop for credit and compare the APR for each loan. 12. Term of the loan, interest rate and payment amount are interrelated. A change in one results in changes in the other two. The rules of thumb that explain this relationship are listed below. The longer the term of the loan, the greater the total interest charges, when comparing loans with the same rate. To decrease the payment, increase the length of the loan, when comparing loans with the same rate. A longer term means more total finance charges, and often a higher interest rate when compared to a shorter-term loan. The lower the interest rate, the lower the payment, when comparing loans over the same term. The shorter the term of the loan, typically the lower the interest rate, when compared to longer-term loans.

A lower rate means lower interest charges, per payment and over the life of the loan. 13. The most inexpensive loan sources are usually the family, the cash value of a life insurance policy, a home equity loan, or other secured loan. Credit unions, S&Ls, and commercial banks are a more expensive source of loans, depending on the type of loan, desired maturity, and type of interest (variable- or fixed-rate). Comparison-shopping is critical when considering these sources, but credit unions often offer the best deal. Retail stores, finance companies, and small loan companies offer the most expensive loans and accept consumers with greater risk of default. 14. Consumers can reduce the risk and return for the lender by: ï¿½ maintaining a strong credit report and high fico score. ï¿½ choosing a variable-rate loan. ï¿½ keeping the term of the loan as short as possible...this means higher payments! ï¿½ providing collateral for the loan...this means managing income to acquire savings and assets! ï¿½ paying a large down payment to reduce the amount financed...this means managing income to accumulate savings. 15.

Sound debt decisions should take into consideration the following five factors: ï¿½ Does the purpose of the loan (i.e., good or service to be purchased on credit) and the loan repayment fit into the total personal financial plan? ï¿½ How much debt is affordable within present and future income? Will additional debt exceed the safe limit? ï¿½ How will the loan repayment affect future financial flexibility? ï¿½ Is it worthwhile to use credit to maintain sufficient liquidity (cash savings) for emergency needs? ï¿½ If sufficient liquid funds are available, is the cost of credit greater than or less than the after-tax return lost from using savings? Use credit only if the cost of borrowing is less than the after-tax return lost from using savings. 16. The benefit from borrowing to invest is the income, or earnings, produced by the investment. Borrowing to invest is advisable as long as the benefits, or earnings, are greater than the cost of borrowing. 17. The other primary factor that affects your debt limit ratio is your take-home pay; however, your mortgage payment is also a factor if the lender is using the ï¿½28/36 rule.ï¿½ 18.

The debt resolution rule asserts that consumers should be capable of paying off all consumer credit within any 4-year cycle, with the exception of financing a home or education. 19. Remedies for excessive credit use vary with the severity of the problem, as well as the impact on the household finances. To overcome payment problems, consider the following: ï¿½ Develop and implement a budget that brings in more money than is going out. In other words, live on current income, including debt repayment, and pay as much as possible. Pay off the short-term debt with the highest interest rate first. ï¿½ Develop self-control with credit use. In other words, stop charging and building more debt; live on current income. ï¿½ Talk to creditors about restructuring the loan, changing the payment amount, etc. ï¿½ Get help from a credit counselor. ï¿½ Review borrowing sources and costs to determine if there is a cheaper way to borrow money to repay this debt (i.e., refinance) or as a future loan source. ï¿½ Use savings to pay off current debt. This is an emergency measure and ignores the original purpose of savingsï¿½for future goal achievement.

ï¿½ Get a debt consolidation loan to reduce payments and possibly the interest rate. ï¿½ Declare bankruptcy. 20. The primary difference between Chapter 7 and Chapter 13 bankruptcy is the repayment of debt. With Chapter 13, assets are maintained and the majority of debt is repaid over a 3- to 5-year court-supervised period; with Chapter 7 assets are liquidated (with some restrictions) to repay debts and the remainder are discharged. Chapter 7 bankruptcy excludes debts for child support, alimony, student loans, and taxes, which must be repaid. Filer eligibility for each Chapter is contingent on: ï¿½ income less than or greater than the median income in the state; ï¿½ disposable income less than or greater than $100 per month; or ï¿½ sufficient disposable income to repay at least 25 percent of debt owed over 5 years. the home and automobile decision CHAPTER CONTEXT: THE BIG PICTURE This chapter is the last in the four-chapter section titled ï¿½Part 2: Managing Your Money.ï¿½ Other chapters in this section considered financial products and strategies for managing cash and credit within the financial plan.

This chapter introduces the four-step Smart Buying Process and applies it to the purchase of housing and transportation. The home-buying process, including the associated costs and variety of mortgage loans, is a primary focus of this chapter. Significant messages include (1) the importance of assessing personal needs and wants when selecting transportation and housing, and (2) the need to consider these costs in the context of the financial plan. CHAPTER SUMMARY This chapter uses the four-step Smart Buying Process to illustrate planned purchases of automobiles and housing. Comparison-shopping to make a selection that fits personal and financial needs is stressed. Both leasing and financing of automobiles is considered. Different housing options are considered, as are the advantages and disadvantages of owning and renting housing. Costs of housing ownership are reviewed and categorized as initial or one-time costs, recurring costs, and maintenance and operating costs. The chapter concludes by describing the process of selecting a home, negotiating the price and contract, and securing financing. LEARNING OBJECTIVES AND KEY TERMS After reading this chapter, students should be able to accomplish the following objectives and define the associated key terms: 1. Make good buying decisions. 2. Choose a vehicle that suits your needs and budget. a. holdback b. closed-end lease or walk-away lease c.

purchase option 3. Choose housing that meets your needs. a. cooperative or co-op b. homeownerï¿½s fee c. condominium (condo) d. planned unit developments (PUDs) e. down payment f. closing or settlement costs g. points or discount points h. loan origination fee 3. Apartments and other rental housing B. Step 1: Differentiate want from need C. Step 2: Do your homework 1. One-time costs 3. Maintenance and operating costs D. Renting versus buying E. Determining what you can afford 1. Financial history 2. Ability to payï¿½PITI to Monthly Gross Income 3. Ability to payï¿½PITI Plus Other Debt Payments to Monthly Gross Income 4. Appraised home value 5. Calculating your mortgage limit 6. How much should you borrow? 7. Prequalifying F. Financing the purchaseï¿½the mortgage 1. Mortgage features that affect housing costs 2. Sources of mortgages G. Conventional and government-backed mortgages H. Fixed rate mortgages K. Adjustable-rate versus fixed-rate mortgages L.

Mortgage decisions: Term of the loan M. Coming up with the down payment N. Step 3: Make your purchase 1. Real estate agents and other sources of help 2. The contract O. Step 4: Maintain your purchase APPLICABLE PRINCIPLES Principle 12: The Agency Problem in Personal Finance Although real estate agents, mortgage bankers, and mortgage brokers may offer to guide you through the process of home buying, remember to discern advice from sales pitch. Often these professionals are paid a commission; itï¿½s up to you to protect yourself. Principle 9: The Best Protection is Knowledge It is your responsibility to protect yourself my including contingencies in the sales contract, to seek out home inspections and to carefully review estimates of closing costs against the final documents. It also is your responsibility to ascertain the best housing alternative, mortgage loan, and interest rate for your particular situation. If you are rentingï¿½read the lease and know what the contract says. The same applies to buying or leasing a car. Comparison shop, read the contracts, and understand what this commitment means for your financial future. Protecting yourself depends on what you know and how you use that knowledge. Review question answers 1.

The end result of the smart buyer process is buying decisions that are well thought out and well researched. As such the process attempts to control: ï¿½ purchasing, or differentiating need from want and limiting purchasing to needs; ï¿½ product selectionï¿½a needed product, that is the best choice for the price and at a cost that fits your budget; and ï¿½ impulse buying. 2. The four steps of the smart buying process entail: ï¿½ Pre-shopping homework to explore personal needs and wants, to identify product alternatives, and to consider the relationship between your budget and the productï¿½s cost. ï¿½ Making your selection, after detailed comparison-shopping to consider price, product features, quality, and warranty. ï¿½ Making the purchase after negotiating the price and evaluating alternatives for financing. ï¿½ Maintaining the purchase or resolving any product, service or quality complaints with the seller, manufacturer, or government, after the purchase. 3. To make an effective complaint, briefly but clearly include the following five key points: ï¿½ Note the date and place of the purchase or service. ï¿½ Describe the product or service (e.g., serial or product number, warranty information, etc.).

ï¿½ Describe the specific problem with the product or service (e.g., what is the problem?). ï¿½ Explain your attempts, and with whom, to correct the problem, including specific details. ï¿½ Explain what you want done to correct the problem and identify a reasonable date for action, including your next step if the problem is not resolved. Type your letter and include copies, not originals, of any relevant documents describing the product or service and your attempts to resolve the problem. Sending your letter with return receipt requested insures that your complaint was received and the identity of the person who signed for it. If the company does not respond in a reasonable time, take the next step by filing a complaint with the local or state consumer protection office, the Better Business Bureau, or the appropriate state or federal regulatory agency. 4. Some factors that help determine personal preferences in vehicles include: ï¿½ Amount buyer can afford to spend on the vehicle. ï¿½ What the vehicle will be used for. ï¿½ Lifestyle of the owner. ï¿½ How long the vehicle will be kept. ï¿½ The reliability of the vehicle. ï¿½ How many people the vehicle needs to accommodate. ï¿½ The operating costs of the vehicle.

ï¿½ The physical ï¿½fitï¿½ between car and driver. Is the vehicle comfortable? ï¿½ The climate in which the vehicle will be used. 5. The three factors that determine the monthly auto loan payment are: ï¿½ Amount of the loan. ï¿½ Length of the loan. ï¿½ Interest rate on the loan, which will depend on the source of the loan. 6. A holdback is a payment from the manufacturer, typically 2 to 3 percent of the new car retail price, paid to the dealer after the car is sold. Holdbacks increase the dealerï¿½s profit, as do markups. Rebates are typically paid to the customer, while dealer incentives may or may not be shared with the customer. In sum, these issues complicate the auto purchase and pricing. The best defense is knowledgeï¿½of the dealer cost or invoice price on the vehicle as well as the related holdback and any available rebate or incentive. In negotiating the price, use the guideline of paying no more than $100 to $500 over invoice price for a new American-made auto or slightly more for a foreign-made vehicle, after any available rebate.

Remember that this guideline is contingent on the demand for the vehicle and the amount of the holdback. 7. The purpose of an auto lease is to allow the lessee to have a new car every few years without the up-front costs of purchasing. The two types of leases are closed-end and open-end. With a closed-end lease, the lessee is required to return the vehicle in good condition with only normal wear and tear. Under these conditions, no further payment is required and the lessor carries all responsibilities for the vehicle at lease end. In contrast, with an open-end lease, the consumer assumes all responsibility for the vehicle at the end of the lease. At the end of an open-end lease, the value of the vehicle is compared with the estimated end-of-lease value of the auto. If the vehicle is worth less at turn-in than the lease had specified, the lessee must pay the difference. For this reason, open-end leases are not recommended. 8.

A financially stable person, who has good credit but lacks the funds for a down payment, drives less than 15,000 miles annually, takes good care of the vehicle but wants to avoid maintenance and trade-in, and does not mind the idea of never ending vehicle payments is a good candidate for a lease. The six factors that determine monthly lease payment are: ï¿½ Price of vehicle. ï¿½ Up-front fees such as taxes, insurance, or service contracts. ï¿½ Amount of the down payment or trade-in. ï¿½ Vehicle value at the end of the lease. ï¿½ Rent or finance charges. ï¿½ Length of lease. 9. Maintaining your purchase is always important (Step 4 of Smart Buying), but especially so with the investment involved in an autoï¿½new or used.

Consider the following maintenance tips (the five tips listed by the student may vary): ï¿½ Read the ownerï¿½s manual ï¿½ Follow the suggested maintenance instructions ï¿½ Be alert to warning signsï¿½anything that looks (e.g., drips, leaks, smoke), feels (e.g., performance, gas mileage), or sounds different (e.g., engine sounds, squeaks) ï¿½ Be prepared to accurately and completely describe the symptoms ï¿½ Identify a repair facility before you need one by seeking recommendations ï¿½ Check the qualifications and training of the technicians ï¿½ Talk with the repair shop owner or manager if not satisfied with the service to resolve the problem and avoid jumping from shop to shop 10. In a co-op, the residents own shares in the corporation that gives them rights to their living space and reflects the dollar value of their ï¿½space.ï¿½ In contrast, condominium residents actually own their living space and jointly own the land, common areas, and facilities. Both require a monthly maintenance fee. Advantages and disadvantages of both forms of ownership, as listed, are common with two major exceptions.

Co-ops (1) offer less opportunity for capital appreciation than a home or condominium where the owner can improve the unit and (2) co-op shares can be more difficult to sell. Advantages include: ï¿½ Affordability and amenities such as pools, tennis courts, and health centers ï¿½ Low maintenance ï¿½ Lack of privacy ï¿½ Lack of choice about style and decoration 11. A planned unit development (PUD) is a variation on condos and cooperatives, where the individual homeowners not only own their house and the site on which it sits but also own a portion of the entire development. This ownership has a fee to cover common expenses and maintenance. The major difference between PUDs and condos is that condo-owners own the land directly under their home. 12. The major expense categories of home ownership include: ï¿½ Initial costs (e.g., discount points, origination fees, application fees, appraisal fees, title search fees, attorney fees, title insurance, and down payment). ï¿½ Recurring costs (e.g., mortgage payments for principal, interest, property taxes, and homeownerï¿½s insurance).

ï¿½ Maintenance and operating costs (e.g., painting, roof repairs, appliance replacement, and landscaping). 13. The initial costs of home ownership are: ï¿½ Down payment: Up-front equity ï¿½purchasedï¿½ at the time of closing. Depending on the lender, the proportion of the sales price required for down payment ranges from 5 percent to 20 percent or more. Typical down payment is 20 percent for a traditional mortgage. ï¿½ Discount points: These are one-time additional interest payments charged by the lender. Each point is one percent of the mortgage amount. Often these points are used to ï¿½buy downï¿½ the interest on the mortgage. These points are tax deductible. ï¿½ Loan Origination Fee: Normally one percent of the loan amount. This fee is considered payment to the lender for finalizing the loan and is not tax deductible. ï¿½ Loan Application Fee: This fee covers the costs that the lender incurs in processing the loan. ï¿½ Appraisal Fee: Lenders require that the exact value of the home be established before the mortgage is finalized. This fee pays for having the dwelling appraised.

ï¿½ Title Search Fee and Title Insurance: Fee paid to an attorney to verify that the person selling the house actually owns that house. Title insurance may be required in some instances to protect against challenges to the title. ï¿½ Attorney, Notary, and Other Recording and Inspection Fees: These various fees include charges for recording the deed, credit reports, preparing and notarizing the legal paperwork, and various property inspections. 14. The mortgage payment consists of principal (P), interest (I), taxes (T), and insurance (I). Therefore, the payment is given the acronym PITI. 15. The advantages of buying include tax deductions, value appreciation, equity, personal freedom, forced savings, and a potential loan source in built-up equity. The disadvantages include a large up-front monetary commitment, maintenance, property taxes, selling costs, and potential problems with resale. For those who move often, renting is advantageous because of the costs and hassles associated with buying and selling a house. It takes owners a number of years of price appreciation and tax benefits to offset the initial costs of purchasing a home. Renters pay no down payment, no maintenance, and no property taxes. In addition, renting may provide some amenities like pools and fitness facilities.

Renting allows for more financial and lifestyle flexibility. 16. Two primary factors to consider when deciding to buy or rent are timing and taxes. First, you must plan to stay in the home for a minimum of several years to recover initial purchase costs, to benefit from price appreciation, and to repay a significant portion of the mortgage to increase equity. Second, buying offers substantial benefits to those who itemize their taxes, as owners get to take advantage of the points, mortgage interest and real estate tax deductions. Since these costs may exceed the standard deduction for many households, all other itemized deductions are ï¿½icing on the cake.ï¿½ 17. Owning is better than renting over a seven-year period. This is true because over seven years, the up-front costs of the purchase are offset by the price appreciation and the tax advantage of being able to itemize housing-related expenses, such as mortgage interest and real estate taxes. 18. The lending institution specifically looks at three factors when qualifying a prospective homebuyer for a mortgage. ï¿½ Financial history to determine the steadiness of income and credit rating.

ï¿½ Ability to pay to determine qualification ratios comparing (1) PITI to monthly gross income and (2) PITI plus other debt payments to monthly gross income. ï¿½ Appraised value of the home to determine 80 percent of the value, the mortgage loan limit for most lenders. 19. Using IRA accumulations for up to $10,000 of a down payment offers the benefit of no penalties on the withdrawal. Also, the funds had been growing tax-deferred which allows for a little faster accumulation than in a taxable account. However, if the down payment is withdrawn from a Traditional IRA, income taxes will likely be due on the contribution (depending on whether the contribution was originally fully or partially tax deductible) and taxes will be due on the earnings. With a Roth account, the withdrawal is tax-free if the 5-year period has been satisfied. Other disadvantages include the trade off of one goal for another, and once withdrawn from the IRA account, the funds cannot be later replaced and allowed to grow tax-free for retirement. 20. A real estate agent traditionally represents the seller, and it is the seller who pays the agentï¿½s commission.

Because of this potential conflict of interest, the buyer needs to know the difference between advice and sales pitch. An independent buyer/broker, on the other hand, exclusively represents the prospective buyer. These independents are obligated to get the buyer the best possible deal. Buyer/brokers show buyers potential houses that are listed with a firm or that are being sold by the owner. This exclusive relationship tends to promote more objective and critical home buying. All of these factors are advantages for the prospective homebuyer. 21. Before signing a lease or rental agreement, be sure to: ï¿½ Determine if the unit is affordable. What percentage of take-home pay will be needed for housing costs? ï¿½ Review the location for safety and convenience features. ï¿½ Understand the lease and all restrictions (e.g., who is responsible for the utilities). ï¿½ Get any changes in the lease in writing. Do not accept a verbal agreement. ï¿½ Determine the reliability of the landlord for handling complaints and repairs. ï¿½ Purchase renterï¿½s insurance for personal property and liability protection. 22. Provisions to be outlined in a real estate contract include: ï¿½ The buyer, seller, selling price, and method of payment.

ï¿½ The legal description of the property. ï¿½ The date of possession. ï¿½ The provisions for the title search payment. ï¿½ Listing of necessary inspections (e.g., termites, radon) and actions to be taken. ï¿½ That purchase is contingent on suitable funding of specific amount, interest rate, and term. ï¿½ Provisions for the partial year payment for utilities, taxes, insurance. ï¿½ Condition of house at closing, with provisions for a final inspection to insure compliance. ï¿½ Any other agreed-upon contingencies. 23. Mortgage bankers originate mortgage loans and sell them to investors for a fee. Mortgage brokers work as middlemen who place mortgages with investors but do not originate the mortgages. The advantage mortgage brokers offer to prospective homebuyers is that they comparison shop to find the best terms and rate available. 24. Advantages of FHA and VA financing include: ï¿½ Lower down payment. ï¿½ Lower interest rates. ï¿½ More lenient lending requirements. Disadvantages of FHA and VA financing include: ï¿½ Increased paperwork for loan qualification. ï¿½ Higher closing costs (with the exception of the down payment).

ï¿½ Limits on the maximum mortgage funding available. 25. The two factors that determine the rate for an ARM are the interest rate index and the margin of ï¿½Xï¿½ percent of interest that is arbitrarily added to the index rate. In this instance, the ARM rate equals the index rate plus the margin. Annual and lifetime caps are common and limit the maximum percentage points of interest that a rate could increase on an annual basis (e.g., 2.0 percent per year) and over the life of the mortgage (e.g., 6.0 percent). The adjustment interval, ranging from three months to several years, determines how often the rate on the ARM can be adjusted. After a number of adjustment intervals, an ARM rate could fluctuate below or above the initial rate. Consumers are best protected by: ï¿½ An index that is more stable so radical rate shifts do not occur. ï¿½ A longer adjustment interval so mortgage payments are more stable. ï¿½ Smaller periodic and lifetime caps. ï¿½ If applicable, a payment cap in conjunction with a rate cap, not just a payment cap. 26.

Stable indices, or ones that are tied to more stable interest rates that do change often, will not result in radical mortgage rate shifts or corresponding payment changes. 27. Balloon payment mortgages, graduated payment mortgages, and shared appreciation mortgages all offer reduced initial payment; however, all also carry an unknown future impact on the homebuyerï¿½s finances. The balloon payment requires refinancing at some future time when interest rates, financial situation, and market value of the home are unknown. Depending on how the payments were set up, the homeowner may have little equity. These factors increase the risk for the homeowner. A graduated payment mortgage assumes that income will increase so the homebuyer can afford the rising payments. Again, the homebuyerï¿½s financial situation in the future is unknown and at risk to meet the rising payments. With a shared appreciation mortgage, the rate of appreciation is unknown and will affect the homeownerï¿½s future equity. 28. Fixed-rate mortgages offer the benefit of planning and controlï¿½your payments are known and will not change, except for small increases in the taxes and insurance.

Adjustable rate mortgages (ARMs) offer the benefit of interest rates that are initially lower than fixed rate mortgages in exchange for the risk of changing mortgage payments. Lower rates mean you can qualify for a larger mortgage and buy a bigger house. But consider the lifetime cap and the maximum mortgage payment you could face. If the maximum mortgage payment is too high, then the bigger house may not be worth the potential financial strain and uncertainty. The ARM may be a better choice if (1) you do not plan to stay in the house for a long period of time, and therefore would not have to face the higher mortgage payment, or if (2) interest rates are extremely high. 29. The choice of mortgage term is influenced by a number of factors, including interest rates, financial discipline, competing financial goals, financial flexibility, the time value of money, and taxes. The time value of money suggests that the 30-year mortgage is the better option, as the latter payments are made with dollars that are worth less due to inflation. The lower payment also means more dollars may be available for alternative investments as opposed to making the larger payment required for the 15-year term.

Conversely, all of the payment at the end of the 15-year period would be available for investment. Earnings on both scenarios would vary with the assumptions made. Finally, the longer the term, the longer the homeowner can benefit from the tax advantage of itemized deductions. In sum, the lower interest rate associated with the shorter-term mortgage should not be the deciding factor when considering mortgage term. 30. Two rules of thumb guide the decision to refinance. First, are rates at least two percentage points lower than the existing mortgage? Second, does the homeowner expect to live in the house more than two years? If the answers are ï¿½yes,ï¿½ then it is probably cost effective to pay the closing costs necessary to refinance. Regardless of the rules of thumb, the homeowner must determine if the costs of refinancing can be paid back in a reasonable amount of time through savings from the lower interest rate. CHAPTER CONTEXT: THE BIG PICTURE This chapter is the first in a two-chapter section titled ï¿½Part 3: Protecting Yourself With Insurance.ï¿½ An underlying premise of this section is the use of insurance products to provide financial control, a fundamental element of financial planning.

An important message to students is the need to plan insurance purchases that will enable them to control their financial situation and to control the cost of insurance. Fundamental to this is the need to protect financial well-being throughout the financial life cycle with life, health, disability, and long-term care insurance. A secondary message focuses on controlling policy costs through knowledge of the policy features and an awareness of what provisions are important to the individual. Purchasing the right insurance product(s) at the best price will enable students to fit the cost of insurance, and any losses covered by insurance, into their financial plan. CHAPTER SUMMARY Determining the need for and selecting cost-effective life, health, disability, and long-term care insurance products are the objectives of this chapter. The purpose of life insurance and the underlying principles of risk pooling introduce the chapter. Two methods for determining the need for life insurance and the level of coverage illustrate this step in the purchase process. Major types of life insurance and the different product variations are reviewed, as are strategies for selecting the type of policy that best matches individual needs. Common features of most insurance policies are considered. Choosing a cost-effective health care insurance plan requires an understanding of the major types of health insurance coverage and the typical provisions included.

Characteristics of private and public health care providers are considered, as are strategies for controlling health care costs. Fundamental provisions that will adapt the health care policy to individual needs are discussed. Next, the purposes of disability and long-term care insurance, sources of coverage, determination of coverage needs, and policy features are presented. Recommended buying strategies to help students select the company, agent, and policy are considered throughout the chapter. I. The Logic Behind Insurance: Risk Management A. Planning and controlling your financial situation through insurance B. The need for life and health insurance II. Determining Your Life Insurance Needs A. Do you need life insurance? B. How much life insurance do you need? 1. The earnings multiple approach 2. The needs approach III. Major Types of Life Insurance A. Term insurance and its features 1. Renewable term insurance 2. ï¿½Reentryï¿½ term insurance 3. Decreasing term insurance 5. Credit or mortgage group life insurance 6. Convertible term life insurance B. Cash-value insurance and its features 1. Whole life insurance and its features 2. Universal life insurance and its features 3. Variable life insurance and its features C. Term versus cash-value life insurance IV.

Fine-Tuning Your Policy: Contract Clauses and Riders A. Beneficiary provision Principle 10: Protect Yourself Against Major Catastrophes Life insurance protects loved ones when income and household services are unexpectedly lost. Without adequate funds to replace lost income or pay for household services, dreams and goals that were once realistic may now be impossible. Likewise, the continually rising costs of health care, the astronomical charges for some medical procedures (e.g., open heart surgery), and the expense associated with ongoing health care (e.g., AIDS) require you to protect yourself from a major budget catastrophe. Health insurance, disability insurance, and long-term care insurance are tools for protecting your financial future. Principle 3: Diversification Reduces Risk Death is unavoidable. But determining the probability of when it will occur allows insurance companies to pool the risk of large groups of consumers who pay a premium based on that probability. Pooling the risk and the premiums allows everyone to have an annual small loss (i.e., the premium paid) as a means to avoid a catastrophic loss when the death occurs.

Principle 12: The Agency Problemï¿½Beware of the Sales Pitch Confusing life insurance products, a commission-based sales system, the emotional issue of facing your mortality, and the fact that coverage needs are changing over the life cycle makes it hard to differentiate advice from sales pitch. Some salespeople may take advantage of this situation. REVIEW 1. Life insurance, like other types of insurance, is based on the concept of pooled risk, or the idea that diversifying the cost of a loss over large numbers of individuals reduces the risk associated with the loss for any one individual. Clearly this does not reduce the risk of dying or having an auto accident, but by large numbers of individuals pooling their funds, over time, the accumulated ï¿½potï¿½ of money can be paid out to individuals suffering a loss. Actuaries, using statistics and loss characteristics of any group, determine the likelihood of loss for the individual and the corresponding amount, or premium, needed to provide protection. For example, smokers pay more than nonsmokers for life insurance, because of greater likelihood of an early death, while young drivers, who are involved in more accidents, pay more than other drivers.

With increased risk of loss, there is lower likelihood of return for the insurance company, so the insured must pay more but has the potential to receive a greater return (e.g., the young driver will be covered for losses from potentially multiple accidents). 2. Definitions of these insurance terms are as follows: ï¿½ Beneficiary: person designated by the owner of a life insurance policy to receive the policy proceeds upon the death of the insured. ï¿½ Face amount: the amount of insurance provided by a life insurance policy upon the death of the insured. ï¿½ Insured: person whose life is insured by a life insurance policy (i.e., if they die, policy proceeds are paid). ï¿½ Policyholder: the owner of a life insurance policy; policyholders can include individuals (including the insured) or businesses. ï¿½ Policy owner: synonymous with policyholder. A policyholder or policy owner purchases and maintains a life insurance policy on the life of the insured. Upon the insuredï¿½s death, the beneficiary receives the face amount of the life insurance policy. 3. The main purpose of life insurance is to protect an insuredï¿½s dependents in the event of death.

Life insurance provides needed funds for survivors to repay a deceased personï¿½s debts (e.g., home mortgage). It can also provide a stream of income to help replace a deceased breadwinnerï¿½s salary. Life insurance proceeds can also be used to fund specific financial goals (e.g., a childï¿½s college education) if a family earner dies, and it helps to maintain a familyï¿½s standard of living. In summary, life insurance provides peace of mind by reducing the financial consequences experienced when a family member dies. It is not meant to benefit the insured but, rather, those left behind. Life insurance can also provide tax and estate planning advantages, but these are secondary to its major purpose. Types of households that need life insurance might be characterized as: ï¿½ Persons with children who are financial dependents. ï¿½ Single-earner married couples who need insurance for either or both of two purposes: 1) to allow the non-employed spouse to maintain his/her lifestyle until he/she can become self-sufficient and 2) to allow the employed spouse to pay for child care and housekeeping services formerly provided by a homemaker. ï¿½ Business owners with outstanding business-related debts.

ï¿½ Households with large taxable estates (to provide funds to pay estate taxes). Types of households that do not need life insurance might be characterized as: ï¿½ Single persons without a spouse or financial dependents. ï¿½ Dual-income couples without children in cases where a survivorï¿½s lifestyle would not suffer upon his/her spouseï¿½s death. ï¿½ Retired couples with adequate savings, Social Security, and/or pension income to provide for a surviving spouse. ï¿½ Persons of any age with a sufficient nest egg accumulated to support their dependents. ï¿½ The great majority of minor children who do not contribute substantially to household income and who are considered dependents, not family breadwinners. Factors that determine a personï¿½s need for life insurance include: ï¿½ Amount of accumulated financial assets that can be used to support dependents. ï¿½ Number of dependents/stage in family life cycle. ï¿½ Level of financial support provided to others (e.g., total or partial). ï¿½ Risk of contracting a terminal illness or uninsurable condition. 4. The two approaches to life insurance planning are the earnings multiple approach and the needs approach.

The earnings multiple approach is a ï¿½rougherï¿½ estimate than the needs approach. The earnings multiple approach does not take into account the surviving spouseï¿½s income or other accumulated household assets; it only considers income replacement. No allowance is made for funding specific financial goals (e.g., college). The needs approach is more precise because it includes specific expense categories and financial goals and makes allowances for the surviving spouseï¿½s income, existing assets, and other insurance. The earnings multiple approach calculates the need for life insurance based on some multiple (e.g., from 5 to 15 times) of annual gross income to be replaced. Using present value of annuity factors, this method is used to determine the lump sum needed to replace the lost stream of annual income. Key variables in an earnings multiple calculation are the number of years that income replacement is needed and the assumed after-tax and after-inflation rate of return from investing insurance policy proceeds. An adjustment is also made for reduced household living expenses accompanying a breadwinnerï¿½s death. The needs approach calculates specific categories of expenses anticipated by a deceasedï¿½s survivors.

Various anticipated expenses are totaled, including: burial costs, medical expenses, outstanding debts, job training for the surviving spouse, and educational expenses for children. Once needs are estimated, survivorsï¿½ anticipated resources are totaled to determine the income shortfall that needs to be covered by insurance. For example, a surviving spouse may receive income from employment and/or Social Security survivorï¿½s benefits or have some existing life insurance (e.g., a group policy at work) or assets that can be used to provide income. The amount of life insurance needed is determined by subtracting current assets and insurance from the present value of a familyï¿½s insurance need. 5. Six common types of term life insurance include: ï¿½ Renewable term: Term insurance that can be continually renewed, regardless of changes in health status. Each time a policy is renewed, however, premiums increase to reflect the increased risk of mortality with increased age. ï¿½ ï¿½Reentryï¿½ term: Term insurance that can be renewed at either of two premium levels: a lower rate if a policyholder can pass a medical exam and a much higher rate if they cannot.

ï¿½ Decreasing term: Term policy where premiums remain constant, instead of increasing with age, but the face amount of the policy gradually declines. These policies are often sold as ï¿½mortgage insuranceï¿½ because they are used by homeowners as a source of funds to repay a home mortgage. As the mortgage balance declines, so does the face value of the policy. ï¿½ Group term: Term insurance provided to a group of individuals who are associated for a purpose other than buying insurance (e.g., co-workers). ï¿½ Credit or mortgage group life insurance: Group life insurance provided by a lender for its debtors. If a debtor dies while a credit life policy is in effect, the insurance proceeds are used to repay the debt (e.g., car loan). ï¿½ Convertible term: Term insurance that can be converted into a cash-value policy regardless of medical condition. Premiums are often increased accordingly. Most group term policies are convertible to allow departing workers to retain their insurance. 6. The three major categories of cash-value insurance include: ï¿½ Whole life: Type of cash-value insurance that provides a death benefit when an insured dies or reaches the maximum stated age (e.g., 100).

Policy premiums are constant throughout a policyholderï¿½s lifetime, although it is possible to make payments for a limited period or with gradually increasing premiums. In the early years, cash value begins to accumulate because the premium charged exceeds the cost of insurance for a younger person. In later years, the accumulated cash value is used to supplement the level premiums that are now insufficient to purchase the death coverage. Policyholders can borrow against their cash value, if desired. ï¿½ Universal life: Type of cash-value insurance that separates premium payments into three categories: mortality charge (term insurance), cash value, and administrative expenses. This ï¿½unbundlingï¿½ of the three insurance components gives policyholders flexibility to vary their premium payments. For example, payments can be skipped as long as there is sufficient cash value to pay the mortality charge and administrative expenses. Otherwise, a policy would lapse. ï¿½ Variable life: Type of cash-value insurance that provides a menu of investments that are chosen by a policyholder (e.g., stock fund, bond fund). The policyholder selects the investments for the policyï¿½s cash-value portion and assumes all of the investment risk.

This type of policy is suitable for people who are willing to take risks and manage their own investments. High administrative expenses are common for both variable life and universal life type policies. More attractive investment options exist. 7. The differences between term life and cash-value life are: ï¿½ Term life insurance provides coverage for a specific time period or ï¿½term.ï¿½ It is pure life insurance and has no savings component. If an insured dies during the coverage period, his/her beneficiary gets paid the face value of the policy. ï¿½ Cash-value life insurance has two components: life insurance and a savings plan. Part of a cash-value policy premium is used for each purpose. Cash-value policies are, thus, a form of forced savings. Accumulated savings grow on a tax-deferred basis. Policies can remain in effect for decades as long as premiums are paid. Consideration of advantages and disadvantages often focus on cost. Term insurance costs less than cash-value life insurance. Since the sole purpose of term insurance is to provide death benefits to a policyholderï¿½s beneficiary, it is relatively less expensive than cash-value insurance, which also includes a savings component.

This affordability is especially important for breadwinners with young childrenï¿½they need life insurance the most. Term insurance provides the most coverage per premium dollar. In addition, commissions paid to insurance agents on term policies are less than those for cash-value insurance. Cash-value policies offer the convenience of level premiums, while term insurance premiums increase over the life cycle and can become prohibitively expensive with age. Another advantage cited for cash-value insurance is the tax-deferred growth of the cash value. 8. The different features in life insurance policies include: ï¿½ Grace period: An automatic extension for premium payments, generally 30 to 31 days after payments are due. During this period, a policy remains in force and payments can be made without penalty. ï¿½ Incontestability clause: Clause that states that an insurance company cannot dispute the validity of an insurance contract after it has been in place for a specified number of years (usually two). ï¿½ Loan clause: Clause in cash-value policies that allows a policyholder to borrow against their cash value, often at a guaranteed rate. ï¿½ Nonforfeiture clause: Clause that establishes options for a policyholder who chooses to cease premium payments.

The three major nonforfeiture options are: 1) receiving a policyï¿½s cash value, 2) exchanging the cash value for a paid-up whole life policy with a reduced face value, or 3) exchanging the cash value for a paid-up term policy. ï¿½ Reinstatement clause: Clause that allows a policyholder to restore his/her policy within 3 to 5 years after expiration. Most companies require a physical exam and payment of all past-due premiums. ï¿½ Suicide clause: Clause stating that an insurance policy wonï¿½t pay off for suicide deaths that occur within two years of the purchase of the contract. The purpose is to keep financial concerns from motivating suicide. 9. Four different life insurance settlement options include: ï¿½ Lump-sum settlement option: Beneficiary receives policy proceeds in a single lump sum. It allows the beneficiary the freedom to select investment alternatives and to make withdrawals as desired. ï¿½ Interest-only settlement option: Beneficiary leaves the policy proceeds invested with the insurance company for a specified period and receives interest on his/her deposit. Generally, the interest rate paid is tied to market rates with a guaranteed minimum rate.

ï¿½ Installment payment settlement option: The face value of a policy, including principal and interest earned, is distributed to the beneficiary over either a fixed period or in a fixed number of payments. ï¿½ Life annuity settlement option: Beneficiary receives income for life. With a straight life annuity, a beneficiary receives monthly payments for as long as he/she lives. With a life income with period-certain annuity, payments are guaranteed for a stated period (e.g., 10 years) and go to a secondary beneficiary if the primary beneficiary dies within this time period. With a refund annuity, a beneficiary receives income for life and any remaining death benefit is returned to a secondary beneficiary if the primary beneficiary dies. With a joint and survivor annuity, monthly payments continue as long as the two named beneficiariesï¿½generally a husband and wifeï¿½remain alive. The method of annuity payment affects the amount received by beneficiaries. For example, because two life expectancies are involved with a joint and survivor annuity, payments are less than they would be under a straight life annuity. 10. A rider is a special provision added to a life insurance policy to provide extra benefits, generally for additional premium cost.

Common types of riders include: ï¿½ Waiver of premium: Rider that provides for payment of premiums if a policyholder becomes disabled. ï¿½ Multiple indemnity: Rider that increases the death benefit by a specific multiple (e.g., 2 - 3 times) if the insured dies as a result of an accident. ï¿½ Guaranteed insurability: Rider that gives the policyholder the right to increase his/her life insurance protection at specified future times without a medical exam. ï¿½ COLA adjustment (an acronym for cost-of-living adjustment): Rider that annually increases death benefits at the rate of inflation. No medical exam is required for the policyholder. ï¿½ Living benefits: Rider that allows for an early payout of anticipated death benefits for the terminally ill. This rider provides additional income for paying medical bills or other expenses associated with a terminal disease, such as cancer or AIDS. 11. To systematically shop for life insurance, consider the company, the agent, and the policy. To evaluate the companies consider the following: ï¿½ Ratings given to the insurance company by the four major ratings services (e.g., A. M. Best) to evaluate if the company is well managed and financially sound.

ï¿½ Insurance company profitability and expenses, or the efficiency with which the company operates, especially if you are buying a whole life policy where the actual return should exceed the specified minimum return. To evaluate the agents consider the following: ï¿½ Competence, experience and integrity of the insurance agent. ï¿½ Educational credentials and training of the insurance agent (e.g., CLU designation). ï¿½ Recommendations from others. ï¿½ Personal interviews to identify the agent with whom you feel most comfortable. To compare the costs and features of similar policies use the following cost comparisons: ï¿½ Traditional net cost method (TNC)ï¿½calculated by summing premiums over a stated period (e.g., 10 or 20 years) and subtracting dividends paid during this same period and the policyï¿½s cash value at the end of this period. The final result is divided by the number of years in the stated period. In other words, (premiums ï¿½ dividends ï¿½ cash value) / number of years = TNC The formula, while used often, is virtually meaningless because it does not consider the time value of money.

ï¿½ Interest-adjusted net cost method (IANC)ï¿½also known as the ï¿½surrender cost index,ï¿½ this method incorporates time value of money concepts. It is, therefore, considered an improvement over the TNC method. Its accuracy, however, depends on the selection of an appropriate discount rate and accurate estimates of policy dividends and cash value. Finally, when comparing term and cash-value policies, for most consumers term insurance offers the best protection for the cost. The higher cost of cash-value polices may prohibitively limit the amount of insurance purchased. The tax-deferred growth of the cash-value is a benefit, as is the exclusion of the policy proceeds from the calculation of the taxable estate upon death, assuming the policy was not owned by the decedent. However, other tax-deferred investments and estate planning options are available. 12. When shopping for term insurance, the Internet makes comparison shopping very easy. Some services, such as QuoteSmith, offer information on multiple companies. Shopping for cash-value insurance on the Internet is not quite as easy, but low-load polices sold directly to the public eliminate the agentï¿½s commission.

Ameritas Direct and USAA Life Insurance are examples of such low-load providers. The companies will arrange for the required physical exam to be conducted by a professional at your home. Fee-only insurance advisors, available through the Life Insurance Advisors Association, analyze insurance needs but do not provide insurance products. Fees range from $100 to $200 per hour for which the consumer is assured of an expert, unbiased evaluation. 13. Basic health insurance consists of three types of coverage that are generally sold together: hospital insurance for costs associated with a hospital stay, surgical insurance for the costs of surgical procedures, and physiciansï¿½ expense insurance for doctorsï¿½ fees outside of surgery. Often, a maximum dollar amount is specified, such as a limit for a specific type of service or a set reimbursement per day of hospitalization. Major medical insurance is designed to cover medical costs beyond those covered by a basic policy. Its purpose is to offset the expenses of a catastrophic illness. To keep premium costs down, major medical policies generally require consumers to pay out-of-pocket deductibles and co-insurance. 14.

Common health insurance terms include the following: ï¿½ Coinsurance: The percentage of an insurance claim shared with an insurance company after a deductible is paid. Generally, the insured pays 20 percent and the insurance company 80 percent, up to the stop-loss limit. ï¿½ Percentage participation plan: Another term for coinsurance. ï¿½ Deductible: The amount that an insured must pay before an insurance company will pay for a claim. Generally, the higher the deductible, the lower the premium for a given amount of insurance coverage. ï¿½ Co-payment: Payment required of the insured before the insurer will pay any benefits. ï¿½ Lifetime cap: The maximum amount of health care expenses that an insurance company will pay during the lifetime of an insured (e.g., $250,000, $1 million). ï¿½ Stop-loss provision: Health insurance policy feature that limits the total dollar responsibility of the policyholder. Once an insured has paid a specific amount (e.g., $4,000) out-of-pocket, the insurance company takes full responsibility for any additional expenses up to the lifetime cap. 15.

Dental and eye care insurance pay for expenses that are relatively minor and can be planned for in advance without insurance. Dread disease insurance is too limited in its scope of coverage. It only pays health care claims if an insured is struck with a specific disease (e.g., cancer). Accident insurance only pays if medical expenses are incurred as a result of an accident, and is usually limited to a specific benefit for loss of a body part or limb. Instead of spending money on insurance coverage with limitations, consumers should buy comprehensive health coverage. It should provide protection not only against major catastrophes but also be comprehensive enough to cover all medical claims. 16. Differences between a fee-for-service health care plan and managed health care include: ï¿½ Under a fee-for-service health care plan (a.k.a. traditional indemnity), policyholders are billed directly for the cost of medical services and are later reimbursed for all or part of their medical expenses. Another distinguishing feature is greater freedom to choose medical care providers (e.g., doctors, hospitals). Disadvantages include typically higher costs and more paperwork.

ï¿½ Under managed health care, most expenses are already covered (by virtue of being a plan participant) but consumers are limited to receiving health care provided by specific doctors, hospitals, and clinics. Managed health care plans both pay for and provide health care services. Most managed care plans (e.g., HMOs, PPOs) provide participants with a primary care physician who is consulted before obtaining medical services. Typically, costs and paperwork are reduced. 17. Similarities and differences between an HMO and a PPO health plan include: ï¿½ Both are examples of managed care plans, which provide health care at a discount. ï¿½ Both offer comprehensive medical care services, including prescription drug coverage. ï¿½ Both employ a system of co-payments for services beyond the premium paid by the individual, employer, or both. ï¿½ Both limit access to a specific group of health care providers. Getting a referral to a non-HMO doctor, especially one outside of the HMOï¿½s geographic region, can be extremely difficult. With an HMO point-of-service plan, co-payments are higher for non-affiliated doctors.

Similarly, choosing the services of a non-PPO provider carries an additional, or penalty, co-payment. In other words, a PPO is a cross between an HMO (member doctors) and a traditional fee-for-service plan (consumer choice). ï¿½ HMO doctors may work in individual offices or in a central facility, whereas PPO doctors are free-standing practices that have negotiated with the employer or insurer to provide health care to members at a reduced rate. ï¿½ HMOs focus on preventive care and attribute reduced overall costs to this feature. PPOs typically do not. ï¿½ Drawbacks specific to HMOs include quick, cursory service associated with an incentive to see greater numbers of patients and the lack of relationship developed with one specific physician. 18. An HMO subscriber concerned about choice in physicians might be best served by an individual practice association plan, or IPA, made up of independent doctors, who may serve the HMO patients as well as others. A point-of-service plan allows subscribers to see affiliated and non-affiliated doctors; however, co-payments are higher for non-affiliated doctors. A group practice plan HMO limits members to services provided only by the doctors employed at the central HMO facility. 19.

Major differences between group and individual health insurance include: ï¿½ Group health insurance is provided to a specific group of people who are associated for a common purpose other than the purchase of insurance (e.g., association members, co-workers). Most employer group policies do not require policyholders to pass a medical exam. Those offered through professional or trade groups often do. Costs of group health insurance are 15 percent to 40 percent less than individual policies. ï¿½ Individual policy insurance is written for a specific person or family, usually requires a medical exam prior to issuance, and is generally more expensive than group insurance. Important considerations are age, health, geographic location, and deductible amounts. The benefit is a policy specifically designed to your needs; cost is a major disadvantage. 20. Government-sponsored health care plans include the following: ï¿½ Workersï¿½ compensation is a state government program that provides coverage for work-related accidents and illnesses. State laws determine benefit levels and requirements for coverage; exclusions do exist, such as for small business employees. ï¿½ Medicare is a federal government plan that provides limited medical benefits to persons aged 65 and older.

Part A of Medicare pays for hospital costs, while part B covers doctor bills and a broader range of services. Deductibles and co-pays apply. Part A is financed by workersï¿½ Social Security taxes and part B charges participants a monthly premium. Prescriptions are not covered and coverage for skilled nursing home care is limited. ï¿½ Medicaid is a joint federal and state medical assistance program that provides benefits for persons with low incomes and limited assets, specifically the aged, blind, and disabled, as well as needy families with dependent children. Note: Eligible individuals can receive benefits from both Medicare and Medicaid programs. 21. Medicare Part D provides prescription drug coverage, with applicable premiums and co-pays, for seniors. For catastrophic medicine expenses that exceed $5,100 annually, Medicare will pay 95 percent of the cost. Medicare Advantage plans provide comprehensive care, including prescription benefits, and in some cases vision, dental, and preventive services. These services are provided through contracts with private providersï¿½both HMOs and PPOs.

The 10 standardized Medigap plans provide a range of benefits to supplement Medicare Part A and B coverage, as well as benefits for foreign travel emergency, at-home recovery, preventive care, and prescription drugs. After 2006, new Medigap plan enrollees will not be offered prescription drug coverage. In summary, Medicare Part D, Medicare Advantage, and Medigap policies expand the network of health benefits and eligible providers for seniors with Social Security. 22. Designed as a savings plan of pre-tax dollars, medical reimbursement or flexible spending accounts offer the advantage of paying for uncovered (e.g., deductibles) or otherwise unreimbursed (e.g., eyeglasses or dental charges) health care expenses with pre-tax dollars. Disadvantages include the annual ï¿½use it or lose itï¿½ feature of the plan and the annual cap on the maximum deposit allowed. To avoid forfeiting funds, a conservative estimate of 80 percent of anticipated health care expenses is recommended as the amount deducted to fund the account. 23. The combination of a qualified, high-deductible health plan and a Health Savings Account (HSA) offer consumers the benefit of tax free savings.

The funds accumulate for paying health care costs incurred prior to meeting the annual deductible or for health care expenses not covered by the high-deductible health plan. Funds not spent remain in the account for future long-term expenses such as for health expenses after retirement or long-term care expenses. The combination is cost effective because high-deductible plans have lower premiums and annual HSA contributions (limits apply) are an adjustment to income, so the funds are not taxed and they grow tax-deferred, and tax free, if spent according to the HSA rules. 24. Opting out offers the advantage of a cash payment or credits for purchasing other benefits, assuming you have adequate health insurance coverage through a spouse or other source. An obvious disadvantage would be no health insurance coverage or the inability to enroll. However, the Health Insurance Portability and Accountability Act of 1996 made enrollment access available to those who, for whatever reason, lost coverage through another plan and wish to have coverage without waiting until the next enrollment period. These special rights are available to those who initially declined coverage because of coverage under another plan or for those whose situation has changed due to marriage, birth, adoption or placement for adoption of a new dependent.

Consideration should be given to the dollar amount of cash incentives available to opt out of the plan (i.e., are you giving up a lot for a little?). 25. When changing jobs or starting a new job, you may be ineligible for health insurance immediately. If previously employed at a company with 20 employees, you could continue coverage under COBRA benefits. Depending on why you left, coverage, for which you are financially responsible, can extend for 18 to 36 monthsï¿½much longer than the typical ineligibility period for a new employee. This same COBRA benefit may be available to dependents that lose coverage, such as college students who graduate but have a lapse between graduation date and eligibility for employment. An individual health insurance policy from a private provider is another option. Although restrictions may apply, trade groups, alumni, political, and religious organizations may also be a source of health coverage. All of these options will cost you money, but certainly less than the risk of facing a medical situation with no insurance. 26. Health care policy terms include: ï¿½ Guaranteed renewable: Policy provision that allows an insured to renew his/her coverage until a pre-set age, usually 65.

Although individual premiums canï¿½t increase, the insurance company can increase rates for specific groups of policyholders. ï¿½ Noncancelable: Policy provision that protects against having a policy canceled, guarantees that the policy is renewable, and protects against rate increases. Applies to individual insurance policies. ï¿½ Pre-existing condition: Clause that excludes coverage for illnesses and conditions that a policyholder had before obtaining a policy. It is meant to protect insurance companies and discourage people from waiting until they are sick to sign up for health insurance. Because of pre-existing condition clauses, consumers should purchase health insurance while they are healthy or they may not be able to obtain, or benefit from, a policy later. When changing jobs, you would be covered by the guaranteed renewability clause in effect with the group policy of your new employer; you could not be singled out for different coverage. Recall that most employer groups do not require a physical exam prior to coverage. Assuming you have had continuous coverage for two years prior to switching jobs, the new employer cannot impose a new preexisting condition exclusion period. 27. Disability insurance is earning power insurance. It provides income for household expenses if a worker is unable to work due to accident or illness.

Anyone who relies on earnings from a job or self-employment for financial support should purchase a disability insurance policy to protect against the risk of loss of income. This includes single individuals as well as those with dependents. The recommended amount of disability insurance to purchase is the portion of a workerï¿½s income used to maintain his/her standard of living. Insurance company rules also apply. Most insurance companies donï¿½t write policies that pay more than 60 percent to 80 percent of a workerï¿½s after-tax salary. Otherwise, there is a reduced incentive to return to work. 28. Disability insurance terms include the following: ï¿½ Definition of disability: Explanation of when an insured is considered ï¿½disabled.ï¿½ Some policies define disability as the inability to perform the duties of your ï¿½own occupation,ï¿½ while others define disability as the inability to perform the duties of ï¿½any occupation for which you are reasonably suited.ï¿½ ï¿½Own occupationï¿½ policies provide the broadest coverage but are more expensive because there is a greater likelihood of claim payments.

Combination definition policies offer significant cost savings and provide benefits if you cannot perform ï¿½your occupationï¿½ during the first 2 years, when retraining could occur, and revert to a definition of unable to perform ï¿½any occupation for which you are reasonably suitedï¿½ thereafter. ï¿½ Benefit duration: The length of time that policy benefits are paid. Short-term disability (STD) policies generally provide benefits for six months to two years. Long-term disability (LTD) policies provide benefits until a specified age, generally 65 or 70, or for the personï¿½s lifetime. Only LTD policies truly protect against financial catastrophe. ï¿½ Residual (partial) payments: Disability insurance policy payments made to individuals who return to work on a part-time basis. Residual benefits help make up the difference between full-time and part-time earnings. The definition of disability, as set forth by Social Security and private policies, determines the eligibility for benefits. Consequently, understanding the policy definition is very important, as having a policy does not mean that benefits will necessarily be available. 29.

Long-term care insurance pays for nursing home expenses and/or home health care expenses for persons unable to live on their own due to a stroke, chronic disease, or other impairment. Long-term care coverage is generally purchased by those aged 40 or older. The younger the age of the purchaser, the lower the premium. Features that a policyholder should look for in a long-term care policy include: ï¿½ Coverage for cognitive impairments such as Alzheimerï¿½s disease. ï¿½ Type of care coverage that offers flexible benefits for nursing home care, adult day care, hospice care, or home care by licensed or non-licensed caregivers. ï¿½ A benefit period of at least three to six years, as the average length of nursing home stay is under two years. Women tend to have longer stays and should consider a longer benefit period for this reason. ï¿½ Inflation adjustment provisions to increase benefits as the cost of care escalates. ï¿½ Waiver of premium clause that keeps the policy in force while benefits are received. ï¿½ Waiting period that matches an insuredï¿½s ability to cover costs out-of-pocket before insurance payments begin. A twenty-day waiting period is recommended. 30.

The waiting (elimination) period for both disability and long term care insurance represents a deductible, or period of time when benefits are not received and the insured meets the costs. For both types of insurance, the longer the waiting period, the lower the premium cost However, recommended waiting periods for the polices are different. For example, a minimum of 3-month waiting period is recommended for workers to absorb their lost income (e.g., sick days, emergency savings), although a range of 1 to 6 months is typically available. During the long term care waiting period, the insured must absorb the cost of nursing home or other care. The waiting period range is typically 0 to 365 days, but the most common is 20 to 100 days. For both types of insurance, a waiver of premium provision waives premium payments once benefits are received. Although the provision or clause can be expensive, it offers valuable protection that benefits will continue. Long term care policies may offer waiver of both spousesï¿½ premiums when one spouse becomes eligible; however, comparison shopping is very important if this rider is important, due to the variation in price.

Question: What work-related term popularly refers to loan companies which offer short-term unsecured personal loans at high interest rates?
Answer: Payday