Applied 40S May 19, 2009

How much are you worth?(Net Worth)

Money Suit by flickr user zoomar

The Dirksons Additional Costs to Purchase Their Home

The Dirksons live in Brandon and bought a house in Portage. They had the home appraised and paid $125.00 to have it done. The bank required a survey, and the cost of the survay was $300.00. the price of the home was $135 000.00, and since their down payment of $20 000.00 was less than 25% of the total price, they had to buy “High Ratio Mortgage Insurance” at a cost of 1.25% of the mortgage. The home insurance premium was $475.00 but they recieved a $150.00 rebate from the policy they had on their home in Brandon. The property taxes for the year had been paid by the previous owner, and so they owed 7 months of the total tax bill of $2 125.00. A dry-walling bill of $650.00 was split equally between themselves and the former owner. The Dirksons bought a used washer and dryer for $920.00. Moving expenses were $320.00 and legal fees that included the land transfer costs were $965.00.

HOMEWORK

The Dirksons live in Brandon and bought a house in Portage. They had the home appraised and paid $125.00 to have it done. The bank required a survey, and the cost of the survay was $300.00. the price of the home was $135 000.00, and since their down payment of $20 000.00 was less than 25% of the total price, they had to buy “High Ratio Mortgage Insurance” at a cost of 1.25% of the mortgage. The home insurance premium was $475.00 but they recieved a $150.00 rebate from the policy they had on their home in Brandon. The property taxes for the year had been paid by the previous owner, and so they owed 7 months of the total tax bill of $2 125.00. A dry-walling bill of $650.00 was split equally between themselves and the former owner.

The Dirksons Additional Costs to Purchase Their Home

The total additional costs are $5 957.08, or approximately $6 000.

If they do not have enough money set aside to cover these expenses, they might be able to add these costs into their mortgage.

Buying vrs. Renting

http://tinyurl.com/4x8exeDo you know your Net Worth?

Assets Liabilities

The Meaning of Net Worth

Equity is the same as net worth. Note that equity and 'total assets' are not the same and "Home Equity" is something different.

Net worth = Assets - Liabilities

Net Worth is the difference between your assets and your liabilities. The term assets refers to the value of everything you own, including any cash or bank deposits, material goods, and investments. A liability is any debt you need to pay.

AssetsWhen completing a Net Worth Statement, it is useful to subdivide the assets into three categories:


1. Liquid Assets: These include cash accounts (i.e., your chequing and savings accounts), T-bills, money market funds -- any money you can get at quickly and without penalty. This is money available in case of emergency, and also in case of investment opportunities.


1. Liquid Assets: These include cash accounts (i.e., your chequing and savings accounts), T-bills, money market funds -- any money you can get at quickly and without penalty. This is money available in case of emergency, and also in case of investment opportunities.2. Semi-Liquid Assets: These include longer-term investments such as stocks, bonds, mutual funds, RRSPs, or real estate. These investments are intended to provide for major future needs such as purchasing a house or retirement.


1. Liquid Assets: These include cash accounts (i.e., your chequing and savings accounts), T-bills, money market funds -- any money you can get at quickly and without penalty. This is money available in case of emergency, and also in case of investment opportunities.2. Semi-Liquid Assets: These include longer-term investments such as stocks, bonds, mutual funds, RRSPs, or real estate. These investments are intended to provide for major future needs such as purchasing a house or retirement.

3. Non-Liquid Assets: These include material goods such as your house, car, computer, and other personal property. These items are intended for your long-term personal use, and are not easily converted to cash.

Liabilities

Liabilities are divided into two types:

Liabilities

1. Short-Term Debts: These are debts that must be paid within the next 12 months. These include credit card debts, consumer loans, and smaller personal debts.


Liabilities

2. Long-Term Debts: These are used for two purposes:

• to pay for investments such as real estate, including your home • to pay for major purchases such as a summer cottage, motor home, or car

1. Short-Term Debts: These are debts that must be paid within the next 12 months. These include credit card debts, consumer loans, and smaller personal debts.


The Meaning of Net Worth

Equity is the same as net worth. Note that equity and 'total assets' are not the same.

Net worth = Assets - Liabilities

Net Worth is the difference between your assets and your liabilities. The term assets refers to the value of everything you own, including any cash or bank deposits, material goods, and investments. A liability is any debt you need to pay.

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Includes Mortgage

Does Not Include Mortgage

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Debt/Equity Ratio =Total Liabilities - Mortgage

Net Worth

The Debt/Equity Ratio

The debt mentioned above includes all short-term and long-term debts except the mortgage on your home. Therefore, the formula for the debt/equity ratio is:

The debt/equity ratio shows how your debts compare with your net worth. A debt/equity ratio of 0.40 would indicate that the value of all the debts is 40% of one's net worth. A person's or family's debt/equity ratio should not exceed 50%.

Debt/Equity Ratio =Total Liabilities - Mortgage

Net Worth

Net Worth Problem

• Her house is valued at $93,000, and she still has a $62,000 mortgage against the house.• She has $4600 in a bank savings account, and she has invested $21 500 in mutual funds.• Her car is valued at $16,000, and she still has a two-year loan for $9600 against it.• She has a life insurance policy with a cash surrender value (near cash) of $5300.• She has RRSPs worth $9450, and owns Canada Savings Bonds valued at $1800.• Her credit card debt is $2554, and she has a $3015 consumer loan (for furniture) payable in the next six months.

Mona would like to do some extensive house renovations, but she decided to calculate her net worth and debt/equity ratio before applying for a loan. The following information was used in her calculations.

Mona's financial situation looks good, because her debt/equity ratio is 0.20, or 20%. How would this change if she made a bank loan for $15,000? Should she apply for the loan?

It is also interesting to note that if Mona were to take the money from her mutual funds instead of making a loan, her debt/equity ratio would rise to about 0.26, or 26%. (This calculation has not been shown.)

Note that the loan would raise Mona's debt/equity ratio to 0.51, or 51%. Maybe she should postpone the renovations and save some money first, or reduce the cost of the renovations.

How to Increase Net Worth

The following three strategies to raise one's net worth are often recommended by financial planners.


1. Get a higher rate of return on your investments. You need to exercise caution here, because investments with higher rates of return are often more risky, and there may be a greater chance of losing money.



2. Reduce your debt. Most consumers can reduce their debts -- especially consumer debts -- by planning and following a budget.




3. Save more on a regular basis. Most financial advisors believe that this is the primary key to building wealth. The advice in Senior 3 Applied Mathematics was to save 10% of your income to 'pay yourself first.' This means save before you spend, not save if you have anything left after spending.

2. Reduce your debt. Most consumers can reduce their debts -- especially consumer debts -- by planning and following a budget.



Dave, age 30 and single, is concerned about his finances. He visits a financial advisor to help him determine whether his finances are in good order. The advisor requires the following information to prepare a Net Worth Statement.

He lives in a $100,000.00 home on which there is an outstanding mortgage of $60,000.00. There is a car loan of $15,000.00 on a car that is valued at $20,000.00. The loan is for three years. Dave has $3000.00 in the bank and a $4000.00 cash surrender value (near cash) on his life insurance policy. He has $10,000.00 in mutual funds and $3000.00 in Canada Savings Bonds. He also has RRSPs totaling $15,000.00. At the present time, Dave has a credit card balance of $4000.00 and a small loan of $2000.00 that must be paid this year.

Prepare a Net Worth Statement for Dave. What is his debt/equity ratio?

Bill is married and has a young family. He wants to borrow money to buy a travel trailer. The loan officer at the bank uses the following information to prepare a net worth statement.

Bill and his family live in an $80,000.00 home on which there is an outstanding mortgage of $52,000.00. He owns a car valued at $20,000.00 and owes $12,000.00 on a loan he took to buy the car. He has $30 000.00 in an RPP (Registered Pension Plan). He also has RRSPs valued at $7000.00. Bill owes a credit card company $6000.00, and he has a personal loan for $2500.00 that must be paid in the next few months. The family has $1500.00 in a chequing account and another $3000.00 in a savings account at the local bank. He owns a boat worth $5000.00.

HOMEWORK

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1. What is the family's present net worth?

5. Suggest some ways the family could increase their net worth and/or decrease their debt/equity ratio.

4. Should Bill buy the travel trailer? Explain.

3. The loan required to buy the travel trailer is $25,000.00. Will the loan increase their debt/equity ratio beyond 0.5?

2. What is their debt/equity ratio?

HOMEWORK

Answers(2)(a) Net worth is $74,000. (b) Debt/equity ratio is 0.28, or 27.7%.

(c) Their assets increase by $25,000, and the liabilities also increase by $25,000. The debt/equity ratio increases to 0.62, or 62%.

(d) Bill should probably postpone buying the travel trailer until he has at least half of the money saved up for it. By doing this, he would keep the debt/equity ratio below 50%. He should not cash in his RRSPs and RPPs to pay for the trailer, because these funds are intended for retirement.

(e) The family could increase their net worth by: • limiting their consumer spending (which would likely decrease the

credit card and short-term loans debts)• increasing their savings (they have a reasonable amount in RRSPs

and RPPs, but very little in bank savings or other semi-liquid assets)• investing their money in accounts that pay more interest or returns

than a bank savings account

The Jamison's MortgageThe Jamison family has decided to buy a house. they will require a $121 000.00 mortgage to help pay for the house.• Bank A offers them a 25 year mortgage at 7.25%. Determine the size of the monthly payment, the total amount paid for the mortgage, and the total amount of interest paid when the mortgage is repaid.• Bank B offers them a 20 year mortgage at 7.25%. Determine the size of the monthly payment, the total amount paid for the mortgage, and the total amount of interest paid when the mortgage is repaid if they repay the mortgage with monthly payments over 20 years.• How much interest do they save by repaying the mortgage in 20 years instead of 25 years?• Bank C offers them a 25 year mortgage at 7.00%. Determine the size of the monthly payment, the total amount paid for the mortgage, and the total amount of interest paid when the mortgage is repaid.

• How much interest do they save by paying the mortgage in 25 years at 7.00% instead of in 25 years at 7.25%. (i.e. how much cheaper is Bank C than bank A?)

HOMEWORK

The Jamison's MortgageThe Jamison family has decided to buy a house. they will require a $121 000.00 mortgage to help pay for the house.

• Bank A offers them a 25 year mortgage at 7.25%. Determine the size of the monthly payment, the total amount paid for the mortgage, and the total amount of interest paid when the mortgage is repaid.

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• Bank B offers them a 20 year mortgage at 7.25%. Determine the size of the monthly payment, the total amount paid for the mortgage, and the total amount of interest paid when the mortgage is repaid if they repay the mortgage with monthly payments over 20 years.

The Jamison's Mortgage• How much interest do they save by repaying the mortgage in 20 years instead of 25 years?

The Jamison's Mortgage

• Bank C offers them a 25 year mortgage at 7.00%. Determine the size of the monthly payment, the total amount paid for the mortgage, and the total amount of interest paid when the mortgage is repaid.


The Jamison's Mortgage• How much interest do they save by paying the mortgage in 25 years at 7.00% instead of in 25 years at 7.25%. (i.e. how much cheaper is Bank C than bank A?)

Applied 40S May 19, 2009

Education

Transcript of Applied 40S May 19, 2009