The Basics of Retirement Plan Options

Document Sample
The Basics of Retirement Plan Options Powered By Docstoc
					Introduction to Loans
             Why Borrow Money?
• You don’t have the cash on hand
• Don’t want to wait until you save enough
• “Large ticket” items and/or expansion
    – House, car, land, farm, etc.
•   Don’t want to use your money
•   Help improve your cash flow
•   Tax breaks on interest payments
•   Emergencies
•   Convenience
                 Loan Basics
• Down Payment
  – Cash payment needed “up-front”
• Principal
  – Amount of money borrowed
• Annual Percentage Rate (APR)
  – Actual interest cost of the loan
• Term
  – Life of the loan (Years until paid off)
• Points
  – 1 point = 1 percent of the loan amount
  – Up-front interest charge
           Main Considerations
• Down Payment
  – Can you afford it
• Interest Rate
  – Fixed or variable
• Amount Borrowed
  – How much can you repay?
• Payments
  – Amount and timing
• Prepayment Penalty
  – Is there a fee for prepayment? (Rule of 78s )
       General Borrowing Limits
• Debt Payment/Income Ratio
  – Annual Debt Payments divided by Gross Income
• Rules of Thumb
  – PITI/Inc < 28% for housing payments
     • Includes mortgage payment, taxes, insurance
  – DP/Inc < 38% (some say 40%) for total debt
    payments
     • Includes credit cards, car loans, etc.
• Repayment ability, solvency, risk attitude,
  & credit history determine the amount you
  can borrow
            Ag Borrowing Limits
• Depends on the lender’s “underwriting”
  – Certain limits/ranges for various ratios
• Typically examine your
  –   Liquidity & solvency
  –   Profitability & repayment ability
  –   Collateral & Loan/Value ratio
  –   Financial efficiency
  –   Credit history
     Main Types of Loan Payments
• Equal Payment (Amortized)
  – Payment remains constant over life of loan
  – Use PMT function to determine payment
  – Most loans are Equal Payment
• Equal Principal
  – Payment = Principal/Term + Interest
  – Total payment decreases over time
     • Interest charges decrease as you pay off principal
• Others
  – Balloon payment, unscheduled, etc.
                  Car Loans
• Dealer cost is about 85% of sticker price
  – $20,000 sticker price = $17,000 dealer cost
• Trade-in Values
  – What is your vehicle worth (www.kbb.com)
• Extended warranties aren’t worth it
• Include “after-market” items in loan?
• Insurance & maintenance costs
  – Can you make your insurance and car
    payments, and still have enough to maintain the
    car (gas, oil, etc.)
                   Car Loans
• Simple Interest Loans
  – Rather than add-on or discount loans
  – Look at Credit Unions for lowest rates
  – Beware dealer financing - read the fine print!
• Make as big a down payment as possible
  – Lower interest rate, smaller payments
  – Maintain your emergency fund though!
• Prepayment Penalties
  – Can you make double payments?
• Lease vs buy?
            Car Loan Payments
• Don’t fall into “low monthly payment” trap
  – $15,000 loan
     • 3-year, 9% = $477/month Total Int. = $2,172
     • 5-year, 9% = $311/month Total Int. = $3,683
  – Stretch payments over long time period, but
    prepay if you can!
     • Lowers monthly payment required
        – Good during hard times
     • Prepay (without penalty)
        – Lowers total interest cost
        – Pays off loan faster
              Operating Loans

• Used for purchase of operating inputs
  – Seed, feed, fertilizer, feeder calves, etc.
• Usually a 1-year (or less) loan
  – Borrow a set amount
  – Purchase your inputs
  – When product is sold, repay principal & interest
        Operating Line of Credit

• For operating expenses
• Acts like a credit card
  – You are “qualified” for a certain limit
  – You borrow as you need funds, up to the limit
  – You pay back as you can (usually w/i 1 year)
     • May have to make interest-only payments
     • Try to repay all principal when you sell your
       product
             Equipment Loans

• Terms vary – new vs used
• Typically
  – Term of 1-7 years (3-5 years is most common)
  – Fixed interest rate
  – Payments set up to match your cash flow
     • Monthly, semi-annually, etc.
  – Equipment is used as collateral
     • If you don’t pay, lender “repos” your livestock
              Livestock Loans

• Feeder Livestock
  – Operating loan (interest only loans)
  – To be repaid in full when livestock are sold
  – May be variable interest rate (tied to index)
• Breeding Livestock
  – 1-5 year loans
  – Scheduled payments
• Livestock are used as collateral
                  Mortgages

• A mortgage is a loan for real estate
  – Houses, land, farms, buildings, businesses, etc.
  – Property is collateral (security)
     • If you default, the lender takes ownership of
       the property
         – Foreclosure, repossession
  – Typically over a longer time period
     • 10-30 years
             Types of Mortgages
• Fixed Rate Mortgage
  – Interest rate is fixed (constant) for the term of the
    loan
  – Usually 10-30 year terms
• Adjustable Rate Mortgages (ARMS)
  – a.k.a. variable rate mortgages
  – Interest rate varies over time
  – Typically lower beginning interest rate than fixed
    rate mortgages
           Fixed Rate Mortgages
• Provides less risk to borrower than ARMs
  – Avoids fluctuations in interest rate
     • Good if rates increase, bad if they decrease!
  – Avoids fluctuations in monthly payments
• Safer for people in weak financial condition
• Initial interest rates are higher than ARMs
  – More risk for lender (Higher risk, higher return ...)
• Don’t forget about “Points”
  – Impacts the interest you pay up-front
• Lower rates for 10-year vs 30-year loans
      15-year vs 30-year Mortgage

• 15-year Mortgage • 30-year Mortgage
  – $100,000, 7%      – $100,000, 7%
  – $898.83/month     – $665.30/month
  – $61,789 total     – $139,508 total
                        interest
    interest
                      – 30-yr usually have
                        higher interest
                        rates
 Adjustable Rate Mortgages (ARMs)
• Interest rate tied to some index
  – Index plus margin (LIBOR + 1.75%)
• More risk for borrower
  – Monthly payments will vary over term of loan
  – Increasing interest rates means higher payments
• Can your cash flow handle the risk?
• Initial interest rate is typically lower
  – But can increase over time!
               Types of ARMs
• 1-year ARM
  – Interest rate can change every year
• 3-year ARM
  – Interest rate can change every 3 years
• 5/1-year Arm
  – Initial interest rate is fixed for 5 years
  – After 5 years, interest rate can change yearly
              ARM Terminology
• Points
  – Up-front interest cost
• Cap
  – Limit on interest rate increases
  – 2/5 cap: max. 2% increase/yr; 5% increase over term
• Index
  – Basis for variable rates
  – 11th District Cost of Funds, LIBOR, 1-yr Treasury index
• Margin
  – Amount added to index to determine variable rate
• Rate = Index + Margin
             Fixed Rate vs ARM
• Depends on:
  – Interest rates
  – Points
  – How long you plan on carrying the mortgage
     • 5-7 year rule (Low payments vs Points)
     • < 7 years - go with ARM; > 7 years - go with fixed
  – Your cash flow
  – Your ability to handle “shocks” (like higher payments)
  – Amount of down payment required
  – What you expect interest rates to do
     • If rates are low, Fixed are typically better
     • If rates are high (10%), ARMs may be better
         Fixed Rate vs ARM Example
• Fixed Rate                 • ARM
  – $100,000, 7%, 15 years        – $100,000, 5%, 1-yr, 2/6 cap


Year    Int/yr Cum. Int      Int/yr            Cum. Int
 1     $6,968 $6,968             $4,966           $4,966
 2     $6,894 $13,862            $6,858           $11,824
 3     $6,816 $20,678            $8,715           $20,539
 4     $6,731 $27,409            $10,533          $31,072
 5     $6,641 $30,450            $10,405          $41,477

                             ARM figures assume worst case scenario
            Main Considerations
• Down Payment
  – Can you afford it
• Interest Rate & Term (years)
  – Fixed or variable
  – Rapid payoff/higher payments vs slower payoff/lower
    payments
• Amount Borrowed
  – How much can you repay?
• Payments
  – Amount and timing
• Prepayment Penalty
  – Is there a fee for prepayment? (Rule of 78s )
               Al’s Suggestions
• Know your cash flow BEFORE getting a loan
• When in doubt, choose the longer term
  – Prepay as you go if you have the cash flow
• Match your loan payments to your cash flow
• Work WITH your lender
  – Lender is your business partner
• Keep your Debt Payment ratio < 55%
  – This includes mortgage, consumer & ag debt
         Borrowing Suggestions

• Try to have all of your loans with the
  same bank
  – Avoid “split lines of credit”
• Be prepared to meet your lender
  – 2-3 years of financial information
     • Balance Sheet, Income Statement
     • Cash Flow Statement
     • Breakevens, business plan

				
DOCUMENT INFO
Shared By:
Categories:
Tags:
Stats:
views:1
posted:5/18/2012
language:
pages:26
fanzhongqing fanzhongqing http://
About