Economics Unit 5

Unbanked

No one in the household has a bank or credit union account

*Unbanked Characteristics

• Approximately 6 million U.S. households (4.5% of population) are unbanked

• People are unbanked for reasons including past account issues, fees, and convenience

• About 50% of Americans cannot come up with $2,000 for an emergency expense

*Alternative Financial System

Includes check cashers, pawn shops, and payday/title lenders

• Alternative lenders charge significantly higher rates than mainstream lenders

*Mainstream Financial System

Includes banks and credit unions

• Mainstream lenders charge significantly lower rates than alternative lenders

Payday Loan

The most popular alternative loan option but should be a last resort;

A short-term loan that you repay when you get your next paycheck

*Payday Loan Characteristics

• Military members have special protection with a 36% maximum APR on payday loans

• Typically charge $15 per $100 borrowed (translating to 391% APR)

Check Casher

A business that turns a paper check into immediate cash for a fee

Title Loan

A short-term loan where a borrower uses their vehicle as a guarantee for the debt

Pawn Shop

A business that provides short-term cash loans in exchange for physical personal items

Personal Loan

Can be secured (backed by collateral) or unsecured (signature loans);

Borrowed money used for everyday bills and purchases

Secured Loan

Backed by collateral

Unsecured Loan

(Signature loans) No collateral involved

Installment Loan

Provides a lump sum upfront with fixed monthly payments

Deposit Advance

Are short-term loans repaid when the next electronic deposit is made

• Typically charge $10 per $100 borrowed

Line of Credit

Allows borrowers to draw funds as needed with variable interest rates

• Typically has annual fees of $25-$50

Peer-to-Peer Lending

Connects borrowers and lenders via online platforms

*Credit Cards

Can be both secured and unsecured forms of credit

FAFSA (Free Application for Federal Student Aid)

To determine what types of financial aid you may receive

Federal Direct Loans

Make up the primary form of student financial aid;

Include subsidized, unsubsidized, PLUS, and consolidation loans

Subsidized Loans

Government pays your interest while you’re in school;

has no interest until 6 months after graduation

Unsubsidized Loans

You pay all interest from the day you get the loan

PLUS Loans

Loans for parents or graduate students to cover extra costs

Grace Period

Repayment typically begins within 6 months of completing school

*Repayment Plans

Available include standard, graduated, extended, and income-based

Public Service Loan Forgiveness (PSLF)

Available after 120 payments while working for government or nonprofit

Income-Based Repayment

Sets federal student loan payments based on your income and family size

Investment Payback Period =

Total education costs / increase in annual income

• Small decisions like working during the summer can reduce education payback period

*3 Factors Affecting College Wealth Accumulation:

Rising costs, more debt, and slower income gains

529 Plan

Offers tax-advantaged college savings with tax-free distributions for qualified expenses

Grants and Scholarships

Grants are typically need-based

Scholarships are typically merit-based

Use Asset

Assets that depreciate (decrease in value) over time

• Ex: Automobiles

Depreciation

Decrease in value over time

*Vehicle Purchasing Process Starts With:

Determining transportation needs

• Budget for total cost include payment, gas, insurance, maintenance, and repairs

*Key Variable to Negotiate in Auto Loan:

Is the lowest insurance rate possible

Lease For Automobile

A financial agreement for the right to drive a car for a set period

*Loan Repayment Period

Should be shorter than the expected useful life of the asset

*Present Value of an Annuity Formula

Can determine maximum affordable car price

*Before Purchasing a Vehicle Always Research:

Vehicle reliability and repair histories

*Ownership Options

Include cash purchase, financing (loan), and leasing

!Housing Payments-to-Income Ratio (General Budgeting)

The percentage of your gross monthly income that goes toward paying your monthly housing expenses

• Housing typically consumes 30-50% of monthly income

• Calculation: Monthly Housing Payments / Monthly Gross Income

*HUD (U.S. Department of Housing and Urban Development) Recommends:

Spending no more than 30% of pretax income on rent

*Landlords May Encourage:

Spending up to 50% of gross monthly income on rent

!Total Fixed Payments-to-Income Ratio (General Budgeting)

The percentage of your gross monthly income used to pay your housing costs plus all other monthly debts

• Calculation: (Monthly Housing Payments + Other Monthly Debt Payments) / Monthly Gross Income

Lease For Housing

Legal documents outlining rental terms and protecting both parties

Subletting

Refers to allowing someone not on the lease to live in the rental

Security Deposit

Typically cover potential damage beyond normal wear and tear

*Pet Deposit

Average is approximately $400

Renter’s Insurance

Costs about $150 per year and covers personal property

*Benefits of Renting a Home

Include flexibility, no repair responsibilities, and freedom to move

*Benefits of Buying a Home

Include long-term stability, building equity, and tax advantages

Mortgage

A loan secured by real property (land and improvements)

Foreclosure

Occurs when lender takes possession after missed payments

Short Sale

Allows underwater homeowners to sell for less than mortgage balance

Closing Costs

Include loan origination fees, title insurance, appraisal fees, and prepaid items

Housing Equity

The difference between a home’s value and mortgage balance

Title Insurance

Insurance that protects against financial loss if someone later claims they legally own your property

Good Faith Estimate (GFE)

A document showing your estimated mortgage loan costs, interest rate, and monthly payments

*The Typical Homeowner:

Buys and sells a home every 7 years

*Maintenance Costs

Average about 2% of home value annually

*Multi-Family Housing Options

Include duplexes, condominiums, co-ops, and planned unit developments

!Front-End Mortgage Qualification Ratio (Mortgage Qualification)

The percentage of your gross monthly income that goes toward paying your monthly housing expenses

• FHA recommends spending less than 31% of monthly income on housing expenses

• Calculation: Monthly Housing Payments / Monthly Gross Income

!Back-End Mortgage Qualification Ratio (Mortgage Qualification)

The percentage of your gross monthly income used to pay your housing costs plus all other monthly debts

• Total fixed payments-to-income ratio should be less than 43%

• Conventional mortgages often use a more stringent 36% limit (back-end)

• Calculation: (Monthly Housing Payments + Other Monthly Debt Payments) / Monthly Gross Income

Government Purchases

Government spending on new goods and services

*Federal Expenditures

Include transfer payments, goods/services purchases, and interest payments

*State/Local Spending

Focuses on employees (police, teachers)

*Revenue Characteristics

• Revenue comes primarily from taxes and social insurance contributions

• Individual income taxes are the largest federal revenue source

Public Good

A good (or service) provided for all of society; no one is excluded from use of a public good

Quasi-Public Good

A government-provided public good that could also be offered in a private market/business

Transfer Payments

Money from the government given to individuals for nothing in return

Progressive Tax

Tax percentage increases as income rises (federal income tax)

Proportional Tax

Tax percentage remains constant (flat tax)

Regressive Tax

Tax percentage decreases as income rises (sales tax)

Tax Reform (and Tax Reform Act of 1986)

Changes in tax policies and structures

• Tax Reform Act of 1986: Reduced brackets and maximum rates

Tax Base

The particular thing on which a tax is levied (imposed)

Tax Abatement

A policy of reducing or eliminating a tax that would normally be charged

Fiscal Policy

Changes in taxes/spending to control unemployment or inflation

Discretionary Fiscal Policy

Deliberate changes in taxes/spending to control unemployment or inflation

Automatic Fiscal Policy

Changes in taxes/spending that occur automatically as economic activity changes to control unemployment or inflation

Expansionary Policy

Increase spending, decrease taxes

Contractionary Policy

Decrease spending, increase taxes

*Government Purchase Changes

Have greater impact than equal tax changes

Multiplier Effect

Changes in government spending/taxes create larger economic effects

Balanced Budget

Expenditures equal revenues (slightly expansionary)

Surplus Budget

Revenues exceed expenditures (contractionary)

Deficit Budget

Expenditures exceed revenues (expansionary)

Automatic Stabilizers

Push toward deficit during recession; surplus during growth

*Budget Concerns

Include Social Security trust fund and entitlement programs

Entitlement

Programs set up by the government to pay benefits to people who meet the eligibility requirements of the programs

National Debt

Total accumulated federal borrowing from deficit spending

• Financed through treasury bills, notes, and bonds at public auction

Debt Service (Interest)

An ongoing burden

Crowding Out

Government borrowing can increase interest rates, reducing private borrowing

U.S. Treasury Securities

Given out by the federal government when you lend them money