Financial Planning Test 2

Content from week 5-10

What is consumer credit?

Borrow now, repay later.

Name advantages of credit.

Facilitates purchases when cash is insufficient; provides ~30-day grace period before payment is due; may offer bonuses (rebates, miles, insurance); demonstrates financial stability.

What is the grace period for many credit cards?

About 30 days before payment is due.

What is a bank-issued credit card?

A widely accepted credit card issued by a bank that allows purchases almost anywhere and often includes rewards such as cash back or travel points.

What is a retail (store) credit card?

A store-specific credit card that can only be used within a particular retail chain and usually has higher interest rates.

What is a credit card cash advance?

Allows a credit cardholder to withdraw cash against their credit limit; higher interest rates; no grace period.

Typical interest on credit cards if not paid in full?

~20–25% annually.

What is overdraft protection?

Allows withdrawal beyond account balance; prevents bounced checks; interest/fees apply if overdrawn.

What is a student loan?

A government or private loan designed to help students pay for post-secondary education.

Eligibility for Canada Student Loan Program?

Canadian citizens; permanent residents; financially needy students.

Interest rates for federal and provincial portions?

Federal: 0%; Provincial (Ontario): ~5.45%.

When does repayment start for student loans?

6 months after graduation or dropping below full-time status.

What is the Repayment Assistance Program (RAP)?

Reduces payments based on income.

What is a secured line of credit & examples?

A line of credit backed by collateral such as a home or assets; lower interest rates and higher borrowing limits; e.g., HELOC or business equipment loan.

What is an unsecured line of credit?

A line of credit not backed by collateral; usually higher interest rates and borrowing limits; based on creditworthiness.

What is a HELOC?

A Home Equity Line of Credit secured by a homeowner’s property allowing flexible borrowing against home equity.

What is a payday loan?

Short-term; high-interest loan due on the borrower’s next payday.

What is closed-end (installment) credit?

Fixed amount borrowed with a fixed repayment schedule.

What is open-end (revolving) credit?

Borrow up to a limit with flexible repayment.

Difference in repayment schedules: installment vs demand loans?

Installment: fixed schedule; Demand: flexible/variable, can be called anytime.

What is an installment loan and give examples?

A loan where a fixed amount is borrowed and repaid in scheduled payments over time; examples include personal loans, auto loans, student loans, mortgages.

What is a demand loan and give examples?

A loan where the lender can request repayment at any time with variable payments; examples include personal lines of credit and family loans.

What are the pros and cons of installment loans?

Pros: structured repayment, predictable budgeting, builds credit, generally lower interest; Cons: less flexible in emergencies, missed payments harm credit score.

What are the pros and cons of demand loans?

Pros: flexible access to funds, fast borrowing; Cons: risk of sudden repayment, higher interest.

What is the Canadian credit score range?

300–900.

What score is considered good?

600+ (650+ very good).

Name Canada’s two credit bureaus.

TransUnion and Equifax.

What improves a credit score?

On-time payments and low balances.

What happens if you miss payments?

Credit score decreases.

How does borrowing affect your future credit?

Regular payments improve credit; missed payments harm credit; high debt can limit future borrowing.

What does Credit History mean?

Past borrowing behavior reported by bureaus.

What does Character refer to?

Borrower’s reliability and employment stability.

What does Capacity measure?

Ability to repay debt based on income and ratios.

What is Capital in credit approval?

Net worth (assets minus liabilities).

What is Collateral?

Asset pledged as security.

What is credit utilization?

Percentage of available credit currently used; high utilization can lower credit score.

What is the Gross Debt Service Ratio (GDSR)?

Percentage of gross income used for housing costs (max ~35%).

GDSR formula?

GDSR (%) = (Mortgage Principal + Interest + Taxes + Heat) ÷ Gross Annual Income × 100

What is the Total Debt Service Ratio (TDSR)?

Percentage of gross income used for all debt (max ~40%).

TDSR formula?

TDSR (%) = (PITH + Other Debt Payments) ÷ Gross Annual Income × 100

What do debt-to-income ratios measure?

Percentage of income used to pay debt; helps assess borrowing capacity.

What is Cash Flow?

Cash Flow = Net Income − Expenses.

What is a savings account best for?

Liquidity, safety, earning interest.

How does inflation affect savings?

Reduces purchasing power.

What is a mortgage?

Long-term loan to purchase property; secured by property.

Who is a mortgagor?

The borrower; keeps possession of property; responsible for payments and maintenance.

Who is a mortgagee?

The lender; holds a lien on the property; ensures repayment.

What is Equity?

Property value minus mortgage balance; increases as mortgage is paid or value rises.

What is amortization?

Total time to fully repay a mortgage.

What is a blended mortgage payment?

A payment that includes both principal and interest.

Conventional Mortgage

Down payment ≥20%; usually no mortgage insurance; lower cost.

High-Ratio Mortgage

Down payment

Open Mortgage

Can prepay or repay anytime; slightly higher interest.

Closed Mortgage

Prepayment limited; penalties apply; usually lower interest.

Fixed Rate Mortgage

Interest rate stays constant; predictable payments; lower risk.

Variable Rate Mortgage

Interest rate changes with prime; payments fluctuate; potential savings.

Second Mortgage

Additional loan against same property; first mortgage has priority; higher interest.

HELOC

Flexible line of credit using home equity; second charge; interest-only possible.

Reverse Mortgage

For homeowners 55+; borrow up to ~55% of home value; interest accrues; reduces inheritance.

LTVR formula

LTVR (%) = (Mortgage ÷ Property Value) × 100

80% rule

Lenders usually will not lend more than 80% of a property's value without mortgage insurance.

Maximum LTVR before insurance

80%

Mortgage Payment (BA II Plus)

Set P/Y = 12, C/Y = 2; input PV, N, I/Y, FV = 0; CPT PMT for monthly payment.

How is interest calculated?

On outstanding principal; may allow interest-only payments on secured loans.

New payment when interest rises

Keep PV, N, P/Y, C/Y the same; enter new I/Y; compute PMT.

Construction mortgage

Loan used to finance building a home; secured by property.

Bridge loan

Short-term loan to buy a new home before selling existing one; secured by equity.

Debt consolidation

Combines multiple debts into one loan; usually lower interest; reduces monthly payments.

Daily interest rate formula

Daily Rate = Interest Rate ÷ 365

Bridge loan interest formula

Monthly Interest = Loan Amount × Days × (Interest Rate ÷ 365)

Emergency fund formula

Emergency Fund = Monthly Expenses × Months

Recommended emergency fund

3–6 months of monthly expenses.

Fixed vs Variable mortgage

Fixed: stable payments; Variable: fluctuating payments with potential savings.

Risk of variable mortgage

Payments can increase if interest rates rise.

Why debt consolidation helps

Combines high-interest debts into lower-interest loan; reduces monthly payments.

How do you calculate available equity for consolidation?

Available equity = 80% − current LTVR; $ amount of available equity = available equity % × mortgage balance

How do you calculate a 3-month mortgage prepayment penalty?

Penalty = Mortgage × Interest Rate ÷ (3/12); Only applies when breaking or refinancing a mortgage

How do you calculate the new mortgage after consolidation?

New Mortgage = Old Mortgage + Debt to Consolidate (+ Prepayment Penalty if applicable)

How do you calculate a new mortgage payment?

Use BA II Plus: END mode; p/y = 12; c/y = 2; PV = New Mortgage; N = years × 12; I/Y = interest rate; FV = 0; CPT PMT

How do you compare cash flow before and after consolidation?

Old payments = sum of all current debts; New payment = new mortgage payment; Cash Flow Improvement = Old Payments − New Payment