Personal Budgeting and Financial Planning

Personal Budget

• Financial goals should be developed and updated annually.
• A spending plan and cash-flow statement should be set up for the upcoming month and every month thereafter.
• Track net worth, and calculate financial ratios each year to assess financial progress.
• Maintain an uncomplicated yet effective personal financial record-keeping system.
• Communicate honestly about money matters a key loved one on a regular basis.
• Assets are possessions with future economic benefit.
• Fair market value is the price a willing buyer would pay a willing seller for an item.
• Monetary/liquid assets/cash equivalents are assets easily converted to cash.
• Tangible/use/lifestyle assets are personal property easily converted to maintain an everyday lifestyle.
• Liabilities represent "the money you owe."

Short-Term Liabilities

• Personal loans owed to other people.
• Credit card and charge account balances.
• Unpaid professional services (doctors, dentists, chiropractors, lawyers).
• Unpaid taxes.
• Past-due rent, utility bills, telephone, Internet, and insurance premiums.

Long-Term Liabilities

• Automobile loans
• Real estate mortgages
• Student loans
• Home equity and second mortgage loans
• Consumer installment loans and leases

Net Worth

• Determined by subtracting liabilities from assets using the formula: Assets - Liabilities = Net Worth, or What I own - What I owe = Net Worth.
• Anne Coulty, a college student from Boise, Idaho, had items of value with a fair market value of $8,000 and she owed $4,500 to others, her net worth, or wealth, is $3,500 ($8,000 - $4,500=$3,500).

Financial Ratios

• Liquidity Ratio (Monetary): Assets divided by monthly expenses; e.g., $12,750/$7,977 = 1.6 ratio or about 1 1/2 months.
• The number of months in which living expenses can be paid if an emergency arises; 3 to 6 months is preferred.
• Asset-to-Debt Ratio: Total assets/total debt; e.g., $393,250/$101,520 = 3.873 or a 3.9 to 1 ratio.
• Provides a broad measure of one's financial liquidity; a high ratio is desirable.
• Debt-to-Income Ratio: Annual debt repayments/gross income; e.g., $20,400/$95,720 = 21.31%.
• Compares amounts spent on debt repayments to gross income; should be 36 or less and should decline as one grows older.
• Debt Payments-to-Disposable Income Ratio: Monthly non-mortgage debt payments/monthly disposable (not gross) income; e.g., $500/$6,102 = 0.082 or 8.2%.
• Funds available for debt repayment are estimated; 14 percent or less is desirable, and 15 percent or more is problematic.

Setting Your Own Debt Limit

• Debt-to-income method: Monthly debt repayments (including mortgages and alimony) are divided by gross monthly income and multiplied by 100.
• Disposable income is the amount of income remaining after taxes and withholding for purposes like insurance and flexible benefits.
• The debt payments-to-disposable income method focuses on monthly debt repayment rather than total debt.
• Three approaches to establishing a debt limit are: the continuous-debt method, the debt-to-income method, and the debt payments-to-disposable income method.

Budgeting

• Budgeting involves logical thinking about finances.
• Budgeting requires consideration of what is important in life, desired possessions, lifestyle, and life goals.
• A budget is a process used to record projected and actual income and expenditures over a period of time.
• Regularly review financial records to manage personal finances effectively and save/make money.

Good Credit Habits

• Check your credit file for free with one of the three credit bureaus, rotating every four months.
• Shop at various lenders for the best credit terms and lowest APR.
• Calculate debt limit using appropriate ratios at least once a year.
• Inspect statements for errors and signs of identity theft.
• Once a loan is paid off, direct those payments toward savings goals.

Use of Credit

• Credit is an arrangement where goods, services, or money is received in exchange for a promise to repay at a future date.
• A loan is consumer credit repaid in equal amounts over a set period.
• Credit cards allow repeated use of credit as long as regular monthly payments are made.
• Interest is the charge for borrowing money, typically expressed as an annual percentage rate (APR).

Credit-Related Terms

• Credit bureau: A firm that collects and keeps records of borrowers' credit histories.
• Prescreened: A credit card offer aimed at consumers based on their borrowing histories, with likely card approval but not necessarily for the indicated interest rate and credit line.
• Invitation-to-apply: A credit card offer without prior screening, requiring the applicant to fill out the application and await approval.
• Preapproved: A credit offer based on a pre-qualification of credit from a credit bureau report, where the issuer obtains detailed credit information and sets an interest rate upon acceptance.
• Credit History: a continuing record of a person's credit usage and repayment of debts
• Credit Score: an indication of a person's credit worthiness or how likely the individual will be able to repay any credit extended in a timely manner.
• FICO Score: Widely known credit scoring system developed by Fair Isaac Corporation, used by 90%+ of companies for lending decisions.
• Credit agreement: This is a contract that stipulates repayment terms for credit cards.
• Promissory note (note): A contract that stipulates repayment terms for a loan.
• Tiered Pricing: lenders offer the lowest interest rates to applicants with the highest credit scores while charging steeper rates to more risky applicants.
• Subprime Borrowers: those with poor credit histories that are required to pay lenders more than others for credit.

FICO Score Factors

• Impacts on a FICO score ranked by importance:
  • Payment history 35%
  • Amounts owed 30%
  • Length of credit history 15%
  • Taking on more debt 10%
  • Types of credit used 10%
• Credit utilization ratio: Percentage of available credit a consumer has used, with a high ratio potentially lowering the credit score.
• Credit-monitoring service: Companies providing access to one's credit report and personal FICO credit information, often on a daily basis.

Credit Advantages and Disadvantages

• People borrow credit for various reasons, including financial emergencies, immediate access to goods, and discounts.
• The greatest disadvantage of using credit is reduced financial flexibility in personal money management.
• A credit freeze helps avoid identity theft.
• Obtaining credit starts with a credit application and credit report.
• The lender decides the the interest rate and application
• Maintaining/improving credit history can be achieved through building a strong credit reputation, which improve FICO scores.
• FICO credit scores are very important.
• Errors in credit reports are possible and can be disputed.