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1 Objectives




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Presentations text content in 1 Objectives

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Objectives

To define debt and identify the various types of debt and bankruptcy.To differentiate between good debt and bad debt.To analyze the different social and economic consequences of bankruptcy.To identify the sources and consequences of excessive debt.To describe the various strategies to avoid debt and bankruptcy.To analyze debt to income ratios.

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Main Menu

DebtBankruptcyAvoiding Debt

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Debt

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Debt

Is a sum of money due to anotherIs an obligation to deliver particular goods or perform certain acts according to an agreement, such as returning a favorIs a cause of action in a lawsuit for a particular amount owed

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Debt

Can come fromcredit cardsmortgagessecured and unsecured loansborrowing any amount of money

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Secured Loan: legal right to obtain valuable property (e.g., certificate of deposit, car, boat) of the person borrowing, in the event they are unable to repay the loan

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Debt

Revolves around two systems:open-ended creditclose-ended credit

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Creditor: institution who lends an individual or business entity cash to purchase goods

Open-Ended Credit

Is credit for which debtors are given a borrowing limit which may be increased or decreased by the creditor  credit cardsdepartment cardsAccounts for an estimated 36 percent of consumer debt

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Debtor

: an individual or business seeking to borrow credit (cash) from a financial institution

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Closed-Ended Credit

Is credit for which debtors are given a specified amount of credit to purchase specific consumer goods and intangible goods

car loan (consumer good)house (consumer good)franchise startup costs (intangible good)debt consolidation  (intangible good)

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Debt Consolidation

: taking debt from various sources and composing it into one debt to obtain a lower interest rate or payment

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Did you know…

In the United Statesconsumer debt consisted of more than $2.5 trillion at the end of 2011the average household credit card debt is $15,95636 percent of consumer debt is open-ended creditin 2010, 78 percent of U.S. consumers owned a credit card

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Good or Bad Debt?

Good debt includes:student loansreal estate loanshome mortgages business loansBad debt includes:automobile loanscredit cards department store cards

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Tax Liability: the amount of taxes you owe the government

Good Debt

Should be debt which can produce additional wealth in the long runstudent loans  high wage earning jobreal estate  value increases with the passage of timeShould be tax deductiblereduces your tax liability 

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Good Debt Example

You obtain a student loan for $30,0006.8 percent interest raterepay within 10 years making minimum payments of $50total interest paid: $11,428.97 cost of education: $41,428.97

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Good Debt Example

First year salary with an education is $28,000 and without an education is $22,000Over the 10-year term of the loan you earned:$280,000 with a college education (28,000 X 10)$220,000 without education (22,000 X 10)You have earned $60,000 dollars more than a person without a college education (280,000 – 220,000)You profited $18,571.03 from your initial investment of $41,428.97 (60,000 – 41,428.97)

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Bad Debt

Involves purchasing goods with high interest rate cardsCan happen when opening a department card to save 10 to 20 percent on your first purchaseEven includes automobile loans

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Bad Debt Example

You purchase a t-shirt for $20 on your credit cardYou pay 14.99 percent on the purchase since you did not pay the bill in full at the end of the monththe t-shirt cost an additional $2.99 or $22.99 Two months pass byadditional interest is charged and the t-shirt cost is now $26.43the t-shirt shrinks, fades and is no longer popularWas purchasing the t-shirt for “$20.00” worth the cost? 

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Automobile Purchases

Often require an automobile loanaccrues interest  reducing your wealthDepreciates over time you generally cannot sell an automobile for the purchase price or an appreciated valueRequires high maintenance registration inspectionoil changeDo NOT generate future wealth, making an automobile a bad debt choice

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Debt

Assessment

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Assessment

Debt is a sum of money someone owes you.TrueFalseDebt revolves around which of the following?Open-ended creditClose-ended creditBoth open- and close-ended creditNeither open- nor close-ended credit

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Assessment

Open-ended credit accounts for an estimated 75 percent of consumer debt.TrueFalseWhich of the following is an example of open-ended credit?Car loanHouseDepartment cardsDebt consolidation

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Assessment

Good debt reduces your tax liability.TrueFalse

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Bankruptcy

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 Liquidate: sale of assets; exchanging goods for cash

Bankruptcy

Is a legal process for debtors to liquidate their assets and repay their creditor(s)Classified into four types:Chapter 7Chapter 11Chapter 12Chapter 13

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Chapter 7: Ordinary Bankruptcy

Can be filed voluntarily or involuntarilycreditors can involuntarily declare a debtor bankruptif the debtor has 12 or more creditors; three creditors must petition the bankruptcy courtsIs the desire to rebuild a debtor-creditor relationship

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Chapter 11: Reorganization

Involves business organizations onlyRequires a business plan to be developed and approved by creditors and a bankruptcy courtIs the desire to remain in business but reorganize and pay off debts

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Family Farmer: a household receiving one-half oftheir total income from farming

Chapter 12: Family

Farmer Debt Adjustment

Affords family farmers  an opportunity to get out of debt without selling their assetsForces family farmers to develop a plan to repay the debt and run the farmRequires 80 percent of debt to be a result of farm expenses

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Chapter 13: IndividualDebt Adjustment

Is available to individuals onlyForces individuals to develop a plan to repay the debtexempting debtors from paying creditors for up to three years

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Credit Bureau Documents: items which collect information not dating back more than ten years which compose your credit score; includes credit card balances, bankruptcy filings, and credit card payment history

Declaring Bankruptcy

Will be reflected on your credit report for 10 years (Credit Bureau Documents )Becomes a matter of public record (Legal and Government Documents)Results in consequencessocial consequenceseconomic consequences

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Bankruptcy

Can effectreceiving a job offer (economic consequence)obtaining a loan (economic consequence)receiving insurance coverage (economic consequence)standing and reputation in the community (social consequence)your ability to rent an apartment or house (social consequence)

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Bankruptcy Example

You are a landlord You have an applicant who has recently declared bankruptcyYou are aware of the social consequences (e.g., difficulty receiving a job)Would you rent a dwelling unit to this person?

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Filing under Chapter 7

Can cause devastating economic losses Requires you to sell some assets to generate cash to pay creditorsEffects credit score and ability to obtain future loanshigher interest rates on open-ended credit

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Excessive Debt

Increases costs for other consumers (social consequence)Increases tension within the household (social consequence)

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Excessive Debt

Causes problems for the Federal Reserve Board, including inflation, changing interest rates, and other monetary issuesdebt is expressed in a form of monetary denominationdebt increases the “monetary supply,” however the economy is not increasing resulting in an economic imbalancecreates industry bubbles  increase in productiononce debt is under control, deflation occurs resulting in a reduction of consumption (demand)the supply and demand curve changes and disrupts economic equilibrium

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Federal Reserve Board

: a government agency charged with the responsibility to maintain a healthy economy in the United States.

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Types of Bankruptcy                        Economic Social

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Chapter

Qualifying Debtor

Purpose

Consequences

Chapter

7:

Ordinary Bankruptcy

- Everyone

(except

essential services:

banks

,

insurance companies

&

railroads

)

- Voluntary or

involuntary

- Expire old debts and begin a clean slate

- Willing to

lose

assets

-

Lose

assets

- Effects credit record

- Selling of assets makes a public display of your financial situation

Chapter

11:

Reorganization

- Partnerships

- Corporations

- Individuals (DBAs)

- Businesses want to continue operations and reduce debt

- Has a plan of action

- Effects net income

- Effects relationship with creditors

- Effects trust with shareholders

Chapter 12: Family Farmer Debt Adjustment

- Family

farmers

who

receive one half

of their total income from the farm

- Family farmers who need help with

farms

- Willing to adopt a plan of action

- Effects credit record for up to 10 years

- Court appointed officer

oversees finances

Chapter 13: Individual Debt Adjustment

- Individuals only

- Individuals not willing to

lose

assets

- Will adopt a plan of action

- Effects credit record for up to 10 years

- Court appointed officer oversees

finances

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Bankruptcy

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Assessment

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Assessment

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Bankruptcy is classified into how many types?

Ten

Five

Four

Three

Chapter 7: Ordinary Bankruptcy can only be filed involuntarily.

True

False

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Assessment

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Which bankruptcy classification is the desire to rebuild a debtor-creditor relationship?

Chapter

7

Chapter

11

Chapter

12

Chapter

13

Chapter 11: Reorganization involves business organizations only.

True

False

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Assessment

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Declaring bankruptcy is not a matter of public record.

True

False

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Avoiding Debt

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Avoid Debt

Through budgeting your financescalculate income sources (fixed and variable)salary benefits (Social Security, alimony)calculate expenses (fixed and variable)rentutilitiesfood

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Variable Income/Expense: income or expenses changing frequently in a short period of time (dividend income, interest income, utilities)

Fixed Income/Expense: income or expenses not changing for a relatively long period (rent, salary)

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What If…

My expenses exceed my income?cut downdo you need to eat out so much?are you getting the best prices you can?increase income sourcesinvest in stacked certificates of deposit  obtain another jobconsolidate debtconsumer loanhome equity loan

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Stacked Certificates of Deposit

: Investing money with a bank at a high yield interest rate; stacking allows you to generate short- and long-term income

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What If…

My income exceeds my expenses?research investment and savings optionscertificates of deposit401(k)/IRA plansmutual fundsstock market

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Budgets

Assist in planning financial situation throughout the yearIdentify shortages before they happenAct as a control mechanism in regards to the way money is spentAllow you to see the larger picture and assist in reorganizing finances to reduce debt or increase savings

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Get Out of Debt

By paying more than the minimum paymentbecause finance charges are typically higher than minimum payments, paying only the minimum payment causes debt to increaseBy using the rule of thumbrule of thumb: minimum payment + interest charged + additional 2 percent of your balance = monthly payment 

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Paying Minimum Payments

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Card Balance

Minimum PaymentFinance ChargeRemaining Balance2000603202260226065361.602556.602556.6075409.062890.662890.6685462.503268.17

If paying only the minimum payment, the card balance increases by more than 60 percent over four months, even if new purchases are not being added.

In this example, the minimum payment is between 2 and 3 percent of card balance and the interest rate is 16

percent.

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Using Rule of Thumb

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Card Balance

Minimum PaymentFinance ChargeAdditional 2%Remaining Balance200060320401580158045252.8031.601250.601250.6035200.1025.01990.49990.4928158.4819.81784.20

If paying using the rule of thumb, the card balance decreases by more than 60 percent over four months, assuming no new purchases are added.

In this example, the minimum payment is between 2 and 3 percent of card balance and the interest rate is 16

percent.

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Get Out of Debt

By shopping for new credit cardscall your credit card company and ask for an interest rate reductioncompare interest rates and transfer balances to low-interest-rate cards

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Get Out of Debt

By tapping into your savingswhy earn 1-2 percent on interest when you are paying 9-30 percent interest to the credit card industryBy consolidating debtdevelop a relationship with your banksecure a loan paying off all of your debt at a much lower rateBy refinancingcould cost you more in taxesconsult a financial planning professional about refinancing options

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Debt-To-Income Ratio

Determines the amount of income needed to meet the debtor’s total monthly debt obligationsCompares sources of income to fixed monthly obligationsincome: verified by employer (take-home pay)monthly obligations: verified by a credit reportDoes not include daily living expenses

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Debt-to-Income Ratio Example

You want to purchase an additional piece of property you can use for hunting36 percent debt-to-income ratio indicates you can afford this new piece of propertyif you were to go over 40 percent you probably should think about getting a cheaper piece of property or find a way to increase your income

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Debt-to-Income Ratio Example

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Monthly Debt PaymentsMonthly Gross  IncomeNew Real Estate800Your Gross Income3,900Car Loan250Spouse's Gross Income2,200House Payment1200Income on Savings150Total Monthly Debt Payments:2,250Total Monthly Gross Income:6,250Debt-to-Income Ratio2,250/ 6,25036.00 %

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Avoiding Debt

Assessment

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Assessment

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Debt can be avoided through which of the following?

Frivolous spending

Investing in high risk opportunities

Budgeting finances

Employer benefits

Which of the following is NOT a solution if expenses exceed income?

Cut

down

Increase

income sources

Consolidate

debt

Mutual

funds

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Assessment

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A rule of thumb for paying more than the minimum payment is minimum payment + interest charged + additional 2 percent of total balance = monthly payment.

True

False

Consolidating debt allows you to secure a loan paying off all your debt at a higher rate.

True

False

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Assessment

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Debt-to-income ration includes daily living expenses.

True

False

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Assessment

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Assessment

Which of the following defines debt? Sum of money due to anotherInstitution which lends an individual or business entity cash to purchase goodsIndividual or business which seeks to borrow credit from a financial institutionLegal process for debtors to liquidate their assetsOpen-ended credit is credit for which debtors are given a specified amount of credit to purchase specific consumer goods and intangible goods.TrueFalse

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Assessment

Which of the following is NOT a good debt product?Real estate loanStudent loanCar loanBusiness loanBankruptcy is a legal process for debtors to _________ their assets and repay their creditor(s).ImproveLiquidateKeepRefurnish

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Assessment

Chapter 7: Ordinary Bankruptcy must be filed voluntarily.TrueFalseWhich Chapter of Bankruptcy does NOT require a plan of some sort to be developed?Chapter 7 (Ordinary Bankruptcy)Chapter 11 (Reorganization)Chapter 12 (Family Farmer Debt Adjustment)Chapter 13 (Individual Debt Adjustment)

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Assessment

Credit Reporting Agencies can report a declaration of bankruptcy for the remainder of your life.TrueFalse Inflation, Interest Rate Ceilings, Monetary Policy are three issues the Federal Reserve Board encounters as a result of insufficient debt. TrueFalse

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Assessment

You only lose assets for declaring Chapter 7 Bankruptcy (Ordinary Bankruptcy).TrueFalse Which of the following is NOT a way of getting out of debt?Tapping into savingsOpening and closing accountsDebt consolidationRefinancing

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Resources

(n.d.). Retrieved October 6, 2008, from U.S. Census Bureau: http://www.census.gov/(2008). Retrieved October 6, 2008, from Board of Governors of the Federal Reserve System: http://www.federalreserve.gov/Compare Mortgage Rates. (2008). Retrieved October 6, 2008, from Bankrate.com: http://www.bankrate.com/brm/news/debt/debt_manage_2004/gooddebt-baddebt.asp Garner, Bryan (2004) Black’s Law Dictionary. New York, NY: Thompson West. Hempel, George & Simonson, Donald (1999) Bank Management Text and Cases. Hoboken, NJ: John Wiley & Sons, Inc. 

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Acknowledgments

Project Coordinator:Maggie Bigham

Production Manager:Dusty Moore

Executive Producers:Gordon Davis, Ph.D., Jeff Lansdell

Production Coordinator:Aaron Carlson

Graphic Designers:Ann AdamsDaniel Johnson

© MMXIVCEV Multimedia, Ltd.

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Brand Manager:Megan O’Quinn

Technical Writer:

Jessica Odom

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