KEY FORMULAS FOR PERSONAL FINANCE

Calculating Debt to Income Ratio (36% or less is best): Total Monthly Expenses Gross Monthly Income or Total Expenses Gross Income

Which individual is a high risk (borrower)? Expense ratio of 45% Expense ratio of 36% Expense ratio of 20% Solve: If a potential borrower earns $200,000 and has an expense ratio of 50% and discretionary expense of $20,000 what is net income? And would you lend to them?

To solve for no. 4 use formula below Calculating Net Income: Gross Income (Taxes) Disposable Income (Expenses) Discretionary Income (Discretionary Expenses) Net Income

Solution Expense ratio of 45% (high risk) Expense ratio of 36% (moderate risk) Expense ratio of 20% (low risk) Solve: If a potential borrower earns $200,000 and has an expense ratio of 50% and discretionary expenses of $20,000 what is net income? And would you lend to them?

Solution Gross Income $200,000 (Taxes) assume 30% tax rate (60,000) Disposable Income 140,000 (Expenses) 50% (100,000) Discretionary Income 40,000 (Discretionary Expenses) (20,000) Net Income 20,000 Decision to lend would require more information

Which individual is a high risk (borrower)? Expense ratio of 50% Expense ratio of 25% Expense ratio of 10% Solve: If a potential borrower earns $100,000 and has an expense ratio of 50% and discretionary expenses of $20,000 what is net income? And would you lend to them?

Which individual is a high risk (borrower)? Expense ratio of 50%-high risk Expense ratio of 25%-low to moderate Expense ratio of 10%-low Solve: If a potential borrower earns $100,000 and has an expense ratio of 50% and discretionary expenses of $20,000 what is net income? And would you lend to them?

Gross Income $100,000 (Taxes) assume 30% tax rate (30,000) Disposable Income 70,000 (Expenses) 50% (50,000) Discretionary Income 20,000 (Discretionary Expenses) (20,000) Net Income 0 Would very likely not lend to this individual

What else do we need to make a decision?

Calculating Net Worth: Total Assets – Total Liabilities = Net Worth

Also expressed as… A – L = NW

Example Total assets of $500,000 minus total liabilities of $100,000 equals a Net Worth of $400,000. Or using the formula… A – L = NW $500,000 - $100,000 = $400,000

How do you know the true $ value of something? Net worth may not tell the whole story. You may need to subtract assets that have no monetary value (but huge sentimental value or goodwill). In some cases you may reduce the estimate of value => adjusted net worth Example: If someone has a guitar collection which they THINK is worth $100,000 that asset would be eliminated or reduced in value.

Example If total assets of $500,000 minus total liabilities of $100,000 equals a Net Worth of $400,000 but includes a baseball card collection of $200,000 net worth must be adjusted to $200,000 Or using the formula… NW – Overestimate (over valued asset) = Adjusted Net worth $400,000 - $200,000 = $200,000

Solve for adjusted net worth If total assets of $600,000 minus total liabilities of $100,000 equals a Net Worth of $500,000 but includes a Pokemon collection of $150,000…

using the formula… NW – Overestimate (over valued asset) = Adjusted Net worth $500,000 - $150,000 = $350,000

Calculating Leverage (1/1 or less is good): Total Debt (total liabilities) Net Worth or Total Debt (total liabilities) Adjusted Net Worth

Why is this important? If a potential borrower has a net worth of $500,000 and total liabilities of $400,000 what is the leverage?

Solution $400,000 = Leverage is .80 $500,000 Since this is below 1.0 customer a good potential borrower/credit risk.

Solve However, if total assets includes a $200,000 guitar collection what would leverage be?

Solution Solve for adjusted net worth (ANW) Net Worth $500,000 (Goodwill/Overestimate) ($200,000) Adjusted Net Worth $300,000 $400,000 = Leverage is 1.33 $300,000

Calculating Adjusted Net Worth: (Goodwill/Overestimate) Adjusted Net Worth Or Net Worth - (Goodwill/Overestimate) = Adjusted Net Worth

Examples of items that are subtracted from Net Worth… Furniture Household items (appliances) Any kind of a collection (even if certified)

What is the American Dream? Move to America Study Get a job Get married Have two kids; get a dog (maybe a cat) Buy a HOUSE (white picket fence if possible)

What is Fair Market Value (FMV)? For most individuals, if they want to buy a home they get a loan called a MORTGAGE. In order to qualify for that mortgage the LOAN to VALUE (FMV) ratio must be 80% or less. Thus, if you want to buy a house that is worth (FMV) $100,000 the most a bank will lend you is $80,000.

Calculating Loan to Value Ratio (80% or less is excellent): __ Total Loan Amount___ Fair Market Value (FMV) FMV is determined with an appraisal

Solve for loan to value ratio.. Loan amount $100,000, FMV $100,000 Loan amount $100,000, FMV $200,000 Loan amount $100,000, FMV $150,000 Loan amount $100,000, FMV $125,000 Which of the above would you lend to?

Solution… Loan amount $100,000, FMV $100,000-100% Which of the above would you lend to? 2 and 3 May need more info for 1 and 4

Other factors to consider Loan amount Loan purpose Credit rating Type of job “Character”

Would you approve the following loan requests?

Customer 1 Loan request $200,000 Loan purpose buy house Debt to income .30 Net worth $500,000 Net Income $100,000 Leverage 1 Job excellent excellent Credit rating very good Loan to value 80% Bonus…Solve for Total Liabilities

Solution Yes Only concerns based on information given is leverage and credit rating Bonus…$500,000

Customer 2 Loan request $300,000 Loan purpose buy 2nd home Debt to income .20 Net worth $500,000 Net Income $150,000 Leverage 1.2 Job excellent excellent Credit rating Excellent Loan to value 60%

Customer 3 Loan request $800,000 Loan purpose buy RV to see USA Debt to income .30 Net worth $2,500,000 Net Income $150,000 Leverage .75 Job excellent excellent Credit rating very good Loan to value 50%

Customer 4 Loan request $50,000 Loan purpose buy RV to see USA Debt to income .50 Net worth $125,000 Net Income $25,000 Leverage .75 Job excellent excellent Credit rating excellent Loan to value 25%