1. © The McGraw-Hill Companies, Inc., 2004. All Rights Reserved. Irwin/McGraw-Hill C HAPTER 5 Banking Services: Savings Plans and Payment Accounts 7e Personal Finance Kapoor Dlabay Hughes 5-1

2. © The McGraw-Hill Companies, Inc., 2004. All Rights Reserved. Irwin/McGraw-Hill A Strategy for Managing Cash Cash, check, credit card or an ATM are the most common payment choices. Common mistakes in managing cash include…  Overspending as a result of impulse buying and using credit cards.  Not having enough liquid assets (cash and checking account) to pay current bills.  Using savings or borrowing to pay for current expenses.  Failing to put unneeded funds in an interest- earning savings account or investment plan for long-term goals. 5-2

3. © The McGraw-Hill Companies, Inc., 2004. All Rights Reserved. Irwin/McGraw-Hill Types of Financial Services Savings.  Time deposits in savings and in certificates of deposit. Payment services.  Checking accounts monies are commonly called demand deposits.  Automatic payments. Borrowing for the short- or long-term. Other financial services.  Insurance, investment, real estate purchases, tax assistance, and financial planning are additional services you may use. 5-3

4. © The McGraw-Hill Companies, Inc., 2004. All Rights Reserved. Irwin/McGraw-Hill Types of Financial Services (continued) Asset management account.  Also called a cash management account.  Offered by brokers and financial institutions.  Provides a complete financial services program for a single fee and includes...  A minimum balance.  A checking account and an ATM card.  A credit card  Online banking.  A line of credit for quick cash loans.  Access to a variety of investments.  www.schwab.com or www.americanexpress.com. 5-4

5. © The McGraw-Hill Companies, Inc., 2004. All Rights Reserved. Irwin/McGraw-Hill Electronic Banking Services Direct deposit of paychecks and other regular income. Automatic payments transfer funds such as for utilities. Remember to deduct them from your register. ATM access to obtain cash, check account balances, and transfer funds - check out the fees. A debit card - takes money out of your account. Lost card liability $50-$500. 5-5

6. © The McGraw-Hill Companies, Inc., 2004. All Rights Reserved. Irwin/McGraw-Hill Opportunity Costs of Financial Services Higher rate of return may be obtained at the cost of lower liquidity. Convenience of a 24-hour ATM should be considered against service fees. The “no fee” checking account that requires a $500 non-interest-bearing minimum balance means lost interest of nearly $400 at 6 percent compounded over 10 years. 5-6

7. © The McGraw-Hill Companies, Inc., 2004. All Rights Reserved. Irwin/McGraw-Hill Changing Interest Rates and Decisions Related to Financial Services The prime rate is what banks charge large corporations. See www.federalreserve.gov.  When interest rates are rising...  Use long-term loans to take advantage of current low rates.  Select short-term savings instruments to take advantage of higher rates when they mature.  When interest rates are falling...  Use short-term loans to take advantage of lower rates when you refinance the loans.  Select long-term savings instruments to “lock in” earnings at current high rates. 5-7

8. © The McGraw-Hill Companies, Inc., 2004. All Rights Reserved. Irwin/McGraw-Hill Types of Financial Institutions Deposit type institutions  Commercial banks are corporations that offer a full range of services including checking, savings, lending and other services.  Savings and loan associations have checking accounts, specialized savings plans, loans and financial planning and investment services.  Mutual savings banks specialize in savings accounts and mortgage loans. They are owned by their depositors, with profits going back to depositors by paying a higher rate on savings.  Credit unions are user-owned, nonprofit and provide comprehensive financial services. 5-8

9. © The McGraw-Hill Companies, Inc., 2004. All Rights Reserved. Irwin/McGraw-Hill Types of Financial Institutions Non-deposit type institutions.  Life insurance companies offer insurance plus savings and investment features, with some offering financial planning and investing services.  Investment companies offer a money market fund on which you can write a limited number of checks.  Finance companies make short and medium term loans to consumers, but at higher rates. (continued) 5-9

10. © The McGraw-Hill Companies, Inc., 2004. All Rights Reserved. Irwin/McGraw-Hill Types of Financial Institutions Non-deposit type institutions (continued).  Mortgage companies provide loans to customers so they can purchase homes.  Pawnshops make loans on possessions but charge higher fees than other financial institutions. Used for quick cash.  Check-cashing outlets charge 1-20% of the face value of a check. 2-3% is average.  Title and payday loan companies - high interest. (continued) 5-10

11. © The McGraw-Hill Companies, Inc., 2004. All Rights Reserved. Irwin/McGraw-Hill Comparing Financial Institutions Basic concerns of a financial services customer.  Where can I get the best return on my savings?  How can I minimize the cost of checking and payment services?  Will I be able to borrow money when I need it? See Appendix 5A on information on Using a Checking Account. 5-11

12. © The McGraw-Hill Companies, Inc., 2004. All Rights Reserved. Irwin/McGraw-Hill Choosing a Financial Institution Consider  Services offered.  Interest rates.  Fees and charges.  Financial advice.  Safety (deposit insurance).  Convenience.  Locations.  Online services.  Special programs. 5-12

13. © The McGraw-Hill Companies, Inc., 2004. All Rights Reserved. Irwin/McGraw-Hill Types of Savings Plans Regular savings accounts. Certificates of deposit. Require you to leave your money on deposit for a set time period, otherwise you incur penalties.  Several types to chose from.  Consider all the earnings and all the costs. Interest earning checking accounts. Money market accounts and funds.  Money market accounts are covered by the FDIC, but money market funds are not. 5-13

14. © The McGraw-Hill Companies, Inc., 2004. All Rights Reserved. Irwin/McGraw-Hill Types of Savings Plans U.S. savings bonds.  Series EE sold at half of face value, with potential tax advantages if used to pay tuition and fees.  Series HH pays interest every six months.  See www.savingsbonds.gov for rates. Advantages  Exempt from state and local income taxes.  You don’t have to pay federal income tax on earnings until you redeem the bonds. (continued) 5-14

15. © The McGraw-Hill Companies, Inc., 2004. All Rights Reserved. Irwin/McGraw-Hill Evaluating Savings Plans Rate of return or yield.  Percentage increase in value due to interest. Compounding.  Interest on previous interest earned. Inflation - compare the rate of return on your savings with the inflation rate. Restrictions and fees. Liquidity. Safety via FDIC and NCUA.  FDIC insures up to $100,000 per person per financial institution (see www.fdic.gov). Tax considerations for interest earned. 5-15

16. © The McGraw-Hill Companies, Inc., 2004. All Rights Reserved. Irwin/McGraw-Hill After Tax Rate of Return (1 - tax rate) x yield on savings (1 -.28) x.06.72 x.06 4.32% This means that a person who is earning 6% on their savings, but has a 28% marginal tax rate, is actually earning 4.32% rate of return after they pay income taxes on the interest. 5-16

17. © The McGraw-Hill Companies, Inc., 2004. All Rights Reserved. Irwin/McGraw-Hill What is “Truth in Savings?” Requires Disclosure of...  Fees on deposit account.  The interest rate.  The annual percentage yield.  Other terms and conditions. Sets formulas for computing the APY. Requires disclosure of fees and APY on customer statements. Establishes rules for advertising accounts. Restricts the method of calculating the balance on which interest is paid. 5-17

18. © The McGraw-Hill Companies, Inc., 2004. All Rights Reserved. Irwin/McGraw-Hill Selecting Payment Methods A major portion of business transactions are conducted by check, making a checking account a necessity for most people. Types of checking accounts include...  Regular.  Usually have a monthly service charge.  Activity account.  Charge a fee for each check written, and sometimes for deposits. 5-18

19. © The McGraw-Hill Companies, Inc., 2004. All Rights Reserved. Irwin/McGraw-Hill Selecting Payment Methods (continued) Types of checking accounts include… (continued)  Interest-earning or NOW accounts which usually require a minimum balance.  Share draft accounts are interest earning checking accounts kept in a credit union. Evaluating checking accounts.  Restrictions, such as a minimum balance.  Fees, which are increasing, and charges.  Interest rate and computation method.  Special services, such as overdraft protection. 5-19

20. © The McGraw-Hill Companies, Inc., 2004. All Rights Reserved. Irwin/McGraw-Hill Other Payment Methods Certified check.  Personal check with guaranteed payment. Cashier’s check.  Check of a financial institution you get by paying the face amount plus a fee. Money order.  Purchase at financial institution, post office, store. Traveler’s check.  Sign each check twice.  Electronic traveler’s checks - prepaid travel card with ability to get local currency at an ATM. 5-20