Author: Tomas Perez

A Safe Dollar Is Worth More Than a Risky Dollar

Posted on by Tomas Perez

One principle of the Time Value Of Money concept is the fact that a safe dollar is worth more than a risky dollar. The recent debt crisis projects that the instruments that are about to be in default now were AAA+ rated some time back, that means they had almost no chance of default.

Hence, the Time Value Of Money formula is important to compare the riskiness adjusted value of different cash flows. For instance, if you had an option to lend out money to A at 5% per annum interest or B at 7% per annum interest, you can compare the relative riskiness of the cash-flows using the TVM formula.

The riskiness is compared using the discount factor, which includes the risk of default, alternative opportunity costs, inflation premium and many more components. However, one must understand that the Time Value of Money formula is not a formula in the mathematical sense of the world. It does not give you direct answers.

In reality, it is a framework. You still have to guess what numbers to put in the formula. Moreover, a slight variation in the inputs creates drastic variation in the output, which makes entering the correct input all the more vital.

The framework suggests that you use the respective discount factors on all streams of cash flows. This will bring them down to their risk adjusted present value. Now, these numbers are comparable with each other and you can choose the number with the highest net present value today. This approach is the best known so far and has always been recommended.…

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How Down Payment Works?

Posted on by Tomas Perez

When you approach a lender for your mortgage, you will initially be asked the amount of money that you are willing to pay as down-payment. The lenders will then tell you if they can lend you money and on what terms, depending on the amount you quote. Down payments are linked with various other factors in your borrowing process. Some of the factors are as follows:

Down Payment and Credit Scores: Usually 0% to 20% of the property cost is considered as down payment. You could also pay more than 20%, but usually people would not do so. They would prefer to keep cash on their hands. After the sub-prime fiasco, you are only likely to get a zero down payment mortgage if you are a veteran or have an excellent credit score.

Down Payment and Interest Rates: The more down payments you offer, the more you have at stake to lose in the event of a foreclosure. This reduces the banks risk. You are offered a better interest rate, if you are paying more money upfront.

Down Payment and Borrowing Capacity: You could buy a bigger house and borrow more by making a bigger down payment.

Down Payment and Insurance: If you are offering less than 20% of the loan value as down payment, then you have to take a private mortgage insurance (PMI). This is supposed to offset the lenders risk in case of default. However, it is added expenditure that you pay month after month.

Hence, if you have the money to make a 20% down payment, the terms become much more favourable…

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Confirming Vs Non Confirming Loans

Posted on by Tomas Perez

Conforming loans are more easily available to an average borrower than non-confirming loans. The terms of conforming loans are also better as it is easier for the lender to make these loans without any risks or costs involved. However, conforming loans are made only to the financially prudent. This should give you even more incentive to be financially prudent.

Sold To A State Agency: Though conforming loans are originated by banks, they are soon sold to state agencies, such as Freddie Mac and Fannie Mae. The bank then uses the cash it has received to fund even more loans. Thus, the bank has very little trouble in making money from these loans and provides the best deals on them.

The state has set some criteria which are as follows:

Good Credit: As a borrower you are required to have good credit. This means that you must not have any delinquent accounts in the past 12 months. This also means that your debt-to-income ratio is less than 38%. This is a ballpark figure and may vary depending on which agency is refinancing the loan.

Money In The Bank: A borrower is also required to have significant savings. This includes having money in the bank for making a big down payment to the tune of 20%. It also includes having enough money to pay the closing charges. Some agencies would also require you to have enough money to pay two months payments in advance.

Stable Job: A borrower is required to have a stable job. This means working two years with the same employer and drawing out a consistent salary.

No wonder these stipulations are difficult to meet. There is a market for non-conforming loans as well. However, it is considerably expensive especially after the 2021 sub-prime mortgage.…

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Prioritizing Your Debt

Posted on by Tomas Perez

All debts are not equal. They are equal in the fact that each one of them is lethal if unmanaged. However, they can harm you in different ways. It is not uncommon to see two people with the exact same debt pay very different amounts in interest over the lifetime of the debt. Hence prioritization is important. It needs careful thinking to figure the best way out. Once you are in the debt trap.

Interest: The first thing to do when you have multiple debts is to ensure that you list them by interest rate. The one with the highest interest rates should be at the top. Next thing to consider is tenure. For instance you could be paying a 17% per annum interest on a credit card purchase. However, if the interest amount is only $200 and you have bigger problems like a $1000 interest on your car loan, then the car loan should be the obvious priority!

Fees: Creditors realize that many customers view interest rates only before they take a loan. Hence to make the interest rate appear lower, they disguise the costs in the form of fees and charges. Ensure that you have a good look at the fees.

Lowest Overall Amount: Lastly, you must pay off one debt at a time. This means paying minimum amount due on all other debts, while you finish the one which has the most interest amount and fees attached to it. This can reduce the total amount paid and time taken by as much as 10%-15%. However, there are numerous permutations and combinations that are possible when you have multiple debts.

Taking the help of a professional might be a good idea.

It is better to find out the best way to pay off your debt. Panicking or blindly making fixed monthly payments may not be the best option.…

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One principle of the Time Value Of Money concept is

Posted on by Tomas Perez

The fact that a safe dollar is worth more than a risky dollar. The recent debt crisis projects that the instruments that are about to be in default now were AAA+ rated some time back, that means they had almost no chance of default.

Hence, the Time Value Of Money formula is important to compare the riskiness adjusted value of different cash flows. For instance, if you had an option to lend out money to A at 5% per annum interest or B at 7% per annum interest, you can compare the relative riskiness of the cash-flows using the TVM formula.

The riskiness is compared using the discount factor, which includes the risk of default, alternative opportunity costs, inflation premium and many more components. However, one must understand that the Time Value of Money formula is not a formula in the mathematical sense of the world. It does not give you direct answers.

In reality, it is a framework. You still have to guess what numbers to put in the formula. Moreover, a slight variation in the inputs creates drastic variation in the output, which makes entering the correct input all the more vital.

The framework suggests that you use the respective discount factors on all streams of cash flows. This will bring them down to their risk adjusted present value. Now, these numbers are comparable with each other and you can choose the number with the highest net present value today. This approach is the best known so far and has always been recommended.…

Read more