# Debt and Credit Card Debts

1.A few years ago, Simon Powell purchased a home for $150,000. Today, the home is worth $250,000. His remaining mortgage balance is $100,000. Assuming that Simon can borrow up to 75 percent of the market value, what is the maximum amount he can borrow? (LO 5.2) Present market value of Simon’s home = $250,000. Simon can borrow up to 75 percent of the market value, or $187,500. Simon still owes $100,000 mortgage on his home. Therefore, he can borrow an additional $87,500. 2.Louise McIntyre’s monthly gross income is $3,000. Her employer withholds $700 in federal, state, and local income taxes and $250 in Social Security taxes per month. Louise contributes $100 per month for her IRA. Her monthly credit payments for VISA and MasterCard are $65 and $60, respectively. Her monthly payment on an automobile loan is $375. What is Louise’s debt payments-to-income ratio? Is Louise living within her means? (LO 5.3) Louise’s Gross Income

=

$3,000

Less: Income taxes

=

-700

Less: Social Security Tax

=

-250

Less: IRA contribution

=

-100

Net take-home pay

=

$1,950

Her monthly payments on VISA, MasterCard, and a car loan add up to $500 per month. Louise’s debt payments to income ratio is 500 to 1,950, or 25.6 percent. This ratio exceeds the recommended 20 percent figure. Therefore, Louise is overextended. Her maximum monthly loan and credit card payments should not be over $390. 3. Robert Sampson owns a $175,000 townhouse and still has an unpaid mortgage of $140,000. In addition to his mortgage, he has the following liabilities: Visa

$705

MasterCard

280

Discover card

505

Education loan

2,000

Personal bank loan

300

Auto loan

5,000

Total

$8,790

Robert’s net worth (not including his home) is about $35,000,. This equity is in mutual funds, an automobile, a coin collection, furniture, and other personal property. What is Robert’s debt-to-equity ratio? Has he reached the upper limit of debt obligations? Explain. (LO 5.3) Robert’s total debt (not including mortgage) is $8,790. His net worth (not including his home) is $35,000. Therefore, his debt-to-equity ratio is $8,790 divided by $35,000, or 0.25. Since this ratio is less than 1, Robert has not reached the upper limit of debt obligations. 4. Madeline Rollins is trying to decide whether she can afford a loan she needs in order to go to chiropractic school. Right now Madeline is living at home and works in a shoe store, earning a gross income of $920 per month. Her employer deducts a total of $150 for taxes from her monthly pay. Madeline also pays $105 on several credit card debts each month. The loan she needs for physical therapy school will cost an additional $150 per month. Help Madeline make her decision by calculating her debt payments-to-income ratio with and without the college loan. (Remember the 20 percent rule.) (LO 5.3)

Madeline’s debt payments-to-income ratio with the college loan is 31.85 percent; without the college loan it is 14.07 percent. According to the 20 percent rule, she cannot afford the college loan. However, after Madeline pays off her credit card debts, her debt payments-to-income ratio with the college loan will be 17.5 percent. Therefore, once she pays off her credit cards, she will be able to afford the loan. [ANSWER: 19.48%] 5.Joshua borrowed $500 for one year and paid $25 in interest. The bank charged him an $8 service charge. What is the finance charge on this loan? (LO 5.4) = $33

6.In problem 5, Joshua borrowed $500 on January 1, 2012, and paid it all back at once on December 31, 2012. What was the APR? (LO 5.4) 6.6% APR

7.In problem 5, if Joshua paid the $500 in 12 equal monthly payments, what is the APR? (LO 5.4) = 12.2%

8.Sidney took a $200 cash advance by using checks linked to her credit card account. The bank charges a 2 percent cash advance fee on the amount borrowed and offers no grace period on cash advances. Sidney paid the balance in full when the bill...

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