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Practical Guide to Personal Finance: Housing Loans and Economic Insights

This guide delves into the intricacies of housing loans, demand for mortgage credit, and factors affecting personal income. Learn about market dynamics, wealth accumulation, and investment strategies for future expenses, including buying a house. Explore how interest rates and equity impact financial growth, with practical examples illustrating the benefits and drawbacks of property investments. Gain insight into the importance of savings, net worth calculations, and financial planning tools for achieving economic stability.

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Practical Guide to Personal Finance: Housing Loans and Economic Insights

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  1. Introduction to Economics Elements of Personal Finance

  2. 3. Thursday, Oct. 3, Lecture Three: "Housing loans; demand for mortgage credit; determinants of personal income" Housing loans: interest and equity demand for mortgage credit Determinants of personal income tastes for leisure and income Reading Assignment: O’Sullivan and Sheffrin: Ch.3, “ Markets in the Global Economy” emphasis: comparative advantage and circular flow O’Sullivan and Sheffrin, Appendix to Ch. 7, " Consumer Choice Using Indifference Curves”, pp. 155-162 Internet Resource: http://www.mortgage101.com

  3. Problems O & S Text p. 60: 2, 4, 5, 6 p. 162: 1, 2, 3

  4. Econ 109 Class Page • Econ Home Page:http://www.econ.ucsb.edu

  5. Announcements • E-mail addresses • Llad Phillips <llad@econ.ucsb.edu> • Donghun Cho<cho@econ.ucsb.edu> • Taeil Kang<kang@econ.ucsb.edu> • Kirk Lesh<lesh@econ.ucsb.edu>

  6. Concepts • Lecture: Assets, Liabilities, Net Worth • Lecture: Demand for Housing Loans • Lecture: The Importance of Saving • Lecture: Learning and Earning • Text: Markets, the Magic and the Mantra

  7. Chapter 3 Markets and Governmentin the Global Economy

  8. Markets as a Social Institution • Adam Smith: The Wealth of Nations(1776) • argues for free markets and free exchange • Markets allocate resources so supply meets demand • If markets are competitive, thenthe value that the last consumer entering the market is willing to pay equals the additional cost of producing one more unit of the good • this is the magic of markets: efficiency • The political mantra is that markets solve all problems: false if there is monopoly power

  9. Current Economic Events • Labor Dispute between the shipping association and the longshoremen • lockout • cost to the economy: $1 B per day • What is at stake?

  10. Major Trading Partnersof the United States, 1999

  11. WorldEconomy European Union Japan Mexico Japan US Economy YOU Me

  12. Part I: Wealth (Net Worth) and Debt • Personal Wealth • a million millionaires • ordering the population form the poorest fifth to the richest fifth by income and net worth • the home is the big ticket asset • Liabilities: credit card debt • consumer debt service as a % of personal disposable income (after taxes)

  13. Net Worth in 1995 Source: http://www.irs.gov

  14. Families: Average Income and Average Net Worth, 1995 Source: Consumer Federation of America

  15. Demographics and Per Capita Wealth

  16. A Household’s Home Is By Far the Most Frequent Asset http://www.census.gov/hhes/www/wealth/1995/wealth95.html.

  17. Net Worth = Assets -Liabilities

  18. Assets-Liabilities Statement

  19. http://research.stlouisfed.org/fred/data/business/cmdebt

  20. http://research.stlouisfed.org/fred/data/business/cdsp

  21. Credit Cards Have High Interest Rates On Average: 15-20% You pay 15 % to borrow and you get, currently, 1-2%, to lend

  22. Planning Tools • Assets-Liabilities Statement • Assets Minus Liabilities = Net Worth • measure of wealth • Income-Expenditure Statement • Income Minus Expenditures = Saving • measure of change in wealth

  23. Part II: Housing Loans, Demand

  24. Life Cycle Approach: Planning Education: Investment in Human Capital or Earning Power Accumulating Assets cars appliances furnishings --------------------- house financial assets Spending Age Nurturing High School Education College Work Retirement

  25. Life Cycle Approach: The Planners 100% You 50% Parents 0 % Age Infancy Adolescence Young Adult Adult Senescence

  26. Strategies for Meeting Future Expenses • Buy a House • most valuable asset for most US households • commitment to monthly payment • Tax-Sheltered Savings Plans • commitment to monthly payment • Stocks and Bonds

  27. Positives provides space builds equity interest is deductible Negatives? down payment requires saving for this goal interest payments are front-loaded, equity growth delayed opportunity cost of not investing in stocks Buying a House

  28. 2000

  29. Example for an $80,000 House • price: $80,000 • down payment: $20,000 • loan: $60,000 • interest rate: 10% • loan term: 25 years

  30. calculated using TKSOLVER Level Debt Service Module

  31. Slow Growth In Equity • Interest is front loaded • Start with $20,000 equity in example • After 10 years, gained about $10,000 equity • After 20 years, gained about $35,000 equity • Last 5 years, gain last $25,000 in equity • less interest payments for tax deductions • may not want to refinance, since you are paying off principal

  32. Interest Cost • You may not care so much • if you are experiencing capital gains • i.e. the value of the house is rising

  33. 1999

  34. Demand for Housing Loans • You are more likely to buy a house if the mortgage rate is low • your behavior is sensitive to the national economy • More people will be buying houses and demanding mortgage credit if the mortgage rate is low • More people will be buying houses and demanding mortgages if their income is rising • they can afford a higher monthly payment and a lower loan term

  35. Price, Mortgage Rate Demand for Mortgage Credit 10 % 7 % Quantity of Mortgage Credit

  36. Demand for Mortgage Credit Price, Mortgage Rate Higher Personal Income 10 % Quantity of Mortgage Credit

  37. Expressing The Demand For Mortgage Credit 1. Words Quantity of Mortgage Credit Mortgage Rate, Personal Income 2. Symbols Q = f(r, Y) rule of correspondence: if you know the mortgage rate, r, and if you know personal income, Y, then you can determine the demand for mortgage credit, Q 3. Pictures r Q

  38. Price, Mortgage Rate Demand for Mortgage Credit 10 % 7 % Quantity of Mortgage Credit

  39. The importance of saving • commitment • discipline • personal income • determinants • managing expenses • income-expense statement • budgeting

  40. Part III: Learning and Earning, the Human Capital Story • Stocks • assets • debts • net worth(wealth) • Flows • income • saving (this flow is the increase inyour wealth)

  41. Determinants of Personal Income The Life Cycle Model

  42. An Individual’s Life Cycle for a Socially Productive Life • Learning over the life cycle • Accumulating earning power or human capital • Earnings depend upon • ability • knowledge • work experience

  43. Productive Life Cycle Social Institution Family - PreSchool - School - College - Job - Retirement Function Learning: Accum. Human Capital - Earning - Spending Age Line 0 4 6 18 23 65

  44. Accumulating Human Capital Inflow Outflow Stock

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