Saturday, January 6, 2007
Personal Credit Rratings
In countries such as the United States, an individual's Credit history is compiled and maintained by companies called credit bureaus. In the United States, credit worthiness is usually determined through a statistical analysis of the available credit data. A common form of this analysis is a 3-digit credit score provided by independent financial service companies such as the FICO® credit score. (The term, a registered trademark, comes from Fair Isaac Corporation, which pioneered the credit rating concept in the late 1950s.) or by the bureaus themselves. One's credit score, along with their credit report, affects one's ability to borrow money through financial institutions such as banks. In Canada, the most common ratings are the North American Standard Account Ratings, also known as the "R" ratings, which have a range between R0 and R9. R0 refers to a new account; R1 refers to on-time payments; R9 refers to bad-debt. The factors which may influence your credit rating are: ability to pay a loan, interest, amount of credit used, spending money instead of using it for useful purposes e.g. paying back a loan, saving patterns, spending patterns, and many more.
Credit Rating
A credit rating assesses the credit worthiness of an individual, corporation, or even a country. Credit ratings are calculated from financial history and current assets and liabilities. Typically, a credit rating tells a lender or investor the probability of the subject being able to pay back a loan. However, in recent years, credit ratings have also been used to adjust insurance premiums, determine employment eligibility, and establish the amount of a utility or leasing deposit.
A poor credit rating indicates a high risk of defaulting on a loan, and thus leads to high interest rates.
A poor credit rating indicates a high risk of defaulting on a loan, and thus leads to high interest rates.
Open-end Home Equity Loans
This is a revolving credit loan, also referred to as a home equity line of credit (HELOC), where the borrower can choose when and how often to borrow against the equity in the property, with the lender setting an initial limit to the credit line based on criteria similar to those used for closed-end loans. Like the closed-end loan, it may be possible to borrow up to 100% of the value of a home, less any liens. These lines of credit are available up to 30 years, usually at a variable interest rate. The minimum monthly payment can be as low as only the interest that is due.
Typically, the interest rate is based on the Prime rate plus a margin.
Typically, the interest rate is based on the Prime rate plus a margin.
Closed-end Home Equity Loans
The borrower receives a lump sum at the time of the closing and cannot borrow further. The maximum amount of money that can be borrowed is determined by variables including credit history, income, and the appraised value of the collateral, among others. It is common to be able to borrow up to 100% of the appraised value of the home, less any liens, although there are lenders that will go above 100% when doing over-equity loans.
Closed-end home equity loans generally have fixed rates and can be amortized for periods usually up to 15 years. Some home equity loans offer reduced amortization whereby at the end of the term, a balloon payment is due. These larger lump-sum payments can be avoided by paying above the minimum payment or refinancing the loan.
Closed-end home equity loans generally have fixed rates and can be amortized for periods usually up to 15 years. Some home equity loans offer reduced amortization whereby at the end of the term, a balloon payment is due. These larger lump-sum payments can be avoided by paying above the minimum payment or refinancing the loan.
Home Equity Loans
A home equity loan is a type of loan in which the borrower uses the equity in his home as collateral. These loans are sometimes useful for families to help finance major home repairs, medical bills or college educations. A home equity loan creates a lien against the borrower's house.
Home equity loans are most commonly second position liens (second trust deed), although they can be held in first or, less commonly, third position. Most home equity loans require good to excellent credit history, and reasonable loan-to-value and combined loan-to-value ratios. Home equity loans come in two types, closed end and open end.
Both are usually referred to as second mortgages, because they are secured against the value of the property, just like a traditional mortgage. Home equity loans and lines of credit are usually, but not always, for a shorter term than first mortgages. In the United States, it is sometimes possible to deduct home equity loan interest on one's personal income taxes.
Home equity loans are most commonly second position liens (second trust deed), although they can be held in first or, less commonly, third position. Most home equity loans require good to excellent credit history, and reasonable loan-to-value and combined loan-to-value ratios. Home equity loans come in two types, closed end and open end.
Both are usually referred to as second mortgages, because they are secured against the value of the property, just like a traditional mortgage. Home equity loans and lines of credit are usually, but not always, for a shorter term than first mortgages. In the United States, it is sometimes possible to deduct home equity loan interest on one's personal income taxes.
Effects of Debt
Debt allows people and organizations to do things that they otherwise wouldn't be able or allowed to. Commonly, people in industrialised nations use it to purchase houses, cars and many other things too expensive to buy with cash on hand. Companies also use debt in many ways to leverage the investment made in their private equity. This leverage, the proportion of debt to equity, is considered important in determining the riskiness of an investment; the more debt per equity, the riskier.
Debt as a whole is a sign that a society is optimistic, that it believes in its future earnings capacity, arguably that it lacks a strong work ethic (though the money must be repaid), and perhaps that it is postponing the solution to present problems (for example, it may compensate a fall in revenues that is perceived as short term by an increase in debt).
Excesses in debt accumulation have been blamed for exacerbating economic problems. For example, prior to the beginning of the Great Depression debt/GDP ratio was very high. Economic agents were heavily indebted. This excess in debt, equivalent to excessive expectations on future returns, accompanied asset bubbles on the stock markets. When expectations corrected, deflation and credit crunch followed. Deflation effectively made debt more expansive and, as Fisher explained, this reinforced deflation again, because, in order to reduce their debt level, economic agents reduced their consumption and investment. The reduction in demand reduced business activity and caused further unemployment. In a more direct sense, more bankruptcies also occurred due both to increased debt cost caused by deflation and to the reduced demand.
It is possible for some organizations to enter into alternative types of borrowing and repayment arrangements which will not result in bankruptcy. For example, companies can sometimes convert debt that they owe into equity in themselves. In this case, the creditor hopes to regain something equivalent to the debt and interest in the form of dividends and capital gains of the borrower. The "repayments" are therefore proportional to what the borrower earns and so can not in themselves cause bankruptcy. Once debt is converted in this way, it is no longer known as debt.
Debt as a whole is a sign that a society is optimistic, that it believes in its future earnings capacity, arguably that it lacks a strong work ethic (though the money must be repaid), and perhaps that it is postponing the solution to present problems (for example, it may compensate a fall in revenues that is perceived as short term by an increase in debt).
Excesses in debt accumulation have been blamed for exacerbating economic problems. For example, prior to the beginning of the Great Depression debt/GDP ratio was very high. Economic agents were heavily indebted. This excess in debt, equivalent to excessive expectations on future returns, accompanied asset bubbles on the stock markets. When expectations corrected, deflation and credit crunch followed. Deflation effectively made debt more expansive and, as Fisher explained, this reinforced deflation again, because, in order to reduce their debt level, economic agents reduced their consumption and investment. The reduction in demand reduced business activity and caused further unemployment. In a more direct sense, more bankruptcies also occurred due both to increased debt cost caused by deflation and to the reduced demand.
It is possible for some organizations to enter into alternative types of borrowing and repayment arrangements which will not result in bankruptcy. For example, companies can sometimes convert debt that they owe into equity in themselves. In this case, the creditor hopes to regain something equivalent to the debt and interest in the form of dividends and capital gains of the borrower. The "repayments" are therefore proportional to what the borrower earns and so can not in themselves cause bankruptcy. Once debt is converted in this way, it is no longer known as debt.
Risk Free Interest Rate
Lendings to stable financial entities such as large companies or governments are often termed "risk free" or "low risk" and made at a so-called "risk-free interest rate". This is because the debt and interest are highly unlikely to be defaulted. A good example of such risk-free interest is a US Treasury security - it yields the minimum return available in economics, but investors have the comfort of the (almost) certain expectation that the US Treasury will not default on its debt instruments. A risk-free rate is also commonly used in setting floating interest rates, which are usually calculated as the risk-free interest rate plus a bonus to the creditor based on the creditworthiness of the debtor (in other words, the risk of him defaulting and the creditor losing the debt). In reality, no lending is truly risk free, but borrowers at the "risk free" rate are considered the least likely to default.
However, if the real value of a currency changes during the term of the debt, the purchasing power of the money repaid may vary considerably from that which was expected at the commencement of the loan. So from a practical investment point of view, there is still considerable risk attached to "risk free" or "low risk" lendings. The real value of the money may have changed due to inflation, or, in the case of a foreign investment, due to exchange rate fluctuations.
The Bank for International Settlements is an organisation of central banks that sets rules to define how much capital banks have to hold against the loans they give out.
However, if the real value of a currency changes during the term of the debt, the purchasing power of the money repaid may vary considerably from that which was expected at the commencement of the loan. So from a practical investment point of view, there is still considerable risk attached to "risk free" or "low risk" lendings. The real value of the money may have changed due to inflation, or, in the case of a foreign investment, due to exchange rate fluctuations.
The Bank for International Settlements is an organisation of central banks that sets rules to define how much capital banks have to hold against the loans they give out.
Inflation Indexed Debt
Borrowing and repayment arrangements linked to inflation-indexed units of account are possible and are used in some countries. For example, the US government issues two types of inflation-indexed bonds, Treasury Inflation-Protected Securities (TIPS) and I-bonds. These are one of the safest forms of investment available, since the only major source of risk — that of inflation — is eliminated. A number of other governments issue similar bonds, and some did so for many years before the US government.
In countries with consistently high inflation, ordinary borrowings at banks may also be inflation indexed.
In countries with consistently high inflation, ordinary borrowings at banks may also be inflation indexed.
Accounting Debt
In national accounting debts are added according to those who are indebted. Household debt is the debt held by households. "National" or Public debt is the debt held by the various governmental institutions (federal government, states, cities ...). Business debt is the debt held by businesses. Financial debt is the debt held by the financial sector (from one financial institution to another). Total debt is the sum of all those debts, excluding financial debt to prevent double accounting. These various types of debt can be computed in debt/GDP ratios. Those ratios help to assess the speed of variations in the indebtness and the size of the debt due. For example the USA have a high consumer debt and a low public debt, while in European countries the opposite tends to be true.
There are differences in the accounting of debt for private and public agents. If a private agent promises to pay something later, it has a debt, and this debt is enforceable by public agents. If a public body passes a law stating that it'll pay something later (a kind of promise), it keeps the right to change the law later (and not to pay). This is why for instance the money governments promised to pay for retirements does not show up in the public debt assessment, whereas the money private companies promised to pay for retirements do.
Types of Debt
There are numerous types of debt, including basic loans, syndicated loans, bonds, and promissory notes. Debt, especially large sums of debt, can also be secured through a mortgage or other security interest over some of the debtor's property, in which case the creditor will have some rights over that property in the event that the debtor becomes unable to repay the debt and defaults on the loan.
A basic loan is the simplest form of debt. It consists of an agreement to lend a principal sum for a fixed period of time, to be repaid by a certain date. In commercial loans interest, calculated as a percentage of the principal sum per annum, will also have to be paid by that date.
A syndicated loan is a loan that is granted to companies that wish to borrow more money than any single lender is prepared to risk in a single loan, usually many millions of dollars. In such a case, a syndicate of banks can each agree to put forward a portion of the principal sum.
A bond is a debt security issued by certain institutions such as companies and governments. A bond entitles the holder to repayment of the principal sum, plus interest. Bonds are issued to investors in a marketplace when an institution wishes to borrow money. Bonds have a fixed lifetime, usually a number of years; with long-term bonds, lasting over 30 years, being less common. At the end of the bond's life the money should be repaid in full. Interest may be added to the end payment, or can be paid in regular instalments (known as coupons) during the life of the bond. Bonds may be traded in the bond markets, and are widely used as relatively safe investments in comparison to stocks.
A basic loan is the simplest form of debt. It consists of an agreement to lend a principal sum for a fixed period of time, to be repaid by a certain date. In commercial loans interest, calculated as a percentage of the principal sum per annum, will also have to be paid by that date.
A syndicated loan is a loan that is granted to companies that wish to borrow more money than any single lender is prepared to risk in a single loan, usually many millions of dollars. In such a case, a syndicate of banks can each agree to put forward a portion of the principal sum.
A bond is a debt security issued by certain institutions such as companies and governments. A bond entitles the holder to repayment of the principal sum, plus interest. Bonds are issued to investors in a marketplace when an institution wishes to borrow money. Bonds have a fixed lifetime, usually a number of years; with long-term bonds, lasting over 30 years, being less common. At the end of the bond's life the money should be repaid in full. Interest may be added to the end payment, or can be paid in regular instalments (known as coupons) during the life of the bond. Bonds may be traded in the bond markets, and are widely used as relatively safe investments in comparison to stocks.
Debt
Debt is that which is owed; usually referencing assets owed, but the term can cover other obligations. In the case of assets, debt is a means of using future purchasing power in the present before a summation has been earned. Some companies and corporations use debt as a part of their overall corporate finance strategy.
A debt is created when a creditor agrees to loan a sum of assets to a debtor. In modern society, debt is usually granted with expected repayment; in many cases, plus interest. Historically, debt was responsible for the creation of indentured servants.
A debt is created when a creditor agrees to loan a sum of assets to a debtor. In modern society, debt is usually granted with expected repayment; in many cases, plus interest. Historically, debt was responsible for the creation of indentured servants.
Land Contract
Land contract (a.k.a. contract for deed or "installment sale agreement") is a contract between the owner of the real property (called the "vendor" or the "seller") and a person who wants to buy the property (the "vendee", "contract purchaser", "purchaser" or "buyer")for an agreed-upon purchase price. Under a land contract the vendor grants equitable title to the vendee (which consists of virtually all rights to the property other than actual legal title), and the vendee agrees to pay the purchase price to the vendor over time, usually in monthly installments, by a certain date. When the full amount of the purchase price is paid, the vendor is obligated to deliver legal title to the vendee by an actual deed, and upon delivery of the deed, the vendee owns equitable and legal title to the property.
Equitable title, for all intents and purposes, makes the purchaser the "owner" of the property. There are several "land contract friendly" states in the US, while other states make it extremely difficult to sell or purchase real property by means of a land contract.
It is common for the installment payments of the purchase price to be similar to mortgage payments in amount and effect. The amount is often determined according to a mortgage amortization schedule. In effect, each installment payment is partially payment of the purchase price and partially payment of interest on the unpaid purchase price. This is similar to mortgage payments which are part repayment of the principal amount of the mortgage loan and part interest. However, since land contracts can easily be written or modified by any seller or purchaser, you may come across any variety of repayment plans. Interest only, negative amortizations, short balloons, extremely long amortizations just to name a few. It is therefore even more so advisable to read your contracts and consult professionals. Typical land contracts are easy to understand and usually only make up 3-5 pages. It is not uncommon for land contracts to go UNrecorded. For several reasons the vendor or vendee may decide that the contract is not to be recorded in the register of deeds. This does not make the contract invalid, but it does increase exposure to undesirable side effects. Contrary to common belief, a contract is valid with only a vendors' signature, provided it is delivered and accepted by the vendee. Contracts without the vendee's signature, or without being notarized - although not recommended- are therefore still valid and enforceable in court.
Although land contracts can be used for a variety of reasons, their most common use is as a form of short-term seller financing. Usually, but not always, the date on which the full amount of the purchase price is due will be years sooner than when the purchase price would be paid in full according to the amortization schedule. This results in the final payment being a large "balloon" payment. Since the amount of the final payment is so large, the buyer usually obtains a conventional mortgage loan from a bank to make the final payment. Land contracts are sometimes used by buyers who do not qualify for conventional mortgage loans offered by traditional lending institutional, for reasons of poor credit or an insufficient down payment. Land contracts are also used when the seller is anxious to sell and the buyer is not given enough time to arrange for conventional financing. Besides the obvious reasons, land contracts are a favorite amongst many real estate investors because of their ease of use, extreme flexibility, and fast executions.
Equitable title, for all intents and purposes, makes the purchaser the "owner" of the property. There are several "land contract friendly" states in the US, while other states make it extremely difficult to sell or purchase real property by means of a land contract.
It is common for the installment payments of the purchase price to be similar to mortgage payments in amount and effect. The amount is often determined according to a mortgage amortization schedule. In effect, each installment payment is partially payment of the purchase price and partially payment of interest on the unpaid purchase price. This is similar to mortgage payments which are part repayment of the principal amount of the mortgage loan and part interest. However, since land contracts can easily be written or modified by any seller or purchaser, you may come across any variety of repayment plans. Interest only, negative amortizations, short balloons, extremely long amortizations just to name a few. It is therefore even more so advisable to read your contracts and consult professionals. Typical land contracts are easy to understand and usually only make up 3-5 pages. It is not uncommon for land contracts to go UNrecorded. For several reasons the vendor or vendee may decide that the contract is not to be recorded in the register of deeds. This does not make the contract invalid, but it does increase exposure to undesirable side effects. Contrary to common belief, a contract is valid with only a vendors' signature, provided it is delivered and accepted by the vendee. Contracts without the vendee's signature, or without being notarized - although not recommended- are therefore still valid and enforceable in court.
Although land contracts can be used for a variety of reasons, their most common use is as a form of short-term seller financing. Usually, but not always, the date on which the full amount of the purchase price is due will be years sooner than when the purchase price would be paid in full according to the amortization schedule. This results in the final payment being a large "balloon" payment. Since the amount of the final payment is so large, the buyer usually obtains a conventional mortgage loan from a bank to make the final payment. Land contracts are sometimes used by buyers who do not qualify for conventional mortgage loans offered by traditional lending institutional, for reasons of poor credit or an insufficient down payment. Land contracts are also used when the seller is anxious to sell and the buyer is not given enough time to arrange for conventional financing. Besides the obvious reasons, land contracts are a favorite amongst many real estate investors because of their ease of use, extreme flexibility, and fast executions.
Assumed Mortgage
In real estate an assumed mortgage occurs when a the buyer of a real property is transferred all the obligations of the seller's mortgage.
The buyer assumes all the obligations under the mortgage, just as if the loan had been made to the buyer. The major driving force behind assumptions is the lower interest rate on the assumed mortgage relative to current market rates. This method is frequently used when the buyer can not get a better interest rate then the seller currently has.
The buyer assumes all the obligations under the mortgage, just as if the loan had been made to the buyer. The major driving force behind assumptions is the lower interest rate on the assumed mortgage relative to current market rates. This method is frequently used when the buyer can not get a better interest rate then the seller currently has.
Interest
Interest is the "rent" paid to borrow money. The lender receives a compensation for foregoing other uses of their funds, including (for example) deferring their own consumption. The original amount lent is called the "principal," and the percentage of the principal which is paid/payable over a period of time is the "interest rate."
Mortgage Loan
Mortgage loan is the generic term for a loan secured by a mortgage on real property; the "mortgage" refers to the legal security, but the terms are often used interchangeably to refer to the mortgage loan. Mortgage loans generally refer to a loan secured by residential property, often for the purpose of acquiring the residence. Mortgage loans may be lower priced than other forms of borrowing because the value of the property reduces risk for the lender.
Mortgage lending is the primary mechanism used in many countries to finance private ownership of residential property. For commercial mortgages see the separate article. Although the terminology and precise forms will differ from country to country, the basic components tend to be similar:
Property: the physical residence being financed. The exact form of ownership will vary from country to country, and may restrict the types of lending that are possible.
Mortgage: the security created on the property by the lender, which will usually include certain restrictions on the use or disposal of the property (such as paying any outstanding debt before selling the property).
Borrower: the person borrowing who either has or is creating an ownership interest in the property.
Lender: any lender, but usually a bank or other financial institution. Principal: the original size of the loan, which may or may not include certain other costs; as any principal is repaid, the principal will go down in size.
Interest: a financial charge for use of the lender's money.
Foreclosure or repossession: the possibility that the lender has to foreclose, repossess or seize the property under certain circumstances is essential to a mortgage loan; without this aspect, the loan is arguably no different from any other type of loan.
Many other specific characteristics are common to many markets, but the above are the essential features. Governments usually regulate many aspects of mortgage lending, either directly (through legal requirements, for example) or indirectly (through regulation of the participants or the financial markets, such as the banking industry), and often through state intervention (direct lending by the government, by state-owned banks, or sponsorship of various entities). Other aspects that define a specific mortgage market may be regional, historical, or driven by specific characteristics of the legal or financial system.
Mortgage lending is the primary mechanism used in many countries to finance private ownership of residential property. For commercial mortgages see the separate article. Although the terminology and precise forms will differ from country to country, the basic components tend to be similar:
Property: the physical residence being financed. The exact form of ownership will vary from country to country, and may restrict the types of lending that are possible.
Mortgage: the security created on the property by the lender, which will usually include certain restrictions on the use or disposal of the property (such as paying any outstanding debt before selling the property).
Borrower: the person borrowing who either has or is creating an ownership interest in the property.
Lender: any lender, but usually a bank or other financial institution. Principal: the original size of the loan, which may or may not include certain other costs; as any principal is repaid, the principal will go down in size.
Interest: a financial charge for use of the lender's money.
Foreclosure or repossession: the possibility that the lender has to foreclose, repossess or seize the property under certain circumstances is essential to a mortgage loan; without this aspect, the loan is arguably no different from any other type of loan.
Many other specific characteristics are common to many markets, but the above are the essential features. Governments usually regulate many aspects of mortgage lending, either directly (through legal requirements, for example) or indirectly (through regulation of the participants or the financial markets, such as the banking industry), and often through state intervention (direct lending by the government, by state-owned banks, or sponsorship of various entities). Other aspects that define a specific mortgage market may be regional, historical, or driven by specific characteristics of the legal or financial system.
Debtor
The debtor must meet the requirements of the mortgage conditions (and often the loan conditions) imposed by the creditor in order to avoid the creditor enacting provisions of the mortgage to recover the debt. Typically the debtors will be the individual home-owners, landlords or businesses who are purchasing their property by way of a loan.
A debtor is sometimes referred to as the mortgagor, borrower, or obligor.
A debtor is sometimes referred to as the mortgagor, borrower, or obligor.
Creditor
The creditor has legal rights to the debt secured by the mortgage and often makes a loan to the debtor of the purchase money for the property. Typically, creditors are banks, insurers or other financial institutions who make loans available for the purpose of real estate purchase.
A creditor is sometimes referred to as the mortgagee or lender.
A creditor is sometimes referred to as the mortgagee or lender.
Mortgage
A mortgage is a method of using property (real or personal) as security for the payment of a debt.
The term mortgage (from Law French, lit. death vow) refers to the legal device used in securing the property, but it is also commonly used to refer to the debt secured by the mortgage, the mortgage loan.
In most jurisdictions mortgages are strongly associated with loans secured on real estate rather than other property (such as ships) and in some cases only land may be mortgaged. Arranging a mortgage is seen as the standard method by which individuals or businesses can purchase residential or commercial real estate without the need to pay the full value immediately.
In many countries it is normal for home purchases to be funded by a mortgage. In countries where the demand for home ownership is highest, strong domestic markets have developed, notably in Spain, the United Kingdom and the United States.
The term mortgage (from Law French, lit. death vow) refers to the legal device used in securing the property, but it is also commonly used to refer to the debt secured by the mortgage, the mortgage loan.
In most jurisdictions mortgages are strongly associated with loans secured on real estate rather than other property (such as ships) and in some cases only land may be mortgaged. Arranging a mortgage is seen as the standard method by which individuals or businesses can purchase residential or commercial real estate without the need to pay the full value immediately.
In many countries it is normal for home purchases to be funded by a mortgage. In countries where the demand for home ownership is highest, strong domestic markets have developed, notably in Spain, the United Kingdom and the United States.
Thursday, January 4, 2007
Loan
A loan is a type of debt. All material things can be lent but this article focuses exclusively on monetary loans. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower.
The borrower initially receives an amount of money from the lender, which they pay back, usually but not always in regular installments, to the lender. This service is generally provided at a cost, referred to as interest on the debt.
Acting as a provider of loans is one of the principal tasks for financial institutions. For other institutions, issuing of debt contracts such as bonds is a typical source of funding. Bank loans and credit are one way to increase the money supply.
The borrower initially receives an amount of money from the lender, which they pay back, usually but not always in regular installments, to the lender. This service is generally provided at a cost, referred to as interest on the debt.
Acting as a provider of loans is one of the principal tasks for financial institutions. For other institutions, issuing of debt contracts such as bonds is a typical source of funding. Bank loans and credit are one way to increase the money supply.
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