# 8 Financial Planning

# Learn by watching

The links below will launch the video lessons in YouTube

- Finding Total Interest Paid (10 minutes 35 seconds)
- Paying Off Loans Early (9 minutes 13 seconds)
- The Dangers of Upside-Down Loans (11 minutes 36 seconds)
- Impacts of Down Payments and PMI (8 minutes 03 seconds)

- Retirement Planning (10 minutes 49 seconds)

**Try Exercises (Case Studies) #1-5 and the Reflection Assignment.
**

# learn by reading

## Total Interest paid

Total Interest Paid

- Find how much money you gave the bank: multiply the regular payment by the total number of payments.
- Subtract the value of the loan from your answer to part (1).

*NOTE – when you have a regular payment, the amount of money that goes towards interest is changing with every payment. At the beginning, more of your monthly payment is going towards interest because the bank requires interest to be paid first before paying down the loan. Each month, the balance that is used to calculate interest is decreasing, so the amount of money that goes towards interest each month also decreases. Because of this, we cannot use the interest rate percentage to find the total amount of interest from the loan.

## Paying off loans early

Finding the Amount of Money Still Owed on a Loan

At any point in time, you can find what the balance still owed on a loan.

Use the Loan Formula ( [latex]A=\frac{d\left(1-\left(1+\frac{r}{n}\right)^{-\left(nt\right)}\right)}{\left(\frac{r}{n}\right)}[/latex] ).

- d = value of (monthly) regular payment that you have been making
- r = the interest percentage rate on the loan
- n = the number of compounding periods per year for the loan
- t = the number of years REMAINING on the loan (the number of years the loan was designed for SUBTRACTED BY the number of years of payments that have been completed)

The A value will be the remaining balance owed on the loan (the pay-off amount).

## upside-down loans

Upside-Down Loan

A loan is considered “upside-down” if the value of your purchase is less than the money that you still owe for your loan. That is, even if you were to sell off your purchase for its current value, you would still have to come up with additional funds to finish paying off the loan.

This happens when the value of your purchase is depreciating at a faster rate than you are able to pay down the loan.

^{n}

- a = the value of
**the item**when new (not the value of the loan) - r = the depreciation rate in decimal form (don’t forget that the r should be negative since values are decreasing!)
- n = the number of years that have gone by

## impacts of down payments and pmi

## retirement planning

Retirement Planning

- Use the loan formula: [latex]A=\frac{d\left(1-\left(1+\frac{r}{n}\right)^{-\left(nt\right)}\right)}{\left(\frac{r}{n}\right)}[/latex]
- d = the amount of money you want to regularly get
- r = the interest rate of the loan (in decimal form)
- n = number of compounding periods per year for the loan (how many times/year are you getting a payment?)
- t = number of years you expect to need money after retirement

- The value you find for A is the amount of money you need in savings before you retire.

Part 2 — Figure out how much money you need to save to reach that goal.

- Use the savings plan formula: [latex]A=\frac{d\left(\left(1+\frac{r}{n}\right)^{\left(nt\right)}-1\right)}{\left(\frac{r}{n}\right)}[/latex]
- A = the amount of money you need in savings (answer to Part 1)
- r = interest rate of the loan (in decimal form)
- n = number of compounding periods per year for the loan (how many times/year are you depositing money?)
- t = number of years you expect to work before retiring

- The value you find for d is the amount of money you need to regularly deposit during your working years to meet your retirement goals.

Exercises: Try these!

CASE STUDY #1

You would like to purchase a new car that costs $28,500. You can trade-in your old car for $1500. You need to finance the rest. You qualify for a car loan rate of 5.79%

- Suppose you want to take out a 60 month loan.
- What would be the monthly payment? [HINTS: use the loan formula; make sure A is the amount of the loan (subtract the down payment/trade-in from the value of the car); make sure that t is in years (not months)]
- If you completed the loan on time, how much would you have paid in interest?
- If you sell the car after 2 years, how much do you still owe on the vehicle? [HINTS: use the loan formula; let t = # of years LEFT on the loan; use the monthly payment you found in part (a); find A]
- If the car depreciates at a rate of 20% each year, what will the car be worth after 2 years? Is this more or less than what you still owe on the car? [HINT – use an exponential model, with a starting value of $28,500, and rate of -20%]

- Suppose the finance director at the car dealership offers you a 72 month loan option.
- What would be the monthly payment?
- If you completed the loan on time, how much would you have paid in interest?
- If you sell the car after 2 years, how much do you still owe on the vehicle?
- The value of the car after 2 years is the same as in the 60 month loan option. Is this more or less than what you still owe on the car?

- Which loan option would you take? Explain why you made that choice.

CASE STUDY #2

You would like to purchase a new home. You found one that fits your circumstances for $450,000. You would like to avoid paying Private Mortgage Insurance (PMI), so you have saved up a 20% down payment.

- What is the amount of your down payment?
- How much will you need to borrow/finance from the bank?
- If you qualify for a 30-year loan at 7.2% interest, what would your monthly mortgage payment be?
- What is the total amount of money you would you pay over the life of the loan?
- If you completed the loan on time, how much would you have paid in interest?
- If you decide to sell your house half-way through the loan (after 15 years), how much will you still owe the bank? How does this compare to the original value of the loan and why do you think this might be?

CASE STUDY #3

You can afford a $1800 monthly housing payment. You want to buy a home using a traditional 30-year loan.

- How much of a loan can you afford with an interest rate of 10.13% (this was the home mortgage rate in 1990)?
- How much of a loan can you afford with an interest rate of 3.72% (this was the home mortgage rate in 2020)?
- How much of a loan can you afford at 6.8% (this is the home mortgage rate in 2023)?

CASE STUDY #4

You take out a 15-year loan at 6.2% to buy a $285,000 condo.

- Suppose you have saved up a 20% down payment.
- What is the amount of the down payment?
- What is the amount of the loan? What would be your monthly payment?

- Suppose you have only been able to save up a 5% down payment.
- What is the amount of the down payment?
- What is the amount of the loan? What would be your monthly payment?
- Because you have made less than a 20% down payment, the bank requires you to take out a Private Mortgage Insurance policy (PMI). PMI averages 1% of the value of the loan per year. For this purchase, what would be the PMI
*per month?* - What does your monthly housing cost end up being when you add in the PMI?

CASE STUDY #5

After you retire, you’d like to continue to have a regular income of $1500/month from your retirement savings. Your retirement account grows an average of 6% each year.

- If you plan to live for 25 years after retirement, how much money would you need to have saved up to support this payout? [HINT: use loan formula to find A]
- If you plan to work for 40 years, how much would you need to save each month to have the desired amount when you retire (answer to part 1)? [HINT: use savings plan formula to find d]
- Suppose you decide to wait 20 years before saving up for retirement. How much would you need to save each month to have the desired amount when you retire?

Reflection Assignment: Personal Financial Planning

Answer the questions below — answers do not need to be written in complete sentences; however, include all requested information, cite your sources (a web link is sufficient), and show your work when applying formulas to your calculations.

- Look up a job in your chosen field of study. What is the average pay for this line of work? List the job title, salary/wages, and a link to a website where you found this information.
- Calculate the MONTHLY income for your job. If you were given an annual salary, then divide your total by 12 to get your monthly wage. If you were given an hourly wage, assume you are working a 40 hour week for 4.25 weeks per month.
- Look up a NEW (not used) vehicle you’d be interested in purchasing — this can be practical or a dream car. List the make/model of the car, the cost of the vehicle with the options you want (MSRP), and a link to a website where you found this information.
- Add on 10% to the car MSRP price to account for sales tax. Assume you are going to take out a loan for the full amount (car price + sales tax). Calculate the monthly payment for your loan — use a 5 year car loan at 4.49% interest APR. Show the loan formula with your numbers in it, and your steps to solve for d.
- What is the total dollar amount of interest that you would have paid on the car?
- What percentage of your monthly income would this car payment represent?
- A general rule of thumb for good financial planning is that you should not spend more than 28% of your income on housing. Based on your answer to problem #2, what is the maximum amount of money that you should use for housing each month?
- If you decide you would like to purchase a home, how much of a loan could you afford? Use your answer to problem #7 as your monthly payment, and plan for a 30-year loan at 5.8% interest APR. Show the loan formula with your numbers in it, and your steps to solve for A.
- Suppose you decide after 7 years that your housing needs have changed, and you decide to sell your home for something more appropriately-sized. How much money do you still owe on the house?
- A general rule of thumb for good financial planning is that you should set aside 10% of your income for retirement. Based on your answer to problem #2, how much money should you be saving for retirement each month?
- Assume that you are planning to retire at age 65. If you start saving now, how many years will you be able to contribute to your retirement account (subtract your current age from 65)?
- How much money will you have in your retirement account when you retire? Use your answer to #10 for your monthly contribution. Use your answer to #11 for the number of years that you will be saving. Plan for a 6.5% interest rate of return on your investment. Show the savings plan formula with your numbers in it, and your steps to solve for A.
- Write a paragraph summarizing your over-all take-aways from this project, including what you learned and how you might apply these results. Was there anything you were surprised about?