Question

Case/Exercise 9 Assume you are the financial advisor for an are the financial advisor for a middle-income family. From the situations ow, indicate which appear to be good reasons (G) for going into debt and which appear questionable (Q) at best. (in real life, you would, of course, need mor information before being able to make a final recommendation.) Situations Good reasons (G) Questionable (0) Bank loan for trip around the world Mortgage loan for purchasing a home with a: 1) 2% cash down payment (buyer borrows approximately 98% of home cost) 2) 20% cash down payment Purchase of a 45-inch plasma on an installment loan basis Using your credit card to the maximum amount available When going to college, electing a school with a tuition fee of $52,000 a year vs. the much more economic state school. You want to major in marine biology

Answer 1

1) Questionable - Firstly, going for a trip around the world is an additional luxury for middle income family. these kind of expenses are to be borne generally by high income groups often. but for a middle income family it is an additional burden on their earnings. Now taking a loan to go for a trip is not reasonable as there is no compulsory necessity to go for trip that too with incurring the loan and its interest. going for trip with savings money would more appropriate than taking loan.

2) Buying a home is a good reason for borrowing. As we are dealing with Middle income group, we concentrate on saving more on periodic income of them thus by decreasing as much of payments as possible (interest expenses)

Questionable if they pay only 2% down payment and borrow remaining 98% because this could incur a huge interest portion on that borrowing. however there is no option if the 20% down payment amount is not available with them

Good Reason if they spend 20% on cash down payment as it will decrease the interest expense on the borrowing made for remaining amount. the cut from the income of the family will be less. this is recommendable as that periodic income is the source for their day to day living expenses.

3) Questionable - Purchase of 45-Inch plasma is a kind of luxury for a middle income family and they can always adjust with a small dimensions of TV. so it would be better saving in their income if they would buy a small plasma on which installment amount would be lesser.

4) Good Reason only if Using credit card is up to the maximum amount available because they would not incur any interest if they utilize the maximum credit available but if the bill goes beyond maximum amount then the interest would be very high as it banks levies huge interest rates and most of the banks use daily compounding. There is a risk of over utilization of credit in case of credit card facility which will lead the family into huge debts.

so, Using credit card upto the interest free maximum amount is a good reason

but using credit card beyond the credit limit which is interest prone is questionable

5) Good Reason for spending $52,000 a year - because education is the most important necessary and when anyone want to major in a study like marine biology, then they should definitely prefer a college with high standards(which of course charge high fee) than a state school because the knowledge gaining from college is higher than an economic state school which obviously have low quality in education when compared to college. So it is a good reason for borrowing for this purpose.