Understanding Credit, Debt, and Insurance: Key Concepts

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Understanding Credit, Debt, and Insurance

Credit Rule of Thumb: Product should outlive its payment; don't use credit if the purchase is beyond earnings capability.

Household Credit Paradox: Large credit balance yet a large savings account balance exists.

Factors That Influence Credit Score:

  • Billing history (35%)
  • Length of bill payment history (15%)
  • Amount owed (30%)
  • New credit lines (10%)
  • Types of credit (10%)

FICO Score:

300-850; above 800 is great; below 620 is not good (high risk); 40% of Americans have a score under 600.

Credit Bureaus:

TransUnion, Equifax, Experian (each has its own credit score).

Types of Entries in a Credit Report:

  • Identifying Info
  • Public Records (bankruptcies, civil judgments, and tax liens)
  • Inquiries
    • Soft Inquiries (i.e., a credit card company sends you a credit application -- no effect)
    • Hard Inquiries (i.e., a bank checking as a consequence of filling out a form -- can reduce score; many within a short time count as one)

Collateralized Debt/Loans:

Mortgage loan, car loan; lower interest and hard to qualify; you lose something if you don't pay.

Uncollateralized Loan/Debt:

Credit cards; higher risk, higher interest rate, easy to qualify; only affects credit score.

Ways to Pay Back Card Debt:

Consumer Credit Counseling Services & Bankruptcy:
  • Chapter 7: Takes all goods and auctions them off - extreme - for the super poor.
  • Chapter 13: A mediator assesses debt - sets payment plan - can't wipe child support, alimony, student loans, and taxes.

Credit and Debit Liabilities:

  • Deadbeats: Well educated, usually older, pay off credit debt ASAP.
  • Revolvers: Usually younger, not as educated, pay the minimum on credit debt -- maximizes credit card company profit.
Credit Rationing: Banks say no to some portion of the population even if they have money to give.
Relationship in Lending: Soft Info i.e., how many loans have you taken from this bank? Do you know the loan officer? Works in margin.
Amortization: Refers to the repayment of a loan principal over time.
Security Interest:
Acceleration Clause:

Dealing with Risk:

  • Assumption (don't do anything about it)
  • Avoidance
  • Transfer
  • Prevention
  • Control

Why Companies Take on Risk:

  • Moral Hazard (hidden action)
  • Adverse Selection (hidden information)
Speculating: You make money on it (stock, lottery, tickets, betting).

Term Life Insurance:

Pretty much pay; if you die within the timespan -- payout.

Whole Life Insurance:

Provides savings account policy, pay more early, premium stays the whole time. Critics: black box, inflexible.

Universal: Unbundles and is transparent -- savings and death are clearly delineated and flexible.
Variable Universal: Invest savings in stock to build money faster (401K).

Why Insurance:

Liability (what the insurance company pays) and Property loss.

Subrogation: Right to collect damages from the other party.
Indemnity: Entitles you to pay only if a loss is suffered -- will not exceed loss cost.
Coinsurance:
Underwriting: Process by which the insurance company decides who to insure and at what rate.

Liability (Auto Insurance):

What the insurance company pays the other party; minimum varies from state to state; XX/YY/ZZ : X => per person, Y=> per incident, Z=> property damage.

Auto Insurance Rule of Thumb: If it ain't moving, it ain't guilty.
Not Covered: Floods, earthquakes, acts of war, etc.
HO5: Homeowners; HO4: Renters; HO6: Condo owners.
Viatical Insurance: AIDS person has a $1M plan, needs money for payment of meds. Sells for $600,000 to buyer. Buyer gets $1M when seller dies.
Mortgage Insurance: Protects lender.
Deductible: Amount you have to pay out of pocket before the insurance company pays.

How to Qualify for SSN:

40 credits; 4 per year.

Purpose of SS:

To help the elderly, not fully support them.

Problem of SS:

Reserves running out as life expectancy increases.

Fixing the SS Reserves:

  • Increase SS tax by 2%
  • Raise cap from 100 to 200
  • Increase official retirement age

Money Allocation of SS:

  • Benefit (75%)
  • Reserves (24%)
  • Admin costs (1%)

Portfolio Allocations:

More risk in youth, less risk closer to retirement.

Defined Benefit: Guarantees the amount of income during retirement.
Defined Contribution: Specifies what you and/or your employer contribute -- gives more flex -- you can invest how you want -- puts responsibility back in employee hands.
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insurance retirement planning risk management debt management credit score FICO score auto insurance social security credit bureaus credit cards credit report loans financial planning mortgage