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This Document Contains Chapters 7 to 8 7 THE FINANCES OF HOUSING CHAPTER OVERVIEW This chapter provides a complete discussion of selecting housing based on life situation, needs, and personal values along with the related financial aspects of this major expenditure. First presented is material regarding factors related to renting a residence. This is followed by discussion of buying alternatives and the home buying process including determining housing needs, evaluating potential homes, and pricing the property. The financing section covers types of mortgages and closing costs of a real estate purchase. Finally, suggestions for selling a home are offered. LEARNING OBJECTIVES CHAPTER SUMMARY After studying this chapter, students will be able to: Obj. 1 Evaluate available housing alternatives. Your needs, life situation, and financial resources are the major factors that influence your selection of housing. Assess renting and buying alternatives in terms of their financial and opportunity costs. Obj. 2 Analyze the costs and benefits associated with renting. The main advantages of renting are mobility, fewer responsibilities, and lower initial costs. The main disadvantages of renting are few financial benefits, a restricted lifestyle, and legal concerns. Obj. 3 Implement the homebuying process. Home buying involves five major stages: (1) determining home ownership needs, (2) finding and evaluating a property to purchase, (3) pricing the property, (4) financing the purchase, and (5) closing the purchase transaction. Obj. 4 Obtain mortgage financing. Once you decide to purchase a specific home, you will probably apply for a loan. Financing a home purchase requires obtaining a mortgage, an awareness of types of mortgages, and settling the real estate transaction. Obj. 5 Develop a strategy for selling a home. When selling a home, you must decide whether to make certain repairs and improvements, determine a selling price, and choose between selling it yourself and using the services of a real estate agent. INTRODUCTORY ACTIVITIES • Ask students to comment on the opening case for the chapter (p.199). • Point out the learning objectives (p. 199) in an effort to highlight the key points in the chapter. • Ask students to discuss the relationship between housing selection and other financial goals. • Point out the opportunity costs associated with various housing decisions (see pp. 199, 200). CHAPTER 7 OUTLINE I. Evaluating Housing Alternatives A. Your Lifestyle and Your Choice of Housing B. Opportunity Costs of Housing Choices C. Renting versus Buying Housing D. Housing Information Sources II. Renting A. Selecting a Rental Unit B. Advantages of Renting C. Disadvantages of Renting D. Costs of Renting E. Renting Rights III. The Home Buying Process A. Step 1: Determine Homeownership Needs B. Step 2: Find and Evaluate a Property to Purchase C. Step 3: Price the Property IV. The Finances of Home Buying A. Step 4: Obtain Financing B. Step 5: Close the Purchase Transaction Home buying: A Final Word V. Selling Your Home A. Preparing Your Home for Selling B. Determining the Selling Price C. Sale by Owner D. Listing with a Real Estate Agent CHAPTER 7 LECTURE OUTLINE EVALUATING HOUSING ALTERNATIVES (p. 200) • Instructional Suggestions • Text Highlight: Exhibit 71 (p. 200) presents suggested housing alternatives for different life situations. • Text Highlight: Exhibit 72 (p. 201) evaluating housing alternatives Your needs, lifestyle, and financial resources will determine whether you decide to rent, buy, or have a home built. Your Lifestyle and Your Choice of Housing (p. 200) • • Your lifestyle (how you spend your time and money) is reflected in almost all consumer purchases including housing. While personal preferences and tastes are the foundation of your housing decisions, financial factors may modify your final choice. Opportunity Costs of Housing Choices (p. 200) • • Consider what you are giving up when you live in a certain area or in a certain type of residence. Common housing trade-offs include: ∗ interest earnings lost on the down payment for a house or apartment ∗ time and cost of getting to work living in a distant area ∗ loss of equity growth ∗ time and money to repair and improve a lowerpriced home ∗ time and effort to have a home built to your specifications Renting versus Buying Housing (p. 202) • • Choosing between renting and buying your residence is an essential decision related to housing. Economic conditions can influence this decision as well as a personal desire for ease of mobility or pride of ownership. • Housing Information Sources (p. 202) • As with other consumer purchases, much information is available on housing including books, newspaper articles, people with knowledge and experience in this area, the World Wide Web, and government agencies. RENTING (p. 203) • At some point in your life, you are likely to rent your place of residence. You may rent when you are first on your own and cannot afford to buy a home or later in life when you want to avoid the activities • Concept Check 7-1 (p. 202) CHAPTER 7 LECTURE OUTLINE Instructional Suggestions required to maintain your own home. Selecting a Rental Unit (p. 203) • • An apartment is the most common type of rented housing. People who need more room should consider renting a house. • Text Highlight: Exhibit 7-3: presents the activities involved in finding and living in a rental unit. • Assignment: Have student’s survey people who rent to determine factors that influenced this housing decision over buying. • Supplementary Resource: Talk to a lawyer about common problems associated with renting and leases. Advantages of Renting (p. 203) • ∗ ∗ ∗ The main advantages of renting are: mobility fewer responsibilities lower initial costs Disadvantages of Renting (p. 205) • • The main drawbacks of renting are: ∗ few financial benefits ∗ restricted lifestyle, restrictions on decorating, having pets, and other activities ∗ legal details A lease is the legal document that defines the conditions of a rental agreement. It is designed to protect the rights of both the landlord and tenant. Costs of Renting (p. 206) • A security deposit is usually required when you sign a lease. This money is held by the landlord to cover the cost of any damages that may be done to the rental unit during the lease period. Renting Rights (p. 206) • The Canadian Charter of Human Rights recognizes and protects your rights to rent any apartment without discrimination. THE HOME BUYING PROCESS (p. 206) • What Are the Benefits of Home Ownership? (p. 206) The main advantages of home ownership are pride of ownership, financial benefits, and flexibility in using the property. Concept Check 7-2 (p. 204) • Exercise: Create a list of factors that could encourage or discourage the purchase of a housing unit. • Supplementary Resource: Obtain information from a condominium sales office about the purchasing and management of this type of housing. Owning a home is a goal of many people and involves various activities as well as personal and economic trade-offs. Step 1: Determine Home Ownership Needs • • CHAPTER 7 LECTURE OUTLINE Instructional Suggestions What Are the Drawbacks of Homeownership? (p. 207) • • • • Financial risks related to having down payment funds, obtaining a mortgage, and changing property values. Limited mobility may result if a home is difficult to sell. Higher living costs due to repairs and maintenance. Higher property taxes affect homeowners more directly than renters, who pay them in the form of higher rent. Assess Types of Housing Available (p. 208) • • • • • Single-family dwellings are the most popular type of housing. Multiunit dwellings include duplexes and townhouses. Manufactured homes are housing that is fully or partially assembled in a factory before being moved to the living site. These include prefabricated homes and mobile homes. Mobile homes are a second type of manufactures homes. These housing units are typically less than 100 square meters in size. Some people want a home built according to their specifications. Before you begin such a project, be sure you possess the knowledge, the money, and the perseverance that are needed to complete it. Forms of Ownership (p. 208) • The most common form of home ownership is one in which an individual or a couple is the sole owner of an entire property. Two other legal forms of ownership are condominiums and co-operative housing. • A condominium (condo) consist of two parts: a collection of private housing called units, and the shared areas of the building such as lobbies, hallways, elevators, recreational facilities, garden, etc. Each unit is owned by the purchaser of that unit and the common areas are jointly owned by these individual unit owners. • Co-operatives (co-ops) are member-owned communities where residents make decisions on how • Assignment: Have students talk to people who have had their own house built, or to contractors who work with people having a house built. Obtain information on the process and potential difficulties. • Text Highlight: Exhibit 7-5: goes through the home buying process. CHAPTER 7 LECTURE OUTLINE Instructional Suggestions the co-op operates. A co-op is governed by directors and member of the co-op. Each member has a vote and say in its overall direction. There are two main types of housing co-operatives: non-profit and forprofit. Many provinces require that housing co-ops operate on a non-profit basis because the main purpose is to provide affordable housing. In a nonprofit co-op, members cannot sell their shares. In a for-profit co-op, members own a share of the co-op but not the individual unit they live in. Determine Amount of Down Payment (p. 209) • Before shopping for a home, you should assess your financial situation to determine how much you can afford to put as a down payment. The higher the down payment the lower the loan amount you will need to borrow. • Calculate Your Affordable Home Purchase Price (p. 210) • • Will you have enough money to make your mortgage payments? A mortgage is a long-term loan on a specific piece of property, such as a home or other real estate. Step 2: Find and Evaluate a Property to Purchase (p. 213) • • • • • • Text Highlight: Exhibit 7-6: (p. 211) looks at housing affordability and mortgage qualification amounts. In selecting a neighborhood, consider the character of the community. Zoning laws are restrictions on how the property in an area can be used. If you have or plan to have a family, you should assess the school system. Homeowners without children also benefit from strong schools since the educational advantages of a community affect property values. A real estate agent can help you assess your housing needs and determine the amount you can afford to spend on a home. A real estate agent can be helpful in presenting your offer to the seller, negotiating a settlement price, assisting you in obtaining financing, and representing you at the closing Before reaching your decision about a specific home, conduct a complete evaluation of the property. • Discussion Question: Why is home location considered more important than any other factor when making a housing purchase? • Current Example: In addition to the location, be sure to: ∗ consider the entire community ∗ be aware of possible malls or highways ∗ consider cost and time of commuting ∗ remember that yards, home conditions, and other items in view are an indication of the lifestyles and values of people in the community. • Text Highlight: Exhibit 7-9: (p. 214) presents a detailed format for inspecting a home. CHAPTER 7 LECTURE OUTLINE Instructional Suggestions This evaluation can help minimize future problems. Step 3: Price the Property (p. 214) • • The main factors you should consider in determining the home prices are recent sales prices in the area, the current demand for housing, the length of time the home has been on the market, the owner’s need to sell, the financing options, and the features and condition of the home. Once a price has been agreed upon, the buyer must deposit earnest money—a portion of the purchase price that the buyer deposits as evidence of good faith to show that the purchase offer is serious. • Supplementary Resource: Use local newspapers to obtain information on the price range of houses and other housing in your community. • Text Highlight: Exhibit 710: (p. 215) shows the components of a home purchase offer. • Concept Check 7-3 (p. 215) THE FINANCES OF HOME BUYING (p. 216) • • Assignment: Have students compare mortgage qualification requirements and procedures of several lenders in your area. • Text Reference: The “Financial Planning for Life’s Situations” feature on page 222 provides information and warnings on paying off your mortgage early. Financing a home purchase requires obtaining a mortgage, being aware of the types of mortgages, and settling the real estate transaction. Step 4: Obtain Financing (p. 216) • Personal savings, pension plan funds, sales of investments or other assets, and assistance from relatives are the most common sources of down payment money. • Federal law requires that you have mortgage insurance if your mortgage represents 75 percent or more of the total price you pay for your home. This coverage protects the lender from financial loss due to default. It can be obtained through the Canada Mortgage and Housing Corporation (CMHC), a federal Crown corporation, or GE Capital Mortgage Insurance Company, a private company. To qualify for a mortgage, you must meet criteria similar to those that must be met for other loans. The major factors that affect the affordability of your mortgage are your income, other debts, the amount available for a down payment, the length of the loan, and current mortgage rates. The mortgage loan for which a person can qualify is larger when interest rates are low than when they are high. As interest rates rise, fewer people are able to afford the cost of an average-priced home. Obtaining a mortgage requires the potential borrower to submit an application form containing personal and financial data. • • • • • CHAPTER 7 LECTURE OUTLINE • • • • • • • • Instructional Suggestions The conventional mortgage has equal payments over 25 years based on a fixed interest rate. The mortgage payments are set at a level that allows amortization of the loan, that is, the balance is reduced with each payment. The variable-rate mortgage (VRM), also referred to as a flexible rate mortgage, has an interest rate that increases or decreases during the life of the loan based on changes in market interest rates. A rate cap restricts the amount that the interest rate can increase during the loan term. Split or multi-rate mortgages allow you to arrange part of your mortgage at one rate and term and another part at another rate and term. Most mortgage lenders offer options to your payment plan that will allow you to speed up your payment schedule. The vendor take back (VTB) mortgage is a loan extended to you as the buyer by the seller. This type of loan frequently has the advantage of a lower rate than most institutions offer. A second mortgage, more commonly called a home equity loan, allows a homeowner to borrow on the paid-up value of the property. Reverse mortgages provide an elderly homeowner with tax-free income in the form of a loan that is paid back (with interest) when the home is sold or the homeowner dies. Refinancing refers to obtaining a new mortgage on your current home at a lower interest rate. Step 5: Close the Purchase Transaction (p. 220) • • • • • The closing involves a meeting of the buyer, seller, and lender of funds, or representatives of each party, to complete the transaction. Closing costs, also called settlement costs, are the fees and charges paid when a real estate transaction is completed. Title insurance protects the owner or the lender against financial loss resulting from future defects in the title and from other unforeseen property claims not excluded by the policy. A deed is a document that transfers ownership of property from one party to another. An escrow account is money, usually deposited with a financial institution, for the payment of property taxes and homeowner’s insurance • Text Highlight: Exhibit 711: Common additional costs associated with purchasing a house are dicussed. CHAPTER 7 LECTURE OUTLINE Instructional Suggestions Home Buying: A Final Word (p. 222) • For most people, buying a home is the most expensive decision they will undertake. As a reminder, Exhibit 7-12 provides an overview of the major elements to consider when making this critical financial decision. SELLING YOUR HOME (p. 223) • Concept Check 7-4 (p. 223) Preparing Your Home for Selling (p. 223) • The effective presentation of your home can result in a fast, financially favorable sale. Real estate salespeople recommend that you make needed home repairs and paint the exterior and interior areas. • Current Example: Real estate professionals suggest that your home be made as appealing as possible so potential buyers can imagine themselves living there. The smell of fresh-baked bread or cookies can add to the appeal. • Discussion Question: What types of improvements would add to the sale value of homes in this area? • Assignment: Have students talk to people who have sold their houses on their own. • Supplementary Resource: Talk to a real estate agent and use newspaper housing ads to determine the factors that influence the selling price of homes. Determining the Selling Price (p. 223) • Putting a price on your home can be a difficult decision. You face the risk of not selling it immediately if the price is too high, and you may not get a fair settlement if the price is too low. • An appraisal, which is an estimate of the current value of the property, can provide a good indication of the price you should set for it. Sale by Owner (p. 223) • • If you decide to sell your home without the use of a real estate professional, price the home and then advertise it through local newspapers and through a flier describing it in detail. Use the services of a lawyer or title company to assist you with the contract, the closing, and other legal matters. Listing with a Real Estate Agent (p. 224) • • If you decide to sell your home with the assistance of a real estate agent, you can probably choose among real estate businesses in your area. Your real estate agent will provide you with various services. These services include suggesting a selling price, making potential buyers and other agents aware of your home, providing advice on features to highlight, conducting showings of your home, and handling the financial aspects of the sale. • Concept Check 7-5 (p. 224) CONCLUDING ACTIVITIES • Point out the chapter summary (p. 224) and key terms in the text margin. • Discuss selected end-of-chapter Financial Planning Problems, Financial Planning Activities, and Life Situation Case. • Use Chapter Quiz in the Instructor’s Manual. CHAPTER 7 QUIZ ANSWERS True-False 1. F 2. F 3. T 4. T 5. F 6. F 7. F 8. T Multiple Choice 9. A 10. C 11. B 12. B 13. C 14. C 15. B 16. B Name ________________________________________ Date____________________________ CHAPTER 7 QUIZ TRUE-FALSE _____1. Several financial benefits are associated with renting your place of residence. _____2. A lease is mainly designed to protect the rights of the landlord. _____3. Financial risks are associated with the purchase of a home. _____4. Cooperative housing and condominiums are forms of home ownership. _____5. Higher property values result in lower property taxes. _____6. Refinancing and a second mortgage are essentially one and the same. _____7. There is no ability to negotiate on the price of a home you are interested in purchasing. A variable rate mortgage usually has a lower initial interest rate than a fixed rate mortgage. _____8. MULTIPLE CHOICE ______9 A common advantage associated with home ownership is a. financial benefits. b. ease of mobility. c. limited financial risks. d. low initial costs. _____10 Most real estate professionals believe that the most important factor in selecting a home is a. price. b. style. c. location. d. desired features. _____11 The major factor that affects a person’s qualification for a mortgage is a. current interest rates. b. the applicant’s credit rating. c. the value of the property being purchased. d. the source of the down payment funds. _____12 Most lending institutions believe that a person can afford a monthly payment of about __________ percent of gross income less any long-term debts. a. 20 b. 30 c. 40 d. 50 _____13 A __________ mortgage allows a person to borrow on the paid-up value of a home. _____14 _____15 _____16 a. conventional b. growing equity c. second d. share appreciation One of the advantages of owning your own home is: a. The easy ability to move b. Few or no responsibilities for maintenance c. The growth in equity while you own the home d. Lower initial costs A(n) ____________ is a form of home ownership that consists of individually owned units and shared common areas. a. Single family dwelling b. Condominium c. Cooperative d. Duplex The ____________ ratio is your monthly shelter costs as a percentage of your gross monthly income. a. TDS b. GDS c. Loan to value d. Gross debt service SUPPLEMENTARY ACTIVITY For each of the following types of mortgages, describe life situations and economic conditions that could make this type of home loan an appropriate choice. Type of mortgage Conventional, fixed-rate, fixed-payment Variable Rate Split or Multi rate Vendor take back Second mortgage Description of life situation Description of economic conditions Reverse mortgage Refinancing (Note: This activity may be done as a discussion in a large group, as a small group exercise, or as an outof-class assignment.) ANSWERS TO CONCEPT QUESTIONS, OPENING CASE QUESTIONS, FINANCIAL PLANNING PROBLEMS, FINANCIAL PLANNING ACTIVITIES, AND LIFE SITUATION CASE CONCEPT QUESTIONS Concept Check 7-1 (p. 202) 1. How does a person’s employment and household situation influence the selection of housing? A person who works at home would, for example, require home facilities different from a single person or a household with several small children. (p. 200) 2. What are some common opportunity costs associated with the selection of housing? Opportunity costs include lost interest on a down payment or security deposit and travel time to work when living in the country. (p. 200) Concept Check 7-2 (p. 206) 1. What are the main benefits and drawbacks of renting a place of residence? Advantages of renting are mobility, fewer responsibilities, and lower initial costs. Disadvantages are few financial benefits, restricted lifestyle, and legal concerns. (pp. 203-204) 2. Which components of a lease are likely to be most negotiable? Some people will tell you that just about everything in a lease is negotiable; however, certain things are likely to be more flexible than others. Most negotiable items include rent, amount of security deposit, starting date of lease, and decorating. (p. 205,206) Concept Check 7-3 (p. 215) 1. What are the drawbacks of owning a home? Disadvantages are financial uncertainty, limited mobility, and higher living costs. (p. 207) 2. What type of individual would prefer a condominium over a single-family dwelling? Someone who likes having someone else deal with the maintenance of the building and common areas and who is willing to sacrifice owning land to have that. Maybe even someone who doesn’t need the extra space that a single-family dwelling provides. It all depends on a person’s lifestyle and preferences. (pp. 208-209) 3. What are the main sources of funding for a down payment? Personal savings, pension plan funds, sales of investments or other assets, and assistance from relatives are common sources. (p. 209) 4. What is the TDS ratio? The TDS ratio is your monthly mortgage payment, including any outstanding debt as a percentage of your gross monthly income. (p.210) 5. How do changing interest rates affect the amount of mortgage a person can afford? The lower the rate the higher the amount of the mortgage loan you can qualify for. (p. 210) 6. How can the quality of a school system benefit even homeowners in a community who do not have school-age children? The quality of a school system is an important factor affecting home prices in a community. By maintaining quality schools, all homeowners in an area benefit from stable and increasing property values. (p. 213) 7. What services are available to home buyers from real estate agents? A real estate agent can help assess housing needs and determine the amount a person can afford to spend. Agents also have information on available homes and obtaining a mortgage. (p. 213) 8. How does a seller’s market differ from a buyer’s market? In times of high demand for housing, negotiating may be minimized; this situation is referred to as a seller’s market, since the current owner is likely to have several offers for the property. On the other hand, when home sales are low, a buyer’s market exists and a lower price is likely. (p. 214) Concept Check 7-4 (p. 223) 1. Under what conditions might a variable rate mortgage be appropriate? A variable rate mortgage may be appropriate when interest rates are relatively high and they are expected to decline. This situation would benefit the borrower as rates decline, or the homeowner may refinance when rates drop at a lower-rate, fixed-rate mortgage. (p.218) 2. When might refinancing a mortgage be advisable? Refinancing might be appropriate when interest rates decline and a homeowner plans to stay in the same house long enough for the savings from lower mortgage payments to recover the cost of refinancing. (p. 219) 3. How do closing costs affect a person’s ability to afford a home purchase? Closing costs can add several thousand dollars to the expense of buying a home. These are funds that the homebuyer must have available to complete the real estate transaction. (p. 220) Concept Check 7-5 (p. 224) 1. What actions are recommended when planning to sell your home? When planning to sell your home, make needed repairs, consider new paint, clear out living and storage areas, and remove unnecessary furniture and other items. (p. 223) 2. What factors affect the selling price of your home? Home prices are affected by location, size, condition, features, and current market demand. (p. 223) 3. What should you consider when deciding whether to sell your home on your own or to use the services of a real estate agent? If you decide to sell by owner, you will need to price, advertise, and show the house. Some people would like to save money by taking on these tasks and not use a real estate agent. If you would like someone else to handle these and other duties, you may decide to use the services of a real estate agent. (p. 224) OPENING CASE QUESTIONS (p. 199) 1. What factors affect a person’s ability to buy a house? The amount a person can afford when buying a house is affected by income, amount of down payment money available, current interest rates, and other debts. 2. What are common sources of a down payment? Why should home buyers not use all their savings for the down payment on a home purchase? Common down payment sources include personal savings and investments, gifts from relatives, loans, or use of retirement savings. If home buyers use all their savings for a down payment, they may have financial difficulties when funds are needed for closing costs, home repairs, or family emergencies. 3. What problems could arise in a co-ownership housing arrangement? The problems encountered with a co-ownership housing arrangement may include differences of opinions between the individuals involved, financial difficulties faced by one of the people, or changes in the life situation of one of the individuals. 4. Locate Web sites that provide housing information that would be of value to Ana and Yvonne during their home buying activities. Useful Web sites would include www.themortgage.com, www.canmortgage.com, and www.cmhc-schl.gc.ca. FINANCIAL PLANNING PROBLEMS (p. 225) 1. What type of housing would you suggest for people in the following life situations? a. b. c. d. A single parent with two school-age children A two-income couple without children A person with both dependent children and a dependent parent A couple near retirement with grown children While answers may vary, suggested responses may be found in Exhibit 7-1 (p. 200) 2. Based on the following data, would you recommend buying or renting? Rental Costs Annual rent, $7,380 Insurance, $145 Security deposit, $650 Buying Costs Annual mortgage payments, $9,800 ($9,575 is interest) Property taxes, $1,780 Insurance/maintenance, $1,050 Down payment/closing costs, $4,500 Growth in equity, $225 Estimated annual appreciation, $1,700 Assume an after-tax savings interest rate of 6 percent and a tax rate of 28 percent. Rental Costs $7,380 Rent 145 Insurance 39 Interest lost on security deposit $7,564 Total rental costs Buying Costs $9,800 Mortgage payments 2,830 Taxes, insurance, maintenance 270 Interest lost on down payment closing costs 225 Growth in equity 1,700 Annual appreciation 2,681 Tax savings for mortgage interest 498 Tax savings for property taxes $7,796 Total buying costs Note: The fact that mortgage interest is not a tax deductible expense in Canada was not taken into consideration for this example. In addition, in a real life situation, they could qualify for a provincial tax credit for the rent. These factors will change the bottom line. The total buying costs will increase and the total rental costs could be slightly lower if they qualify for the provincial rent tax credit. 3. Use the buy versus rent analysis on page 199 to compare two residences that you might consider. This activity can help students understand renting vs. buying in a practical situation. 4. Calculate the Gross Debt Service (GDS) and the Total Debt Service (TDS) ratios for the following data. (Obj. 3) Monthly mortgage payment = $2100 Property taxes = $200 Heating costs = $115 Other housing costs = $70 Personal loan payment = $150 Car loan payment = $200 Credit card payment = $150 Gross monthly household income = $7800 GDS = (2100 + 200 + 115 + 70) / 7800 GDS = 31.86 % TDS = (2100 + 200 +115 + 70 + 150 + 200 + 150) / 7800 TDS = 38.27 % 5. Estimate the affordable monthly mortgage payment, the affordable mortgage amount, and the affordable home purchase price for the following situation: Monthly gross income, $2,950 Down payment to be made, 15 percent of purchase price Other debt (monthly payment), $160 Monthly estimate for property taxes and insurance, $210 25-year loan at 6.5 percent. Based on example A (with other debts), Exhibit 7-6 Affordable monthly mortgage payment, $810 (($2,950 x 0.40) - $160 - $210) Affordable mortgage amount, $120,896 (($810/6.70) x $1000) Affordable home purchase, $142,231($120,896/ (1-0.15)) 6. Based on Exhibit 7-7, what would be the monthly mortgage payments for each of the following situations? a. A $40,000, 15-year loan at 7.5%. b. A $76,000, 25-year loan at 9%. c. A $65,000, 20-year loan at 10%. Solution a. $9.21 × 40 = $368.40 b. $8.28 × 76 = $629.28 c. $9.52 × 65 = $618.80 The longer the maturity of the loan, everything else constant, the smaller the payment. The size of the monthly payment is affected by the principal amount borrowed, the maturity of the loan and the mortgage rate (higher the rate, the higher the payment) 7. Which mortgage would result in higher total payments? Mortgage A: $985 a month for 25 years, or Mortgage B: $780 a month for 5 years, and $1,056 for 25 years A: $985 × 300 months = $295,500 B: ($780 × 60 months) + ($1,056 × 300 months) = $363,600 8. Kelly and Tim Johnson plan to refinance their mortgage to obtain a lower interest rate. They will reduce their mortgage payments by $56 a month. Their closing costs for refinancing will be $1,670. How long will it take them to recover the cost of refinancing? $1,670 ÷ $56 = 29.82 (about 30 months; two and a half years) 9. You estimate that you can save $3,800 by selling your own home rather than using a real estate agent. What would be the future value of that amount if invested for five years at seven percent? $3,800 × 1.403 = $5,331.40 FINANCIAL PLANNING ACTIVITIES (p. 226) 1. Interview several people about the factors that influenced their current residence. This assignment can provide students with expanded awareness of factors that motivate housing decisions. Encourage students to talk with people who live in various types of housing. 2. Compare the costs, facilities, and features of apartments and other rental housing in your area. This information may be obtained through newspaper advertisements, information from rental offices, or online searches of the World Wide Web. This activity will be especially useful to students who plan to live on their own for the first time in the near future, and those who may have recently moved to a new area. 3. Interview a tenant and a landlord to obtain their views about potential problems associated with renting. How do their views on landlord-tenant relations differ? This activity can help students appreciate another’s perspective with regard to renting housing. 4. Visit the sales offices of condominiums, new homes, and mobile homes. Based on the information obtained, prepare a written or oral presentation comparing the benefits and potential concerns of these housing alternatives. This hands-on experience will give students the opportunity to see some of the advantages and disadvantages of each housing alternative. After a few students visit each type, a class discussion can bring out different points of view. 5. Interview a real estate agent about the process involving in selecting and buying a home. Ask about housing prices in your area and the services provided by the agent. Also, obtain information about the agent’s opinion as to what will happen to housing prices and interest over the next six months. A debate continues as to whether real estate agents are worth the amount they charge for their services. Some people have had pleasant experiences buying or selling a house without the services of a real estate agent, but the opposite is also true for many who had a difficult time. This activity can assist students in deciding whether they will want to use a real estate agent when the situation arises. The housing prices in a community are affected by many factors; a real estate agent as well as other information sources (newspaper articles, government officials, and insurance agents) can provide current and expected home prices. 6. Talk with people who have different types of mortgages. What suggestions do they offer about obtaining home financing? What were their experiences with closing costs when they purchased their homes? One of the best sources of information related to any purchase or financial decision is the experience of others. Obtaining information about the types of mortgages most people have and the situation under which they were obtained can be most educational. 7. Visit bank websites, such as www.royalbank.ca, to learn how fixed rate and variable rate mortgages differ. What are the advantages and disadvantages of each? Which would a first-time home buyer likely prefer and why? This activity will help students in the future, to make sure they make informed decisions in their everyday life. 8. Contact several mortgage companies and other financial institutions to obtain information about current mortgage rates, application fees, other charges, and the process for obtaining a mortgage. This activity will help students better understand the mortgage application process. 9. Using Web sites such as www.canadamortgage.com, www.cannex.com, or money.canoe.ca, to obtain information on current mortgage rates available in different parts of the country. This assignment will help students to improve their Web research skills and will provide insight into the changing nature of mortgage rates. 10. Visit a couple of homes for sale. What features do you believe would appeal to potential buyers? What efforts were made to attract potential buyers to the open houses? This practical experience can be useful to students who plan to make a purchase in the near future. The checklist for making a home inspection (Exhibit 7-9, p. 214) can be helpful in this activity. LIFE SITUATION CASE Housing Decisions (p. 227) 1. How could the St. Onges have benefited from buying a home that needed improvements? Buying a home that needs improvement can make sense for two reasons. First, it may be the only affordable choice, and the buyer may be willing to fix up the residence. Second, the location or style may be exactly what is desired and improvements a tradeoff that must be made. 2. How might Brigitte Lavoie have found out when mortgage rates were at a level that would make refinancing her condominium more affordable? By regularly reading the business section of the newspaper it is possible to keep up to date on changing home mortgage interest rates. Regularly talking to a real estate agent or a loan officer at a financial institution will also help in keeping informed on mortgage rates. 3. Although the Stewards had good reasons for continuing to rent, what factors might make it desirable for an individual or a family to buy a home? Renting is desired by those who may need to move frequently or who do not want the responsibilities associated with the home ownership. But people who buy their place of residence wish to take advantage of the financial benefits of home ownership along with the stability of residence and flexibility in decorating their home. LIFE SITUATION CASE 2 Mortgage Affordability (p. 227) 1. While on maternity leave, Maria will only receive 55% of her salary. Taking this into account and some of the additional baby costs (such as diapers and formula), will the Diases be able to make ends meet? Will they be eligible for any tax credits and benefits that would increase their cash inflow? Are there any expenses they can reduce to help meet their obligations? Solution While on maternity leave, Maria’s take home pay will be $852.50. So the couple’s new combined take-home pay will be $2,897.5. Their current monthly expenses are as following: Mortgage payment Property taxes Home insurance Auto loan and RRSP repayment Auto insurance Utilities Transportation Food Total $1004.74 310 60 600 90 240 150 400 $2,854.74 Cash inflow of 2897.5 – Cash outflow of 2854.74 = $42.76 The Diases will be able to claim the child tax credit thereby lowering their taxable income. Maria will also receive universal child care benefits of $100 per month from the federal government until the child is 6 years old. As she will be at home, they can cut their transportation cost in half which will save $75 per month. This will give them an additional $175 per month to help cover the baby expenses. Still funds will be tight and they may end up dipping into their savings or incurring some credit card debts during this time. 2. Calculate the maximum monthly mortgage payment, the maximum mortgage amount and the maximum home purchase price, Maria and Jose could have afforded based on the GDS ratio and TDS ratio guidelines? Would this have been wise? Maximum monthly mortgage payment, maximum mortgage amount, and maximum home purchase price based on TDS ratio and GDS ratio guidelines. Monthly gross income (annual income divided by 12) $84,000/12 = $7000 TDS 7000 x 0.40 = 2,800 GDS 7000 x 0.30 = 2,100 Subtract: debt payments (600) property taxes, home insurance, utilities (650) (650) Maximum monthly mortgage payment $1,550 $1,450 Divide by (6.5%, 25 years) $6.7 Multiply by $1000 Maximum mortgage amount $231,343 Divide by 1 – fractional portion of downpayment (1 – 0.25 = 0.75) $6.7 $1000 $216,418 Maximum home purchase price 288,557 $308,485 It would have been extremely unwise for Maria and Jose to use the GDS ratio or TDS guidelines to purchase a home. First of all they would not have qualified for a conventional mortgage because they only had a down payment of $50,000. This means that in addition to making lager mortgage payments, they would have had to pay mortgage default insurance, higher interest rates on their mortgage and higher property taxes. This would have been extremely unwise as with a baby on the way, they can just about make ends meet. Purchasing a house is a big financial commitment and it is important to leave yourself enough room to handle changes in your life such as a job loss or the starting of a family. 3. When her maternity leave ends, will Maria be able to go back to work? Yes. With a combined take home pay of $3595 and UCB of $100 per month, Maria and Jose will be able to meet their financial and living expenses and still be able to afford day care expenses of $600. COMMENTS ON CONTINUOUS CASE FOR PART 2 B (p. 228) Spending Patterns for Financial Security 1. What major factors are affecting the Mortimers spending habits? The fact that the Mortimers have two preschool-age children is affecting their spending habits. As a result, Pamela has chosen to “retire” for a while. This means that the Mortimers must live on Isaac’s salary. 2. Based on a monthly income of $3,600, an estimated $240 per month for property taxes and homeowners insurance, current mortgage interest rates of 9 percent, and a down payment of at least 10 percent, what would it cost the Mortimers to purchase a home? Students should refer to Exhibit 7-8. 3. What tax advantages will the Mortimers realize by purchasing a home rather than renting? Home ownership has many financial benefits. From a tax standpoint, mortgage interest and real estate tax payments can still be used to reduce the amount of taxes the Mortimers pay to the federal government. 4. What transportation alternatives should the Mortimers consider? If they decide that they need a second motor vehicle, how should they finance it? Assuming the Mortimers decide they need a second automobile, they must determine if they should purchase a new or a used automobile. Each option has advantages and disadvantages. Ideally, they would pay cash for the automobile. If they purchase a new, expensive automobile, they will probably have to finance their automobile. Given the fact that the Mortimers are considering the purchase of a home, a used car may be more in order for the Mortimers at this time. 8 HOME AND AUTOMOBILE INSURANCE CHAPTER OVERVIEW Adequate financial protection from risks is a vital component of financial planning. This chapter starts with an introduction to insurance and covers the fundamental aspects of home and auto insurance. Discussed are coverages available to homeowners and renters, along with information on the types of policies and the factors that affect the cost of home insurance. The second major aspect of the chapter involves a presentation of the importance, types of coverages, and cost factors of automobile insurance. LEARNING OBJECTIVES CHAPTER SUMMARY After studying this chapter, students will be able to: Obj. 1 Develop a risk management plan using insurance. The four general risk management techniques are risk avoidance, risk reduction, risk assumption, and risk shifting. In planning a personal insurance program, set your goals, make a plan to reach your goals, put your plan into action, and check your results. Obj. 2 Discuss the importance of property and liability insurance. Owners of homes and automobiles face the risks of (1) property damage or loss, and (2) the risks of legal actions by others for the costs of injuries or property damage. Property and liability insurance offers protection from financial losses that may arise from a wide variety of situations faced by owners of homes and users of automobiles. Obj. 3 Explain the insurance coverages and policy types available to homeowners and renters. Homeowners insurance includes protection for the building and other structures, additional living expenses, personal property, and personal liability. Renter’s insurance includes the same coverages except protection for the building and other structures, which is the concern of the building owner. The main types of home insurance policies are the basic, broad, special, and tenant’s, comprehensive, condominium, country home, and modified coverage. These policies differ in the risks and property they cover. Obj. 4 Analyze factors that influence the amount of coverage and cost of home insurance. The amount of home insurance coverage is determined by the replacement cost of your dwelling and your personal belongings. The cost of home insurance is influenced by the location of the home, the coverage amount, the policy type, discounts, and insurance company differences. LEARNING OBJECTIVES CHAPTER SUMMARY Obj. 5 Identify the important types of automobile insurance coverages. Automobile insurance is used to meet provincial minimum insurance laws and to protect drivers against financial losses associated with bodily injury and property damage. The major types of automobile insurance coverages are bodily injury liability, medical payments, uninsured motorist’s, property damage liability, collision, and comprehensive physical damage. Obj. 6 Evaluate factors that affect the cost of automobile insurance. The cost of automobile insurance is affected by the amount of coverage, automobile type, rating territory, driver classification, differences among insurance companies, and premium discounts. INTRODUCTORY ACTIVITIES • Ask students to comment on the opening case for the chapter (p. 230). • Point out the learning objectives (p. 230) in an effort to highlight the key points in the chapter. • Ask students to give examples of situations when property and liability insurance situations might affect a person’s overall financial planning. • Point out the basic coverages associated with home and automobile insurance. CHAPTER 8 OUTLINE I. Insurance and Risk Management: An Introduction A. What is Insurance? B. Types of Risks C. Risk Management Methods D. Planning an Insurance Program II. Property and Liability Insurance A. Potential Property Losses B. Liability Protection III. Principles of Home and Property Insurance A. Homeowner’s Insurance Coverage B. Tenant’s Insurance C. Home Insurance Types D. Exclusions IV. Home Insurance Cost Factors A. Deductibles B. How Much Coverage Do You Need? C. Factors that Affect Home Insurance Costs D. Reducing Home Insurance Costs V. Automobile Insurance Coverages A. Motor Vehicle Coverages B. Other Automobile Insurance Coverages VI. Automobile Insurance Costs A. Amount of Coverage B. Automobile Insurance Premium Factors C. Reducing Automobile Insurance Premiums CHAPTER 8 LECTURE OUTLINE INSURANCE AND RISK MANAGEMENT: AN INTRODUCTION (p. 230) • • The purpose of insurance is to control the effects of uncontrollable financial risk inherent to life and living. How much insurance you buy should reflect the potential financial impact of the loss or partial loss of what you are insuring. Instructional Suggestions • Discussion Question: Do most people have too much or not enough insurance? • Assignment: Have students survey others about the types of insurance they have and other coverages they are considering. • Supplementary Resource: Have a local insurance agent point out the areas of protection that many people tend to overlook. • Exercise: Discuss the concepts of risk, peril, hazard, and types of risks. Ask students to provide additional examples. • Discussion Question: Why are speculative risks not usually covered by insurance? What is Insurance (p. 231) • • • • • • • • Insurance is protection against possible financial loss. An insurance company is a risk-sharing firm that agrees to assume financial responsibility for losses that may result from an insured risk. An insurer is known as an insurance company. A policy is a written contract for insurance. The premium is the amount of money a policyholder is charged for an insurance policy. The insured is a person covered by an insurance company. The policyholder is a person who owns an insurance policy. The financial trade-offs of not obtaining the right amount and type of insurance can be disastrous. Types of Risks (p. 231) • • • • • • • • • Risk refers to the uncertainty as to loss that a person or property covered by insurance faces. Peril is the cause of a possible risk. Hazard increases the likelihood of loss through some peril. The most common risks are classified as personal risks, property risks, and liability risks. Personal risks are the uncertainties surrounding the loss of income or life due to premature death, illness, disability, old age, and unemployment. Property risks are the uncertainties of direct or indirect losses to personal or real property due to fire, wind, accident, theft, and other hazards. Liability risks are possible losses due to negligence resulting in bodily harm or property damage to others. Personal risks, property risks, and liability risks are types of pure risks. A speculative risk is one in which there is a chance of either loss or gain. Speculative risks are legally CHAPTER 8 LECTURE OUTLINE Instructional Suggestions defined as uninsurable. Risk Management Methods (p. 232) • • • • • • Risk management is an organized strategy for protecting and conserving assets and people. Risk avoidance: Although risk avoidance is practical, not all risks can be avoided. • Text Highlight: Exhibit 8-1 (p. 233) summarizes various risks and appropriate strategies for managing them. • Exercise: Have students suggest methods of determining plans for an insurance program. Also, ask for actions that can be taken to achieve the goals. • Discussion Question: What is the relationship between planning an insurance program and other components of financial planning? • Discussion Question: When does an individual or family know they have enough insurance? • Concept Check 8-1 (p. 236) Risk reduction: You can reduce the risk of injury in an auto accident by wearing a seat belt. Risk assumption: Risk assumption is the act of taking on responsibility for the loss or injury that may result from a risk. Self-insurance is the process of establishing a monetary fund that can be used to cover the cost of a loss. Risk shifting: The most common method of dealing with risk is to shift, or transfer, it to an insurance company or some other organization. Planning an Insurance Program (p. 233) • Because each individual has unique needs and goals—many of which change over the years—a personal insurance program should be tailored to those needs and goals and to the changes they undergo. Step 1: Set Insurance Goals (p. 234) • Your insurance goals should define what you expect to do about covering the basic risks present in your life situation. Each individual has unique goals. Step 2: Develop a Plan to Reach Your Goals (p. 234) • Planning is a sign of maturity, a way of taking control of life instead of letting life happen to you. Step 3: Put Your Plan into Action (p. 235) • The best insurance plan is flexible enough to respond to changing life situations. Your goal should be an insurance program that expands or contracts with the changing size of your protection needs. Step 4: Review Your Results (p. 235) • Evaluate your insurance plan periodically. PROPERTY AND LIABILITY INSURANCE (p. 236) • Although the cost of home and automobile insurance may seem high, the financial losses from which that CHAPTER 8 LECTURE OUTLINE insurance protects you are much higher. Instructional Suggestions • Discussion Question: What type of insurance coverage is more important, property or liability? Explain. • Assignment: Have students research special types of property and liability insurance such as personal computer insurance, trip cancellation insurance, and liability insurance for people who have certain professions. • Discussion Question: What actions could be taken to reduce the high costs of liability insurance for various types of small business owners, such as daycare centers? • Concept Check 8-2 (p. 237) • Current Example: Although nearly half of renters think chances are good that they will lose some of their possessions due to fire or theft, less than 40 percent carry renter’s insurance. The reasons most commonly given by renters for not having insurance are: ∗ It costs too much. ∗ I don’t have anything valuable. ∗ I didn’t know renters could buy insurance. ∗ I’m covered by my landlord’s policy. Potential Property Losses (p. 236) • • Property owners face two basic types of risks. Physical damage may be caused by such hazards as fire, wind, water, and smoke. • The other threat is property loss of use due to robbery, burglary, vandalism, and arson. Liability Protection (p. 236) • Liability is legal responsibility for the financial cost of another person’s losses or injuries. • Negligence is the failure to take ordinary or reasonable care. • Strict liability is present when a person is held responsible for intentional or unintentional actions. • Vicarious liability involves a situation in which a person is held responsible for the actions of another person. PRINCIPLES OF HOME AND PROPERTY INSURANCE (p. 237) • Homeowners insurance is coverage for your place of residence and its associated financial risks, such as damage to personal property and injuries to others. Homeowners Insurance Coverage (p. 237) • • • • • • The main component of homeowners insurance is protection against financial loss due to damage or destruction to a house or other structures. If fire or other damage prevents the use of your home, additional living expense coverage pays for the cost of living elsewhere. Your household belongings, such as furniture, appliances, and clothing, are covered for damage or loss up to a portion of the insured value of the home. A personal property floater covers the damage or loss of a specific item of high value not covered by the personal property policy limits. Personal articles endorsement is additional property insurance to cover the damage or loss of a specific item of high value. In case of damage or loss of property, you must be able to prove both ownership and value. A household inventory is a list or other documentation of personal CHAPTER 8 LECTURE OUTLINE • • • • • belongings, with purchase dates and cost information. Depreciated value is a reduction in the value of an object, based upon its age and the percent it has decreased each year. The personal liability component of a homeowner’s policy protects you from financial losses resulting from legal action or claims against you or family members due to damages to the property of others. This coverage includes the cost of your legal defense. An umbrella policy, also called a personal catastrophe policy, supplements your basic personal liability coverage. Voluntary medical payments coverage pays the cost of minor accidental injuries on your property and minor injuries caused by you, family members, or pets away from home, without determining fault. • ∗ ∗ I’m careful about protecting my belongings. I have enough money to replace anything. · Current Example: While more than 9 out of 10 homeowners have property insurance, only about 4 out of 10 renters are covered. • Current Example: If your property is damaged in an apartment by a fire caused by electrical wiring for which the landlord is responsible, the loss could be the responsibility of the building owner. In this situation, a renter who doesn’t have property insurance may still be able to collect for the damage to the property. • Text Highlight: Exhibit 8-5 (p. 239), property not usually covered by a home insurance policy. • Concept Check 8-3(p. 242) A rider is an addition of coverage to a standard insurance policy. Tenant’s Insurance (p. 240) • Instructional Suggestions For people who rent, home insurance coverages include personal property protection, additional living expenses, and personal liability and related coverages. Protection against financial loss due to damage or loss of personal property is the main component of renter’s insurance. Home Insurance Types (p. 241) • • • To provide the consumer with the coverage best suited to their individual needs, insurance companies offer a number of policy forms. With a named perils policy, only those perils listed in the policy will be covered should a loss occur. With an all-risk policy, should a loss occur, the insured is covered unless the peril was specifically excluded. Exclusions (p.242) • Insurance companies use exclusions to help limit the risks they assure for the policy holder. Pay close attention to them, they are like small print. HOME INSURANCE COST FACTORS (p. 242) • When purchasing insurance, you can get the best value for each premium dollar by selecting the CHAPTER 8 LECTURE OUTLINE Instructional Suggestions appropriate amount of coverage and by being aware of the factors that affect insurance costs. Deductibles (p. 242) l l l A deductible is a fixed sum of money that is stipulated by your policy. The amount is often $100, $250, or $500, and your insurance company will subtract that amount from your claim. In general, the higher the deductible you agree to pay, the lower the premium on your policy. Your deductible should usually total no more than 3 percent of your net worth. How Much Coverage Do You Need? (p. 243) • • • • Your insurance protection should be based on the amount of money you need to rebuild your house, not on the amount you paid for it. In the past, most homeowners’ policies contained a provision requiring that the building be insured for at least 80% of the replacement value. Under this coinsurance clause, the homeowner would have to pay for part of the losses if the property was not insured for the specified percentage of the replacement value. While a few companies may still use a co-insurance clause, today most companies suggest full coverage. With the actual cash value (ACV) method of claim settlements, the payment you receive is based on the current replacement cost of a damaged or lost item less depreciation. Under the replacement value method for settling claims, you receive the full cost of repairing or replacing a damaged or lost item; depreciation is not considered. Factors That Affect Home Insurance Costs (p. 244) • • • • • The location of the residence affects insurance rates along with the construction materials of the building. The policy type you select and the financial limits of coverage also affect the premium you pay. Most companies offer reduced insurance premiums if you have smoke detectors, a fire extinguisher, dead bolt locks, and a burglar alarm system. Studies have shown that you can save up to 25 percent on homeowners insurance by comparing companies. Home insurance rates may be compared using information from Web sites such as www.insuremarket.com. · Concept Check 8-4 (p. 245) CHAPTER 8 LECTURE OUTLINE AUTOMOBILE INSURANCE COVERAGES (p. 246) • • • • All provinces and territories require a minimum automobile insurance coverage. Your policy will protect you from three major financial risks. The risk of injury or death to you as owner and passengers, the possibility of damages, destruction, or theft, and the protection against a third-party liability. A no-fault insurance system provides for drivers in an accident to collect medical expenses, lost wages, and related injury costs from their own insurance company. The main coverages of automobile insurance can be grouped into two categories—bodily injury coverages and property damage coverages. Instructional Suggestions · Text Highlight: Exhibit 8-7 (p. 246): summarizes the major risks assumed by automobile owners, and the protective insurance coverage available. · Text Highlight: the two categories of automobile insurance are shown in Exhibit 8-8 (p. 247). • Discussion Question: What are some arguments in favor of and against mandatory auto insurance? • Concept Check 8-5 (p. 249) Motor Vehicle Coverages (p. 247) • • • • • • • Bodily injury liability covers the risk of financial loss due to legal expenses, medical expenses, lost wages, and other expenses associated with injuries caused by an automobile accident for which you were responsible. Accident benefits cover the costs of health care for people who were injured in your automobile, including yourself. If you are in an accident caused by a person without insurance, uninsured motorist’s protection covers the cost of injuries to you and your family but, in most states, not property damage. Property damage is insurance that covers damage to another’s property, as by an automobile accident. When your automobile is involved in an accident, collision insurance pays for the damage to the automobile regardless of who is at fault. But if another driver caused the accident, your insurance company would try to recover the repair costs for your vehicle from the other driver’s property damage liability coverage. Comprehensive physical damage protection covers financial loss from damage to a vehicle caused by a risk other than collision, such as fire, theft, glass breakage, hail, or vandalism. Other automobile insurance coverages include towing and emergency road service coverage, which pays for the cost of breakdowns and mechanical assistance. You can also purchase waiver of depreciation CHAPTER 8 LECTURE OUTLINE Instructional Suggestions coverage for new vehicles. AUTOMOBILE INSURANCE COSTS (p. 249) • Your automobile insurance cost is directly related to coverage amounts and such factors as the vehicle, your place of residence, and your driving record. The Amount of Coverage (p. 249) • • Every province has laws that mandate automobile liability insurance coverage. Just as medical expenses and legal settlements have increased, so too has the cost of automobiles, making higher amounts of property damage coverage necessary. Automobile Insurance Premium Factors (p. 249) • • • • • The year, make, and model of your automobile have a strong impact on your automobile insurance costs. Your rating territory is the place of residence that is used to determine your automobile insurance premium. Driver classification is a category based on the driver’s age, sex, marital status, driving record, and driving habits; the driver’s category is used to determine his or her automobile insurance rates. The factors used to determine the rate of your insurance premium will vary among provinces. In Quebec, you pay a set premium that is established for a given class of vehicle, rather than depending on your qualifications as the driver. Some drivers have accident records or other characteristics that make them high-risk and thereby unacceptable to standard insurance companies. Having your policy assigned to the high-risk pool mainly means that your premium will be considerably higher. Reducing Automobile Insurance Premiums (p. 251) • • • • Rates and service vary among automobile insurance companies. Among companies in the same area, premiums can vary as much as 100 percent. The best way to keep your rates down is to establish and maintain a safe driving record. Installing devices such as a fuel shutoff switch, a second ignition switch, or an alarm system will decrease your chances of theft and thus lower your comprehensive insurance costs. Increasing the amount of deductible will result in a · Assignment: Have students talk to consumers and insurance agents to determine methods of reducing the cost of auto insurance. · Concept Check 8-6 (p. 252) CHAPTER 8 LECTURE OUTLINE Instructional Suggestions lower premium. CONCLUDING ACTIVITIES • Point out the chapter summary (p. 252) and key terms in the text margin. • Discuss selected end-of-chapter Financial Planning Problems, Financial Planning Activities, and Life Situation Case. • Use the Chapter Quiz in the Instructor’s Manual. CHAPTER 8 QUIZ ANSWERS True-False 1. F 2. F 3. T 4. T 5. F 6. T 7. F 8. T Multiple Choice 9. B 10. A 11. B 12. D 13. C 14. C 15. C 16. A Name ________________________________________ Date____________________________ CHAPTER 8 QUIZ TRUE-FALSE _____1. There is insurance available for every type of risk. _____2. Every liability lawsuit involves an act of negligence. _____3. Homeowners insurance covers the cost of living elsewhere while your home is being repaired from a fire. The only insurance coverage available in Canada for flooding is that caused by sewer back-up. In the event of an accident, bodily injury liability coverage protects both individuals in the driver’s car and people in other cars for medical expenses only. A higher deductible will reduce the amount paid for collision and comprehensive physical damage coverage. It is not important to shop around for a homeowner's insurance company. All companies charge the same rate for homeowner's insurance. An umbrella policy increases coverage. _____4. _____5. _____6. _____7. _____8. MULTIPLE CHOICE _____9. A situation in which a person is held responsible for the actions of another person is a. negligence. b. vicarious liability. c. property damage liability. d. comprehensive coverage. _____10. Renter’s property insurance would include coverage for a. personal belongings. b. structures attached to the main building. c. damages caused by a flood. d. business-related property. _____11. Your neighbor is visiting and falls down the stairs in your home. He has a broken arm and needs 10 stitches in a cut on his head. Which part of your homeowner's insurance policy should cover the cost of his medical treatments? a. Building and other structures coverage b. Personal property coverage c. Additional living expenses coverage d. Collision coverage _____12. Which of the following is not considered a pure risk? a. automobile accident b. fire in your home c. gambling d. illness _____13. Losses caused by damage to your car by another person who is at fault in the accident are covered by a. collision coverage. b. comprehensive physical damage. c. property damage liability. d. assigned risk coverage. _____14. Driver classification includes information on a person’s __________ and is used to set auto insurance rates. a. type of automobile b. place of residence c. driving habits d. credit rating _____15. ___________ is the cause of a possible loss. a. Risk b. Insurance c. Peril d. Hazard _____16. ___________ is the failure to take ordinary or reasonable care in a particular situation. a. Negligence b. Liability c. Property damage d. Fault SUPPLEMENTARY ACTIVITY Do You Face Risks? None of us can escape the possibility of risks in our everyday life. Let us consider how we, individually, may be involved in economic risk—risks that may result in loss of things of value or that may affect our personal health and well-being. A. Divide a sheet of paper into two parts and then print the following headings: Risks that I face B. C. Ways to avoid or reduce the seriousness of each risk On the left side of your sheet, list the risks that might face you during a full week, covering time you spend at school, at home, at work, and during your recreational hours. On the right side of your sheet, indicate how you might be able to prevent these risks or reduce the seriousness of their effects. And indicate in each instance if it would be worthwhile to be protected by insurance. Do You Agree or Disagree With the Following Statements: After each statement, place a check mark in the column you feel is correct. 1. Insurance is made possible because large numbers of people are willing Agree _____ Disagree _____ to share the cost of the same kind of risk. 2. Some of our risks are shared by paying taxes for protection that is provided by local fire and police departments. _____ _____ 3. Most of us can afford to buy insurance to protect us against every possible loss. _____ _____ 4. Well-planned income replacement will provide a family with adequate protection as their needs change. _____ _____ 5. Protection against the loss of income because of illness, accident, or death is obtained by purchasing property and casualty insurance. _____ _____ 6. It is easier to decide how much life and health insurance you need than it is to determine the amount of auto or fire insurance you should carry. _____ _____ 7. If a family is covered by enough insurance, it can prevent or avoid economic risks. _____ _____ 8. Without the responsibility of a family you never have to worry about income replacement. _____ _____ SUPPLEMENTARY ACTIVITY For each of the following types of property and liability insurance, describe a specific situation in which a person would be protected by this coverage. Type of Coverage Additional living expenses An umbrella policy Personal property floater Bodily injury liability Situation Accident benefits Uninsured motorists protection Property damage liability Collision Comprehensive physical damage ANSWERS TO CONCEPT QUESTIONS, OPENING CASE QUESTIONS, FINANCIAL PLANNING PROBLEMS, FINANCIAL PLANNING ACTIVITIES, AND LIFE SITUATION CASE CONCEPT QUESTIONS Concept Check 8-1 (p. 236) 1. What is the purpose of insurance? Insurance is protection. Its purpose is to protect against possible financial loss. (p. 231) 2. How are the most common risks classified? The most common risks are classified as personal risk, property risk, and liability risks. (p. 231) 3. What is the difference between pure risk and speculative risk? Pure risks are accidental and unintentional risks for which the nature and financial cost of the loss can be predicted. Such risks are insurable. Speculative risks entail a chance of either loss or gain. Speculative risks are legally defined as uninsurable. (p. 232) 4. What are the methods of managing risk? Four methods of managing risks are risk avoidance, risk reduction, risk assumption, and risk shifting. Each method has merits, but the most common and most effective method of dealing with risk is to shift, or transfer, it to an insurance company or some other organization. (p. 232) 5. What are the steps in planning your personal insurance coverage? Set your goals, plan to reach your goals, put your plan into action, and review your results. To put your risk management plan to work, you must answer four basic questions: What should be insured, and for how much? What kind of insurance should be bought, and from whom? (pp. 234-236) Concept Check 8-2 (p. 237) 1. What property and liability risks might some people overlook? Many people do not realize the many financial risks associated with homes and automobile ownership. A person could be held responsible for various situations making liability coverage an important financial planning choice. Damage or loss of personal property is another factor to consider. (p.236) 2. How could a person’s life situation influence the need for certain types of property and liability insurance? A person with various financial responsibilities (such as dependents or owning a business) can increase the need for property and liability coverage. (p. 236) Concept Check 8-3 (p. 242) 1. What main coverages are included in home insurance policies? Home insurance includes coverage for the building and other structures, additional living expenses, personal property, and personal liability. (p. 237) 2. What is the purpose of personal liability coverage? Personal liability coverage protects a person from financial loss due to injuries to others or damage to property for which the person is responsible. (p. 241) 3. How does tenant’s insurance differ from other home insurance policies? Tenant’s insurance includes coverage for personal property, additional living expenses, and personal liability. It does not cover the building or other structures. (p. 241) Concept Check 8-4 (p. 245) 1. What major factors influence the cost of home insurance? The main items that affect the cost of home insurance are the location, value, and construction material; the amount of coverage and policy type; discounts for which a person may qualify; and the insurance company’s reputation and service. (p. 244) 2. What actions can a person take to reduce the cost of home insurance? A higher deductible can reduce insurance costs. Also, companies offer insurance discounts to homeowners who have smoke detectors, a fire extinguisher, dead bolt locks, and a burglary alarm system. (p. 245) Concept Check 8-5 (p. 249) 1. What are the main coverages included in most automobile insurance policies? The main automobile insurance coverages are bodily injury liability, accident benefits, uninsured motorist’s protection, property damage liability, collision, and comprehensive physical damage.(p. 246) 2. What is no-fault insurance? No-fault insurance is a system in which drivers involved in an accident collect medical expenses, lost wages, and related injury costs from their own insurance company. (p. 246) 3. How does collision coverage differ from comprehensive physical damage coverage? Collision pays for damage to your automobile when it is involved in an accident, regardless of who is at fault. Comprehensive physical damage covers you for such risks as theft, glass breakage, falling objects, vandalism, wind, hail, or damage caused by hitting an animal. (p. 248) Concept Check 8-6 (p. 252) 1. What factors influence how much a person pays for automobile insurance? The cost of auto insurance is affected by state financial responsibility laws, type of automobile, location, driving record, amount of coverage, age, sex, marital status, and driving habits. (p. 249) 2. What actions can a person take to reduce the cost of automobile insurance? The amount paid for auto insurance can be reduced by comparing companies, maintaining a good driving record, completing a driver training program, using anti-theft devices, increasing deductibles, not using your car to go to work, and insuring several cars with the same company. (p. 251) OPENING CASE QUESTIONS (p. 230) 1. What are some additional factors that would influence the cost of auto insurance for Justin? Some additional factors that would influence the cost of auto insurance for Justin are: the size of the deductible; security devices installed in his car; and possible family discount for insuring with the same insurance company as his parents. (p. 249) 2. What some measures Justin can take to maintain or reduce existing auto insurance premiums? Justin can maintain or reduce his existing auto insurance premiums by maintaining a safe driving record; by increasing his deductible and not making small claims; and by reducing the risk of theft by installing an alarm system or a second ignition switch. (p. 251) FINANCIAL PLANNING PROBLEMS (p. 253) 1. Most home insurance policies cover jewelry and silverware for a limited amount unless items are covered with additional insurance. If $3,500 worth of jewelry and $3,800 worth of silverware were stolen from a family, what amount of the claim would not be covered by insurance? ($3,500 - $1,000) + ($3,800 - $2,500) = $3,800 where $1,000 and $2,500 are the limits for jewelry and silverware respectively. (p.253) 2. What amount would a person with actual cash value (ACV) coverage receive for two-year-old furniture destroyed by a fire? The furniture would cost $1,000 to replace today and had an estimated life of five years. $1,000 - [($1,000 / 5) × 2] = $600 (p.253) 3. What amount would it cost an insurance company to replace a family’s personal property that originally cost $18,000? The replacement costs for the items have increased 15 percent. $18,000 × 1.15 = $20,700 (p. 253) 4. If Carissa Dalton has a $130,000 home insured for $100,000, based on the 80 percent co-insurance provision, how much would the insurance company pay on a $5,000 claim? $4,807.69 = [$100,000/($130,000 x .80)] × $5,000 (p.253) 5. For each of the following situations, what amount would the insurance company pay? a. Wind damage of $785; the insured has $500 deductible. $285 = $785 - $500 b. Theft of a stereo system worth $1,300; the insured has a $250 deductible. $1,050 = $1,300 - $250 c. Vandalism that does $375 of damage to a home; the insured has a $500 deductible. Zero; deductible exceeds loss. (p. 253) 6. Beverly and Kyle Nelson currently insure their cars with separate companies paying $450 and $375 a year. If they insured both cars with the same company, they would save 10 percent on the annual premiums. What would be the future value of the annual savings over ten years based on an annual interest rate of 6 percent? ($450 + $375) × .10 = $82.50 × 13.181 (FVA 6%, 10 years) = $1,087.43 7. Kate Austin currently pays $300 per month for car insurance. When the time arrives to renew her policy, her insurance agent informs her that she could save an additional 15 percent in premium costs if she had a car alarm installed in her car. If the cost of the device is $150 with taxes, what would her net savings be for the year, assuming a monthly interest rate of 0.5%? Monthly savings: ($300 x 0.15 = $45) Annual savings: $45 x {[(1.005)12 – 1] / .005} = $555.10 (note: this accounts for compounding of interest. Ignoring compounding, the savings would be $45 x 12 = $540 Net savings = $555.10 - $150 = $405.10 or ($540 - $150 = $390) FINANCIAL PLANNING ACTIVITIES (p. 254) 1. Survey friends and relatives to determine the types of insurance coverages they have. Also, obtain information about the process used to select these coverages. Students will most likely find that friends and relatives have reasons for purchasing various kinds of insurance coverages that are fairly similar. 2. Locate Web sites that would provide you and others with useful information when selecting and comparing various insurance coverages. Encourage students to start this activity by using the Web sites listed at the end of Chapter 8. 3. Outline a personal insurance plan with the following phases: (a) identify personal, financial, and property risks; (b) set goals that you might achieve when obtaining needed insurance coverages; and (c) describe actions that might be taken to achieve these insurance goals. As students follow the guidelines for a personal insurance plan, their goals will vary according to their age, marital status, income, and household situation. But the steps they will need to take to reach their goals will be very similar. 4. Talk to a financial planner or an insurance agent about the financial difficulties faced by people who lack adequate home and auto insurance. What common coverages do many people overlook? This activity can help to reinforce the importance of home and auto insurance. The trade-off between the relatively low cost of these coverages and potential financial losses is quite extreme. 5. Survey several people about their household inventory records. In the event of damage or loss, would they be able to prove the value of their personal property and other belongings? Maintaining a personal inventory (as described on page 238 of the text) is strongly recommended. Since very few people take the effort to do so, people should at least keep receipts and other proofs of ownership in a safe location. Photos or videos of valuable items can serve as documentation. 6. Contact two or three insurance agents to obtain information about home or renters insurance. Compare the coverages and costs. Students’ responses will vary. (p. 245) 7. Examine a homeowners or renters insurance policy. What coverages does the policy include? Does the policy contain unclear conditions or wording? Students may have access to a policy, or a local agent can supply a sample copy. If a student has an older policy at home, it may be possible to see that format and legal wording have been simplified in recent years. 8. Talk to several homeowners about the actions they take to reduce the cost of their home insurance. Locate Web sites that offer information about reducing home insurance costs. Prepare a video or other visual presentation to communicate your findings. Students will discover to what extent people are aware of home insurance costs and available discounts (see p. 245). 9. Survey several people to determine the types and amounts of automobile insurance coverage they have. Do most of them have adequate coverage? This activity can increase student knowledge of auto insurance costs and coverages. 10. Contact two or three insurance agents to obtain information about automobile insurance. Compare costs and coverages for various insurance companies. It may not be practical to have all students do this activity. Select a few students for this research and have them share their findings with the class. 11. Search the World Wide Web or talk to an insurance agent, obtain suggestions for reducing automobile insurance costs. This activity will assist students with using the Web as a research tool and will provide information to reduce auto insurance costs. LIFE SITUATION CASE We Rent, So Why Do We Need Insurance? (p. 255) 1. Why is it important for people who rent to have insurance? The building owner’s insurance will not cover the tenant’s personal property. Depending on a renter’s personal possessions, their losses can be high. 2. Does the building owner’s property insurance ever cover the tenant’s personal property? The building owner’s property insurance does not cover tenants’ personal property unless the building owner can be proven negligent. 3. What is the difference between cash value and replacement value? Cash value means the insurance company will pay the current value of the item. Replacement value means that the tenant is covered for the cost of replacing the item at today’s prices. 4. When shopping for renter’s insurance, what coverage features should you look for? Most experts recommend that the policy cover your personal belongings and provide funds for living expenses if you’re dispossessed by fire or other disaster. Solution Manual for Personal Finance Jack Kapoor, Les Dlabay, Robert J. Hughes, Arshad Ahmad 9780071320597, 9781259453144

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CH-7-8 The Finances of Housing – Personal Finance : Book Guide

Preview (13 of 42 pages)

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CH-13-15 Investing in Mutual Funds – Personal Finance : Book Guide

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