Personal Finacial Literacy Notes

Modules 4 to 6
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4.1 What is Credit? Credit is using someone else’s money today to purchase something, and paying it back at a later date usually with interest. It’s everything from credit cards to car loans to student loans to business loans to mortgages. Consumer credit refers to the use of credit for the purchase of consumer goods by individuals and families. Consumer credit is basically used by consumers to purchase non-investment goods or services that are consumed and whose value depreciates quickly. This includes electronics, cars, boats, and education loans. A house mortgage is not a consumer credit. Business credit used to start or fund companies or to invest in things like rental homes. Credit is not increased income, a way to buy what you can’t afford, unlimited, or free. It is your financial responsibility and obligation to pay credit back. Credit can be good when used wisely. It can improve a family’s standard of living. For example, most people use credit to buy their homes or cars. The main reason people use credit is they do not have enough cash on hand, and it's easier to pay for a purchase using regular installment payments. Credit can also be very costly. Remember, credit companies are looking to make a profit. You will be charged interest, known as an annual percentage rate (APR), annual fees, late fees, over-limit fees, and penalties if you don’t make timely payments. Secured & Unsecured Credit Secured credit is backed by your home, your car or other property. Car loans, home mortgages and student loans fall into this category. This type of credit has a set interest rate with regular monthly payments for a certain time period. Secured credit is often considered “good” debt because it allows you to build a positive credit history (if you make your payments!). Unsecured credit is only backed by your ability to repay. Credit cards fall into this category, such as VISA, Mastercard, Discover Card and store credit cards. Credit card companies use your credit report to determine how much they will lend you. This type of credit is considered “bad” credit because it is very expensive and if used in excess can keep you from reaching your financial goals. Credit also can be classified as closed-end credit and open-end credit. Closed-End Credit Closed-end credit is a form of credit that needs to be paid in full by a set point in time. Basically, any kind of loans that are paid off in installments are closed-end. Most real estate, auto loans, student loans, and any kind of purchases made in “8 easy payments of $50” are closed-end credit. There are three types of closed-end credit: installment (sales credit), installment cash credit, and single lump-sum credit. Open-End (Revolving) Credit An open-end credit account is one under which you are allowed to make repeated purchases or obtain loans. Credit cards are the most common examples of open-end credit. Another form of revolving credit which became popular in recent years is the “Home Equity Line of Credit” or HELOC. You can borrow up to the limit and pay back all at once or just make installments. One of the benefits of an open ended line of credit is that the credit limit can be increased if the card is managed responsibly! APR The annual percentage rate (APR) is the yearly charge for the money you borrow, and APY is the actual cost of borrowing with compounded interest. The best way to understand the cost of credit is to look at some examples. You already learned about APR and APY in 2.2 What is Interest? Credit Card tore and charges $1000 for a new laptop on her store credit card, which has an APR of 20%. The store has a special offer of no interest for year passes she will owe all the past interest due. She decide this is a good deal, but wants to get a general idea of what the charges would or simple interest outlined in Module 2.2. , and t = 1 year) r on $1000 would be $200. compounding of the interest, but gives LaShay an idea of the penalties for paying late. Unfortunately, it’s not quite as simple as the above example when your interest is compounded. Your cost will be greater than just a simple interest charge on your purchases, especially if you do not pay off your balance in full each month. You will be charged interest on any interest you owe from the preceding month, and any penalties and fees in addition to the actual interest calculation. If you have a good credit rating you will probably be offered a credit card or loan with a low APR. If you are applying for your first credit card or have a poor credit history, your APR will be much higher. The rates can vary anywhere from 3% to greater than 30%. Some credit cards and loans have variable interest rates, which change over time based on the strength of the economy. 4.2 Types of Credit There are four basic types of credit. By uunderstanding how each works, you will be able to get the most for your money and avoid paying unnecessary interest and penalties. Credit Cards A credit card is a thin plastic card, usually 3-1/8 inches by 2-1/8 inches in size with a magnetic stripe on one side. It authorizes the person named on it to charge purchases or services to his account for which he will be billed periodically. It usually contains identification information such as a signature or picture. Today, the information on the card is read by automated teller machines, store readers, and bank and Internet computers. There are many advantages to credit cards. However, credit cards have many pitfalls as well. We will discuss advantages and disadvantages of credit in lesson 4.4. In this lesson we will focus on the cost of credit. The Cost of Credit Credit cards are issued by individual retail stores, banks, or businesses. Bank credit cards, such as American Express, Visa, Discover and MasterCard, may charge a yearly fee and their interest rates vary. Department store credit cards are offered by most major retail stores. They usually don't charge an annual fee but often charge very high interest rates. Although, not all cards are created equal, any credit card purchases can be far more expensive than you think. The following terms and conditions will affect the total cost of credit: Annual Percentage Rate — The APR is the cost of credit expressed as an yearly rate. If you carry a balance even some of the time, a lower APR will cost you less. This may sound simple. However, most credit cards have more than one APR. Different APRs apply to different transaction types and different time periods. Sometimes there is an initial or promotional APR for a limited period of time, followed by higher long term APRs. If your card has an initial or promotional rate, you should pay close attention to exactly when the promotion ends to avoid paying higher interest. Annual Fee — An annual charge similar to a membership fee. Most credit cards do not have annual fees. Finance Charge — The dollar amount paid to use credit, includes interest and all charges associated with the transaction. Grace Period — The number of days you have before a credit card company starts charging interest on new purchases. Not all credit cards have a grace period. Periodic Rate — The interest rate the card issuer applies to your outstanding account balance to figure the finance charge for each billing cycle. Minimum Payment — The amount you must pay every month. If you fail to make a minimum payment, you may be charged a late fee and you will be in violation of your credit card agreement. You may also have your interest rates raised to the penalty APR for all new purchases. One missed or late minimum payment also could mean that you lose your introductory APR and have to start paying the higher long term rate on your existing balance. Other fees - Most credit cards issuers charge a fee for a cash advance, exceeding your credit limit, a foreign transaction fee, and return check fee (if your check, the payment to the credit issuer, is returned by the bank). Each month that you have a balance on your card, your credit card company will send you your statement. It will show both your minimum payment and the due date. You should also bear in mind that paying on time actually means paying at least the minimum before the due date. For more information visit How Credit Card Bills Are Calculated. . Choosing a Credit Card Credit card companies will actively seek you as a credit card user as soon as you are 18 years old. They know that consumers tend to stick with their first credit card and college students have good employment prospects. It is not as simple as choosing a card with the best bonus or rebate. You need to carefully evaluate all the terms and conditions for each card you are considering, especially if you know that sometimes you will not be able to pay the full balance. The longer it takes you to pay off balances, the more expensive the goods and services you purchased. The following factors should be considered to help you select the best credit card:  The credit card interest rate - look for a lower interest rate, but keep in mind that the interest rate is not fixed. The balance calculation method - helps you determine the total cost of credit. Various charges and fees, the length of the grace period. Services and reward programs available.    The terms and conditions for the credit card use are disclosed in the credit card application or contract. Read the fine print before signing. Make sure you fully understand the repayment terms. When you sign a credit card agreement, you are accepting the terms and conditions that come along with it. You are responsible for everything that is written in the contract, whether or not you read it. Your credit card company can change your card agreement. Most significant changes require 45 days’ notice to you. Read your mail and any online messages from your credit card issuer to see if your credit card rates, terms, or conditions are changing. If the card issuer decides to raise your interest rate on new purchases, you have the right to close your account and thereby avoid the increased rate. If the card issuer adds or increases certain fees, you have the right to decline these changes but the issuer may then close your account. In either case, you will still need to pay off your balance to the card issuer. Service Credit Service credit involves paying for services such as cell phones, gas, electricity, and water. The service company advances you the service before it receives full payment. You usually pay a deposit and there are often late charges if your payment is not received on time. Installment Credit Over the course of their lifetimes, many people will find it necessary to apply for installment credit. Installment credit is a type of credit that has a fixed number of payments, in contrast to revolving credit. The borrower takes the goods home in exchange for a promise to pay later. Cars, major appliances, and furniture are often purchased this way. You usually sign a contract, make a down payment, and agree to pay the balance with a specified number of equal payments called installments. The borrower must also pay interest on the principal amount of the loan. The finance charges are included in the payments. The payments must be repaid within a certain specified period of time, which is determined during the origination of the loan. Examples of installment credit include education loan, car loan, home construction loan, home mortgage, and personal loan. Loans Loan – a contractual promise between a borrower and a lender; the borrower agrees to repay a sum of money (generally with interest) in exchange for the lender giving another sum of money. A loan is when you borrow cash, for example, to purchase a home or finance a college education. Loans can be for small or large amounts for a few days or several years. Money can be repaid in one lump sum or with the help of installments (regular payments) until the amount you borrowed and the finance charges are paid in full. Loans can be secured (by your house or car) or unsecured. Home Mortgages A home mortgage is probably the biggest loan you’ll take out in your lifetime. There are many types of mortgages and it’s important to do your homework to see which mortgage works for you, and if you can afford the home you want. The two main types of mortgages are fixed rate and adjustable rate mortgages. A Fixed Rate Mortgage means the interest rate is fixed for the life of the loan, and the monthly mortgage payment remains the same. Fixed rate mortgages are a good choice for first-time homebuyers because they offer a stable monthly mortgage payment, allowing you to adjust to the financial responsibilities of homeownership. There are 15, 20 and 30 year fixed rate mortgages. The longer the length of time, the smaller your monthly payment will be. An Adjustable Rate Mortgage (ARM) has interest rates that areadjustable and not fixed. You could start out with 8% interest, but if market interest rates rise, your mortgage's interest rate will also rise. Your interest rate, and your monthly payment, will increase or decrease at specified points in the loan (1 year, 2 years, etc.). Most consumers find that their rate increases and their monthly mortgage payments go up; a few find their rate goes down, but it could go up again the next year. This type of mortgage can be highly unpredictable and your monthly payments can rise significantly. Just like with any other type of credit, do some research before you take out a loan. Consider the following factors before you take out a loan:       Amount you need and when you can repay. Length of the loan period. Other financial commitment you might have (for example a car payment, rent, bills, etc...). Fees associated with the loan. Interest rate. Customer service (hours of operation, website, etc...). Example: Installment Credit (Car Loan) Rosa has saved $2,000 for down payment on a car, and is actively visiting car dealerships. She sees an advertisement for a new car costing $10,000. The car salesman explains to Rosa that she has two options to put her in the driver’s seat. For the lowest monthly payment, Rosa can opt for a leased car at $165 a month for two years. That's sounds reasonable to her and she can definitely afford it. Rosa tells her family about the lease option, and her mother suggests she work out the numbers on leasing verses purchasing just to be sure this is a good deal. Rosa finds out that purchasing the car costs $195 a month for four years. Both options require a $2,000 down payment. Option 1 - Lease the Car Rosa can lease a car for $165 a month for 24 months, with a $2,000 down payment at lease signing. It looks good, and the monthly payments are low. Let's look at the total cost for 2 years of driving the leased car. Total cost: $2,000 down payment + $3,960 total lease cost ($165 x 24 months) = $5,960 total cost At the end of the 24 month lease, Rosa finds out that she would have to return the car. If she drove too many miles or the car needed repairs, she would be charged extra fees. Option 2 - Purchase the Car with Installment Credit Rosa researched how much it would cost to purchase the car with installment credit, also known as a car loan. She would need a $2,000 down payment, and could finance the other $8,000 with a car loan at 8% interest. That’s $195 a month for four years plus the down payment. Total cost: $2,000 down payment + $9,360 in car payments plus interest ($195 x 48 months) = $11,360 total cost At the end of four years, Rosa would own her car. Which is the better deal? The average new car lasts eight years or 150,000 miles. If Rosa purchases her car, her total cost is $11,360 over four years, and she would have four additional "free" years to drive her car without payments. If Rosa leases her car for two years, the total cost is $5,960. If she leased a car for a total of eight years, that's a total cost of $23,840 ($5,960 x 4 lease periods). Obviously, it is better for Rosa to purchase her car using the installment credit method. 4.3 Credit Reports Your Financial Report Card Just because you want to buy a car or a house doesn't mean that a lender is eager to loan you money. Lenders look at how you have handled your finances in the past before they decide to loan you some money. That's where credit scoring comes in. Credit scoring is a system creditors use to help determine whether to give you credit. It also may be used to help decide the terms you are offered or the rate you will pay for the loan. Your credit report is a key part of many credit scoring systems. A credit report is a record of your credit activities over a number of years. It lists credit card accounts and loans that are open, the balances, and whether payments are made on time. Consumer reporting agencies (CRAs) collect information about your credit activities, stores it in databases and sell it to creditors, employers, insurers, and others. The most common type of CRA is the credit bureau. There are three major credit bureaus that operate nationwide: Equifax, Experian and Transunion. In addition, there are many smaller companies serving local markets. Credit Scores Credit reporting agencies have lots of information in their databases, and it’s difficult for lenders to sort through all of it. As a result, lenders use the information in your credit report to calculate your credit score so they can assess the risk you pose to them before they decide whether they will give you credit. A credit score is a numerical value based on information in a credit report, to represent the creditworthiness of that person. Credit scores are generated by a computer program that looks for patterns, characteristics, and red flags in your credit history. Based on what the program finds, it calculates a credit score. Credit bureau scores are often called "FICO scores" because most credit bureau scores used in the U.S. are produced from software developed by Fair Issac and Company. FICO has been in business since the 1950s but began building the famous FICO score in the mid 1980s. A FICO score can range between 300 and 850. The higher the credit score, the lower the risk. Aiming for a score in the 700s will put you in good standing. A high score, for example, makes it easier for you to obtain a loan, rent an apartment, lower your insurance rate, sometimes even get a job. If you are applying for a loan or some other financial product, your score will also determine what you will pay for that loan or product. The higher the score, the lower the risk for a lender and the greater the likelihood that you will get what you are seeking. A good FICO score can save you tens of thousands of dollars over your lifetime. FICO scores are based solely on credit report data and they are widely accepted by lenders, insurance companies, employers, landlords, and others as a reliable means of credit evaluation. However, more than one score can be used to make decisions about you. There are other credit bureau scores and many lenders use their own credit score in combination with the FICO score. Your credit score may be different at each of the main credit reporting agencies as they use only the data in your credit report at that agency. As your data changes in your credit report, so will any new score based on it. Keep in mind so, that, generally, all your credit history information, good or bad, remains on your report for seven years. If you file for personal bankruptcy, that fact remains on your credit report for 10 years. Each lender has its own strategy to assess risk and they can use additional factors to determine whether to give credit and which interest rates to offer. Your credit score is determined by the following calculation.  Payment history (35%) - the first thing any lender wants to know is whether you've paid past credit accounts on time. This is one of the most important factors in a FICO score. How much you owe already (30%) - having credit accounts and owing money on them does not necessarily mean you are a high-risk borrower with a low FICO score. Length of credit history (15%) - in general, a longer credit history will increase your FICO Score. However, even people who haven't been using credit long may have a high FICO Score, depending on how the rest of the credit report looks. Type of credit (10%) - the score will consider your mix of credit cards, retail accounts, installment loans, finance company accounts and mortgage loans. How many requests for credit have been made (10%) - research shows that opening several credit accounts in a short period of time represents a greater risk - especially for people who don't have a long credit history.     (Source:, March 2013) Credit scores were originally used for lending decisions, but now they are used in other areas of your life as well. Some companies will check your credit report before they hire you, and most apartment complexes will run a credit check before renting to you. Visit The Importance of Good Credit for more information. Five C's of Credit Many lenders look at five factors, called "Five C's" of credit, which are the basic components of credit analysis, before they determine whether to loan you money. Capacity to repay is the most critical of the five factors, it is the primary source of repayment - cash. The prospective lender will want to know exactly how you intend to repay the loan. They will also look at your debts and expenses and evaluate you debt to income ratio. The lower the ratio, the more confident crediters will be that you will repay your loan. For a business loan, the lender will consider the cash flow from the business, the timing of the repayment, and the probability of successful repayment of the loan. Payment history on existing credit relationships - personal or commercial- is considered an indicator of future payment performance. Potential lenders also will want to know about other possible sources of repayment. Capital is your net worth - the value of your assets minus your liabilities. For a business loan creditors will also concider how much money you personally have invested in the business. Banks want to see that you have a financial commitment; that you have put yourself at risk in the company. Collateral, or guarantees, are additional forms of security you can provide the lender. Giving a lender collateral means that you pledge an asset you own, such as your home, to the lender with the agreement that it will be the repayment source in case you can't repay the loan. A guarantee, on the other hand, is just that - someone else signs a guarantee document promising to repay the loan if you can't. Some lenders may require such a guarantee in addition to collateral as security for a loan. Conditions are the number of outside circumstances that may affect the borrower's financial situation. The lender will also consider the current economic conditions and how does your company fit in in case of a business loan. Lenders also will be intersted in the purpose of the loan. Character is the general impression you make on the prospective lender or investor. Lenders look at stability. For example, how long you have been in your current job or how long you have lived at your current address. They will look at your records of paying your bills. For a business loan, the lender will look at your educational background and experience in business and in your industry. The quality of your references and the background and experience levels of your employees will also be reviewed. What is The Relationship Between Credit and Interest Rates? If you aren't careful about your credit, you could end up paying dearly for a low credit score. A poor credit report can mean a lack of credit opportunities, for example, getting a loan for your dream home or dream car. If you get the loan, a low score will make it expensive. As your credit score decreases, you become more of a credit risk in the eyes of lenders. This means even if you are approved for a loan, you will pay a higher interest rate and your monthly payments will jump. On the other hand, people with good credit reports are able to obtain more favorable interest rates and subsequently pay less for what they purchase. Consider the example below. The cost of a three-year auto loan using the different credit scores and corresponding annual percentage rate (APRs). (Source: Checking Your Credit Report It is critical to make sure your credit report is accurate and there is no fraudulent activity. If credit reporting agencies have false information about you, your credit score can suffer. Federal law gives you the right to get a free copy of your credit reports from each of the three national credit reporting companies once every 12 months. The Fair Credit Reporting Act (FCRA) also gives you the right to get your credit score from the national credit reporting companies. Free credit reports do not contain your credit score, although you can purchase it when you request your free annual credit report. They are allowed to charge a reasonable fee, generally around $8, for the score. When you buy your score, often you get information on how you can improve it. Any problems with your credit report should be immediately reported to all three agencies in writing. The company is then responsible for researching and changing or removing incorrect data. This process may take as long as 45 days. The lender who denied you credit must give you the name and address of the credit bureau that produced the credit report. Then, you have up to 30 days to request a free copy of your report. Visit the official website run by the three credit agencies,, for information on ordering your free report. Tip: If you order a credit report from a different agency every 4 months, you can monitor your credit throughout the year for free. . How to Establish Credit o Begin by opening individual savings and checking accounts in your name. Over time, your deposits, withdrawals, and transfers will demonstrate that you can handle money responsibly. o Applying for a loan is another option, but be aware that this method of establishing a credit history will cost, since loans require the payment of interest. You could also apply for department store and gasoline credit cards, which generally are easier to obtain than major credit cards. Before you apply for any credit, however, make sure you understand the terms. For example, how long is the grace period or the time you have to pay the current balance in full before finance charges are added? Is there an annual fee or other fees associated with the credit? If you believe that you will carry a balance, you need to know how finance charges are calculated. Patience is important in this process. It takes time to establish credit and build a record of consistency in making payments to demonstrate your creditworthiness. And it is much better to go slowly and develop a strong credit record than to apply for too many credit cards or a loan that is larger than you can handle. Start slowly, be cautious, keep track of your overall debt, and pay on time. Most importantly, remember that credit actually represents real money and has to be repaid with interest. o o o . How to Protect Credit . Once you have obtained credit, it is necessary to protect it. This means being careful with your credit, debit, and ATM cards, as well as your account and personal identification numbers (PIN). Carry only the cards you expect to use, and keep the others in a safe place. Maintain a list of account and telephone numbers of the companies that issued your cards. Then, if the cards are lost or stolen, you can notify the companies quickly. If your notification is received before the cards are used, you have no legal responsibility for the bills; if it is received after the cards are used, your legal responsibility is $50 for each card  Be cautious about giving anyone your account numbers, especially over the telephone when someone calls you. Save sales receipts to compare with your bill, and when you discard documents with account numbers on them, be certain that the numbers can't be read. If you disagree with an item on a bill, you are responsible for notifying the creditor in writing within 60 days of receiving the bill. You should include your name, account number, the item you believe is in error, and the reasons why.  Click on the Assessment tab. 4.4 Credit Risks & Bankruptcy Credit is a responsibility, not a right. If you're not careful, it's easy to owe large amounts of money in interest and fees. Let's summarize advantages and disadvantages of using credit. Credit Advantages o o o o o Credit pays for goods and services. Can take advantage of sales and large purchases. Can sometimes temporarily help with financial difficulties. You can use goods and services while paying for them. Raises your standard of living without waiting to save to purchase goods and services. Helps establish a credit rating. Can consolidate debts. Can stimulate the economy. Protects against fraud. Sometimes provides free collision damage waiver insurance when renting a car. Provides an interest-free loan if you pay your bill in full every month. Can offer special perks and benefits, like airplane miles. Some credit cards offer protection if a purchased item is damaged or stolen. o o o o o o o o Credit Disadvantages o o o o o Impulse buying is encouraged. Credit costs money. Credit commits future income that may be needed for necessities. Credit makes it easy to overspend. Things may be bought that would not be purchased if one had to pay for them with cash. o o o o Credit tends to discourage comparison shopping. Credit terms and contracts may be hard to understand. Many consumers don't know their credit card interest rate. Consumers may not compare credit card costs and could pay more than necessary for credit. Buying on credit may result in the loss of merchandise and/or income if payments are not made on time. Items purchased may not last as long as it takes to repay the debt. o o Credit Card Pitfalls In addition to understanding the advantages and disadvantages of credit cards, there are also a number of pitfalls you should avoid. Using credit to pay for nondurable items. You may still be paying for an item (such as food or gasoline) long after it is gone or no longer usable. Waiting until the last minute to pay your bill. Send in your payment as soon as your bill arrives if you aren't paying the bill in full. Paying early will reduce your average daily balance, reduce interest compounding, and reduce the total amount of finance charges you will pay. Paying a higher interest rate than necessary. Call the customer service number listed on your credit card statement. Tell them that you have been a satisfied customer, but you have seen several offers for cards with lower interest rates and no annual fee. Ask them to waive your annual fee and lower your interest rate. If you have a good record of making payments, even you make only the minimum payment, the credit card company will often agree to lower your interest rate. If you don't ask, you won't know. Paying only the minimum payment each month. If you have a card with 18.5% interest, it will take you more than 11 years to pay off a debt of $2,000 if you pay only the minimum balance due each month. You will also pay interest charges of $1,934, almost doubling the total cost of your purchases. This assumes, however, you do not add any more purchases to the $2,000 balance. Paying less than the full balance owed on your credit cards can cost you hundreds of dollars a year in interest. Paying the bill late or not paying even the minimum some months. Paying a major credit card on time over several years is the best credit reference you can have. It is even better than a mortgage or car loan because the credit card loan is unsecured and shows that you can be relied on to pay your debts. Always pay at least the minimum and be sure your payment arrives on time. Using a card only because of the perks. Carefully weigh the special bonuses offered at certain stores or with certain cards. With these "co-branded" cards (cards that link a credit card with a business trade name) many people charge more on their card just to get a bonus. They may find that they are charging a lot to gain just a little. Be sure you will really use the extra perks, and you are willing to pay extra for them. If you pay the balance off at the end of each month, however, you could receive extra value for your money. Although if you carry a monthly balance, a card with a lower interest rate may be of more value to you. Forgetting to keep track of your credit card spending and not knowing your credit card limit. Each time you exceed your limit you can be charged an over-the-limit fee. Juggling too many cards. Most people who have their credit under control find that they are able to function quite well with only two or three major credit cards. This makes keeping track of purchases and spending limits much easier. The more cards you have, the less eager creditors are to give you additional credit. If you wish to cancel a card, cut it up and send a letter to the issuer. Ask that they notify the credit bureaus that the card is being canceled at the customer's request. Keep a copy of this letter for your files. Paying a high interest rate on a credit card for a large purchase when you could have borrowed the same amount from a bank or credit union at a lower rate of interest. Paying for unnecessary services. Don't pay for credit card insurance. Instead, photocopy all of your credit cards and indicate next to each card on the photocopy the number to call if your card is lost or stolen. Keep a copy in your safe deposit box and another one at home. Having credit limits that are too high or too many credit cards. Some lenders will deny credit if you have too much credit available. Debt Many people use credit, particularly in times of crisis. The problem, however, starts when people start buying more than they can afford. Borrowing more than you can afford to repay on loans, credit cards and store cards can lead you to debt. If your debt is out of control, advise your lenders immediately of the situation. Contact the credit card company, the department store, the finance house or the bank and explain your problem so you can work out a repayment plan. Take control of your situation: 1. Develop a realistic budget: do a realistic assessment of how much money you take in and how much money you spend. 2. Increase your capacity to repay - find ways to increase your income such as getting another job. 3. Contact your creditors: tell them why it’s difficult for you, and try to work out a modified payment plan that reduces your payments to a more manageable level. Don’t wait until your accounts have been turned over to a debt collector. 4. Learn about The Fair Debt Collection Practices Act (FDCPA), the federal law that governs debt collection. 5. Find out about court installment orders. 6. Get help from a financial counselor. 7. Consider bankruptcy, but only as an absolute last resort. If possible, discuss your options with a financial counselor. Bankruptcy Filing for personal bankruptcy is a big decision and one that will affect your life for years to come. If you owe more than you can pay, you can declare bankruptcy to obtain relief from debt. This is accomplished either through a discharge of the debt or a restructuring of the debt. If you believe you are too deep in debt it is important to first discuss your options with your creditors before you miss a payment. Before filing for bankruptcy, you need to think seriously about the consequences and seek expert help. Your bankruptcy may be reported on your credit report for up to ten years and it can affect your ability to receive credit in the future. Once you file for bankruptcy, you cannot file it again for 8 years. Most people who file for bankruptcy must get credit counseling from a government-approved organization within 6 months of filing. They also must complete a debtor education course to have their debts discharged. Credit counseling must take place before you file for bankruptcy; debtor education must take place after you file. Types of Personal Bankruptcy There are two options for filing personal bankruptcy, Chapter 7 bankruptcy (liquidation of assets and absolvement) or Chapter 13 bankruptcy (repayment of debt). Types of Bankruptcy Chapter 7 Bankruptcy – A trustee is appointed to take over your property. Any property of value will be sold or turned into money to pay your creditors. You may be able to keep some personal items and possibly real estate depending on the law of the State where you live and applicable federal laws. Chapter 13 Bankruptcy – You can usually keep your property, but you must earn wages or have some other source of regular income and you must agree to pay part of your income to your creditors. The court must approve your repayment plan and your budget. A trustee is appointed and will collect the payments from you, pay your creditors, and make sure you live up to the terms of your repayment plan. One of the reasons people file bankruptcy is to get a discharge. A discharge is a court order which states that you do not have to pay most of your debts. However, some debts cannot be discharged. You cannot discharge debts for the following items.       most taxes child support alimony most student loans court fines and criminal restitution personal injury caused by driving drunk or under the influence of drugs Choosing a Credit Counseling Service It’s wise to do some research when choosing a credit counseling organization. If you are in search of credit counseling to fulfill the bankruptcy law requirements, make sure you receive services only from approved providers for your judicial district. Check the list at the U.S. Department of Justice's website or at the Bankruptcy Clerk’s office for the district where you will file. Once you have the list of approved organizations in your judicial district, call several to gather information before you make your choice. Some Questions to Ask      What services do you offer? Will you help me develop a plan for avoiding problems in the future? What are your fees? What if I can’t afford to pay your fees? What qualifications do your counselors have? Are they accredited or certified by an outside organization? What training do they receive?   How do you keep my personal information confidential and secure? How are your employees paid? Are they paid more if I sign up for certain services, if I pay a fee, or if I make a contribution to your organization? Avoid any credit counselors who are not on the approved list, or credit repair companies that charge a fee. Many of these are scams. Visit Coping with Debt for more information. 4.5 Identity Theft Identity theft occurs when someone uses your personally identifying information, like your name, Social Security number, or credit card number, without your permission to commit fraud or other crimes. The Federal Trade Commission estimates that as many as 10 million Americans have their identities stolen each year. In fact, you or someone you know may have experienced some form of identity theft. Identity theft is serious. People whose identities have been stolen can spend hundreds of dollars and dozens of hours cleaning up the mess thieves have made of their good name and credit record. Consumers victimized by identity theft may lose out on job opportunities, or be denied loans for education, housing, or cars because of negative information on their credit reports. They may even be arrested for crimes they did not commit. The potential for damage, loss, and stress is considerable. How do Thieves Get Your Information? Dumpster Diving Thieves rummage through trash looking for bills or other paper with your personal information on it. Skimming Your credit/debit card numbers are stolen using a special storage device when processing your card. Phishing Scammers pretend to be financial institutions, companies or government agencies, and send email or pop-up messages to get you to reveal your personal information. Hacking Computer hackers get into your email or other online accounts to access your personal information, or into a company's database to access its records. “Old-Fashioned” Stealing Thieves steal wallets and purses. Your mail is also at risk, including bank and credit card statements, pre-approved credit offers, and new checks or tax information. They steal personnel records from their employers, or bribe employees who have access. Some identity theft victims even report that their information has been stolen by someone they know. Deter, Detect & Defend Against Identity Theft The Federal Trade Commission suggests using the “Deter, Detect & Defend” strategy to keep yourself safe from identity theft. (courtesy of Review and take notes on the Facts for Consumers handout on the website to view steps you should take if you are a victim of identity theft. Click on the Assessment tab. 4.6 Fraud & Consumer Protection The Federal Trade Commission’s Bureau of Consumer Protection works to protect consumers against unfair, deceptive, or fraudulent practices in the marketplace. The Bureau conducts investigations, sues companies and individuals who violate the law, and develops rules to protect consumers. The Bureau also collects complaints about consumer fraud and makes them available to law enforcement agencies across the country. The Bureau focuses primarily on the following areas of consumer fraud, courtesy of the Bureau of Consumer Protection Responsibilities Advertising Practices Protects consumers by enforcing the nation's truth-in-advertising laws, with particular emphasis on claims for food, over-the-counter drugs, dietary supplements, alcohol, and tobacco and on conduct related to high-tech products and the Internet, such as the dissemination of spyware. Financial Practices Protects consumers from deceptive and unfair practices in the financial services industry, including protecting consumers from predatory or discriminatory lending practices, as well as deceptive or unfair loan servicing, debt collection, and credit counseling or other debt assistance practices. Marketing Practices Leads the Commission's response to internet, telecommunications, and direct-mail fraud; deceptive spam; fraudulent business, investment, and work-at-home schemes; and violations of the Do Not Call provisions of the Telemarketing Sales Rule. Privacy and Identity Protection Safeguards consumers' financial privacy, investigates breaches of data security, works to prevent identity theft and aids consumers whose identities have been stolen, and implements laws and regulations for the credit reporting industry, including the Fair Credit Reporting Act. Billing Errors Have you ever been billed for merchandise you either returned or never received? Has your credit card company ever charged you twice for the same item or failed to credit a payment to your account? While frustrating, these errors can be corrected. It takes a little patience and knowledge of the dispute settlement procedures provided by the Fair Credit Billing Act (FCBA). The law applies to "open end" credit accounts, like credit cards, and revolving charge accounts, like department store accounts. It doesn’t cover installment contracts — loans or extensions of credit you repay on a fixed schedule. Examples of billing errors:      unauthorized charges. Federal law limits your responsibility for unauthorized charges to $50; charges that list the wrong date or amount; charges for goods and services you didn't accept or that weren't delivered as agreed; math errors; failure to send bills to your current address — assuming the creditor has your change of address, in writing, at least 20 days before the billing period ends; In case of a billing error you must:  write to the creditor at the address given for "billing inquiries," not the address for sending your payments, and include your name, address, account number, and a description of the billing error send your letter so that it reaches the creditor within 60 days after the first bill with the error was mailed to you. It’s a good idea to send your letter by certified mail; ask for a return receipt so you have proof of what the creditor received. Include copies (not originals) of sales slips or other documents that support your position. Keep a copy of your dispute letter.  The creditor must acknowledge your complaint, in writing, within 30 days after receiving it, unless the problem has been resolved. The creditor must resolve the dispute within two billing cycles (but not more than 90 days) after getting your letter. If it turns out that your bill has a mistake, the creditor must explain to you — in writing — the corrections that will be made to your account. In addition to crediting your account, the creditor must remove all finance charges, late fees, or other charges related to the error. If the creditor's investigation determines the bill is correct, you must be told promptly and in writing how much you owe and why. You may ask for copies of relevant documents. At this point, you'll owe the disputed amount, plus any finance charges that accumulated while the amount was in dispute. You also may have to pay the minimum amount you missed paying because of the dispute. f you disagree with the results of the investigation, you may write to the creditor, but you must act within 10 days after receiving the explanation, and you may indicate that you refuse to pay the disputed amount. The Federal Trade Commission (FTC) enforces the FCBA for most creditors except banks. If you think a creditor has violated the FCBA, file a complaint with the FTC. The internet is fast becoming a magnet for fraud in advertising, marketing, finances, and identity theft. Review and take notes on the FTC’s Seven Practices for Safer Computing to learn more about fraud on the internet. Reporting Fraud If you are the victim of fraud, you must immediately report it to local law enforcement which will investigate the matter and take appropriate action.. You should also report fraud to the Federal Trade Commission, which collects complaints about companies, business practices and identity theft. When you submit a complaint, it helps the FTC detect patterns of wrong-doing and may lead to investigations and prosecutions. Each individual complaint does not get investigated or resolved by the FTC, but if enough people complain about a certain company then the FTC may investigate. Your complaint will also be entered into a database used by civil and criminal law enforcement authorities around the world, and could help in solving crimes. To file a complaint visit the FTC's Complaint Assistant website. Click on the Assessment tab. 4.7 Buying a Home Purchasing a home will most likely be among your largest and most important investments.Homeownership offers many benefits, but comes with certain responsibilities. Why invest in a home?  It can be a sound investment. As you make mortgage payments over time, you accumulate equity - the term used to refer to your net financial interest in the property. It is the difference between the amount still owed on the mortgage loan and the fair market value of the property. In contrast, rent payments never earn equity. Increasing value. In general, property increases in value over time. This process is known as appreciation. However, real estate value can depend on a number of variables, including the property’s age and location, and appreciation is not guaranteed. Tax advantages. As a homeowner, you can deduct mortgage interest and property taxes from your federal income taxes. Offers generally fixed housing expenses. Unlike rent, which can increase annually, most mortgage loans have fixed or capped monthly payments. This can provide the financial security that comes from knowing what your maximum housing payments (with the exception of property taxes, homeowner’s association fees, etc.) will be from year to year. Gives you control over your environment. Homeownership allows you the opportunity to customize your environment to match your individual tastes and needs. Of course, this also means that you are responsible for all utility costs and the cost of repairs and maintenance on the property. There is no landlord to maintain the property or take care of any problems.     On the other hand, buying a home is a complex, time-consuming, and costly process. It may bring unwanted responsibilities such as maintenance and repairs, additional expenses (property taxes, utilities, homeowner’s insurance), and can possibly create financial hardship. Buying a home is a big decision that requires careful consideration and planning. In this lesson we will discuss procedures for purchasing a home. Let’s get started! Step 1. Assessing Your Financial Situation. You need to know where you are financially to know exactly how much you can afford to spend on a new home. Examine your budget. You can calculate how much you can afford by starting online. There are several online mortgage calculators that will help you calculate an affordable monthly mortgage payments. Visit How much house can you afford? to access a mortgage calculator. You should also take a look at your credit report. This is the time to clean up any past issues and make sure there are no inaccuracies or mistakes. In most cases, a potential homeowner will need to obtain a mortgage loan. To qualify for a mortgage, you’ll need to meet the lender’s credit qualifications (which may vary by lender but you typically need a minimum credit score of 620). If you’re not in that range, you may need to spend time rebuilding your credit or come up with a larger down payment (i.e., 10% vs. 3.5). Mortgage Basics. Mortgage loan is a loan taken to finance the purchase of a house or real estate. Mortgage principal is the amount of the loan required to buy a home. Interest is the fee charged for borrowing the money. Term of the mortgage is the period of time during which the loan contract is active. During this period the borrower makes periodic payments. Since the amount borrowed in case of mortgage is high, their repayment periods are long - usually 15-30 years. Mortgage payment typically includes: Principal, Interest, Taxes, Insurance (homeowner’s insurance and private mortgage insurance if required). If you stop making your mortgage payments, you'll go into default, which means you've failed to meet the terms of the loan and the lender can take back the property (foreclosure). Amortization - amortization is the process of paying down the loan by making mortgage payments. Down payment is the initial payment (usually in cash) made when buying a home. It is not included in the loan amount. Most lenders require five to 20 percent of the purchase price of the home, depending on the type of mortgage loan. The amount of down payment you make will affect your ability to get a mortgage as well as the interest rate and terms of the mortgage loan. Buyers who contribute their own funds to the purchase of a home are considered a better overall credit risk. If your down payment is less than 20%, you will be required to purchasePrivate Mortgage Insurance (PMI). PMI is paid monthly until you build up enough equity in the home. Escrow account. Taxes and insurance are usually held in an escrow account and paid by the mortgage company when they are due (a portion of your monthly payment goes to fund the escrow account). This can be beneficial—especially for first-time buyers or buyers without significant savings—as you set aside a small amount each month instead of having a large, semi-annual or annual out-of-pocket expense. Some lenders require an escrow account and some let the homeowner pay their insurance and taxes directly. Always check with your lender to see what's covered in your monthly payment. Types of mortgage loans Fixed-rate (conventional) mortgage (FRM) – Interest rate remains the same for the life of the loan providing you with a stable and predictable monthly payment. However, interest rates for FRMs typically tend to be higher to cover the risk of a higher market rate for the lender. This mortgage may require a low down payment, sometimes only 3-5 percent of the purchase price. Adjustable-rate mortgage (ARM) – Interest rate is flexible and subject to adjustments—either on specific dates (3-, 5-, 7-year adjustments) or based on market conditions. When interest rates go up, your monthly mortgage payments may go up as well. When interest rates go down your monthly mortgage payments may go down. An adjustable rate mortgage may provide you with a lower rate in the beginning of the loan; however, the payment may increase over time. You can select an ARM with a fixed-rate period for up to 10 years. For more information on other types of mortgage loans visit Step 2. Shopping for a Mortgage Loan. Different lenders will offer different terms, have different requirements, and offer varying levels of service. Consider exploring options from mortgage companies, commercial banks, savings and loan associations, credit unions, and other financial institutions. Remember, while the interest rate you’ll pay is a big factor, it shouldn’t be the only factor. Also consider—the different types of loan options available, their customer service, closing costs, and other fees, etc. This is the largest financial investment you’ll probably make, so shop around. Get pre-qualified for a mortgage loan with a mortgage lender. This involves providing your lender with some basic information—what income you make, what you owe, and what assets you have. They'll look at your overall financial situation and be able to provide you with a preliminary estimate of what loan terms for which you may qualify. You can even take a step further and get pre-approved for a mortgage. This involves completing a mortgage application and providing the lender with your income documentation and personal records. The lender will perform extensive research into your financial history and credit score. You might need the following financial papers to complete a mortgage loan application: names and addresses of all employers for the previous two years, income records (copies of W-2 forms from previous two years, recent pay stubs), a list of your assets (what you own, for example, property, investments, bank accounts), and liabilities (what you owe, for example, auto loans, credit card debt, other mortgages). You’ll usually have to pay a non-refundable application fee. Getting pre-approved for a mortgage loan is an important step in buying a home. First of all, the lender will tell you the precise amount that it is willing to loan to you, so you will be able to begin looking for homes at or below that price. However, you should also take into account your budget as you choose a home. You should look for a home that you can afford, not the one that the bank thinks you can afford. A pre-approval doesn’t guarantee that you can make the corresponding mortgage payments, so you should do the math beforehand. Secondly, getting pre-approved shows sellers that you're a serious and qualified buyer. In addition, when you make an offer, you will more quickly be able to obtain a mortgage, thereby reducing your chances of potentially losing out to another buyer. Step 3. Choosing a Real Estate Professional. All the details involved in buying a home can be confusing. It’s usually recommended that homebuyers work with an experienced real estate professional. Not only will they assist you in your search, but they’ll be able to provide advice and support throughout the process—contract negotiations, financing, home inspections, closing, etc. One of the best sources for finding an agent you can trust is through referrals. Family, friends and neighbors are a great resource for referrals. You can also check out listings in your current or desired neighborhood. Working with a buyer's agent is typically free of charge—the seller will pay both agents (buyer and seller) a commission when the sale closes. However, you should always confirm with your agent. Step 4. Finding Your Dream Home and Make an Offer. Everyone’s idea of a “dream home” may be different, so it is important to formulate a list of the features and benefits you would like in a home. Consider factors such as pricing, location, size, amenities, and design. It often pays to attend several open houses where sellers open up their homes to potential buyers. You can see a variety of options to help you develop a list of your requirements. Your real estate professional will be able to provide guidance and help. If you can’t find a home within your price range with all the features you want, then decide which features are most important to you. Once you have selected a house, you need to make an offer. An offer to purchase is a written preliminary proposal that states what you are willing to pay for the home, the estimated closing date and certain other terms that you might want included in the contract that the buyer and seller need to agree upon. You'll work with your real estate agent to submit an offer, and they'll work with you to determine the best price for the home. Along with this offer you will typically include an earnest money deposit, a nominal amount to show that a buyer is serious about the purchase. This deposit will become part of your down payment.The seller may accept your offer to purchase, reject it, or make a counter-offer. After negotiations are settled and your offer is accepted, a Purchase and Sale Agreement is written up by the broker. It typically contains the following information: the approximate closing date, what property—such as appliances, lighting fixtures—is included, the real estate agent's commission, the amount of the buyer's deposit, the amount of the mortgage that the buyer needs to finance purchase of the house, inspections that the buyer may want to make, what happens if either the buyer or seller backs out of the deal. Because it’s a legally binding contract, you might want your attorney review it before you sign it. Step 5 Home Inspection. You wouldn’t buy a car without taking it for a test drive, the same goes for a home. Having a professional assess and inspect the home will help you know if you are getting what you’re paying for. Once you schedule an inspection, a home inspector will look carefully at the condition of the home, letting you know about any potential problems or necessary repairs. An inspection usually costs a few hundred dollars and is paid for by the buyer. Step 6 Selecting Your Loan. If you have been pre-approved for a loan, the next step is the verification process. During this process, the lender verifies the information on your mortgage application (i.e. income, employment, assets, etc.), the property appraisal is ordered, and the title search is ordered. Once these activities are completed, the lender can then issue a loan commitment. After completing the mortgage application process, your lender will send you a Good Faith Estimate (GFE). The GFE covers almost every expense associated with your home loan. Some of the fees that you will find on the GFE are property appraisal, credit report, lender's inspection, mortgage insurance application, mortgage broker fee, and tax-related service fee. Just remember, that this is an estimate. Closing cost may vary. Step 7 Closing the Deal. Now you are ready to seal the deal and open the door of what will soon be your new home. Your offer has been accepted, the financing is in place, and the inspection is complete. Now, there’s just one more key step in the process—closing! The closing occurs when all the conditions of the contract have been met (full loan approval, evidence of clear title, mortgage insurance is in place, etc.).Prior to the actual closing date, expect to review the list of fees and the terms and conditions of the contract. In addition, you'll need to know the amount that you'll need to bring to closing. Right before your loan closing date, you should receive the HUD-1 (also referred to as the “closing statement” or “settlement sheet”) and it lists all closing costs. Your lender must provide you this form before you close on your mortgage. The HUD-1 itemizes all real estate commissions, loan fees, points, and escrow amounts and provides information about your loan closing. 4.8 Property Appraisal You've found your dream home. The asking price is $400,000 - an amount you've already been preapproved for by your bank. But is the home really worth that amount? This is where the appraisal comes in. Before a lending institution approves you for a mortgage, it wants to know if the property is worth the investment it is about to make. Banks normally have a list of licensed appraisers that they use to determine the market value of a home. Even though the property appraisal is the lender's requirement, it's the borrower's responsibility. You usually pay for it as part of the mortgage cost at the time of closing. The cost of the property appraisal depends on the price of the property. One of the appraisal methods for residential property is sales comparison approach. In the sales comparison approach, the appraiser compares the property with three or four similar homes that have sold in the area. The analysis considers specific components, such as lot size, square footage of finished and unfinished space, style and age of house, as well as other features such as garages and fireplaces. . Steps a qualified appraiser takes: . . It is important to note that, an appraiser is not a home inspector. An appraiser will make note of obvious issues but does not inspect the home to see if it is up to code. For this you will actually need to hire someone to do a home inspection. A home appraisal is more than just another cost added to the buyer's bottom line. It's a protection for everyone involved in the home-buying process. It will help you make a more informed decision about purchasing a home. Although the real estate process can be complex, purchasing your new home can be a rewarding experience. As mentioned in the previous lesson, this is one of the largest and most important investments that you will make in your life. You are looking for more than just a roof over your head. You are looking for a home, a place to express your values and lifestyle, a place to share time with family and friends, a place to retreat at the end of the day. Remember, advanced planning and making sure you have educated yourself regarding the process of buying a home can relieve a great deal of the anxiety and represent the first steps in achieving your dream. The New Jersey Homeowners Security Act of 2002 (NJHOSA) with amendments in 2004, applies to all home loans secured by New Jersey realty or manufactured homes. This law is designed to protect consumers when buying a home. Visit NJ Department of Banking and Insurance for more information. 5.1 What are Taxes? The United States government provides public goods and services for the country as a whole. To pay its bills, the government needs revenue, or a source of income. The money that the federal government uses to pay its bills comes mostly from taxes. Taxes shift resources from private individuals and businesses to the government. Taxes and taxation are often received with mixed emotions. Historically, taxes have been met with rebellion and unrest, patriotism, war, and even voluntary compliance. French tax collectors were sent to the guillotine in 1789. In ancient Greece, tax professionals were revered as the most noble men in society. In Russia, Peter the Great taxed many everyday items including beards (1702), souls (1682), hats, boots, beehives, basements, chimneys, food, clothing, birth, marriage, and burial. The world’s first income tax began in England in 1404, and was so hated that Parliament later had all records of it burned. The first U.S. federal tax office was created in 1862 to raise funds for the Civil War. The first U.S. permanent income tax began in 1913 with the ratification of the 16th Amendment, giving Congress the authority to levy taxes. In 1953, the Treasury Department reorganized the Bureau of Internal Revenue into the modern Internal Revenue Service (IRS). Today, the IRS checks tax returns, collects tax payments, and issues refunds to taxpayers. Electronic filing, available nationwide since 1990, makes filing taxes faster, easier, and more accurate than ever before. Tax Bases The three tax bases that government uses are:  Income (what is earned). Examples are taxes on wages, salaries, commissions, and tips; mandatory taxes for Social Security, Medicare, and unemployment benefits. A person's wealth (what is owned). Examples are property taxes on homes, inheritance tax on wealth passed on from another person. Consumption (what one uses). Example are sales tax on clothes, electronic equipment, books. Taxes on consumption are levied at the same rate for everyone, no matter what a person's income is.   Although taxes teenagers pay are usually at the consumption level, over time you will be contributing based on income and wealth. There are three basic tax structures in the United States: progressive, regressive, and proportional. The tax is considered to be progressive when people who make more money have a higher tax rate, and people who make less money have a lower tax rate. If the opposite occurs and more money is taken from those with low income rather than high income, the tax is said to be regressive. A proportional or flat tax structure is when all individuals are taxed at the same rate regardless of income. The federal income tax is said to be progressive. Tax Levels Basically, the United States government is made up of three layers. These are city (or local) government, state government, and federal government. Taxes are imposed in the United States at each of these levels. The types of tax imposed at each level of government vary, in part due to constitutional restrictions. Income taxes are imposed at the federal and most state levels. Taxes on property are typically imposed only at the local level. Sales taxes are imposed by most states and many local governments. Customs duties or tariffs are only imposed by the federal government. Local government raises money by taxing residents who own property. The city council can also vote on raising a sales tax. The taxes that are raised are used to run schools, maintain roads, and pay for police, firefighters, and other city workers. It is important to know about your local government because it can affect you as a resident. State taxes - a mandatory contribution to finance state government, deducted from paychecks or paid by self-employed persons. Each state has a tax system which collects money, generally, from residents of that state based on their earned income. This money is then used by the state government to fund state and local programs. The largest areas of state spending, on average, are education (both K-12 and higher education) and health care. But states also fund a wide variety of other services, including transportation, corrections, pension and health benefits for public employees, care for persons with mental illness and developmental disabilities, assistance to low-income families, economic development, environmental projects, state police, parks and recreation, housing, and aid to local governments. State departments of revenue collect most state taxes, and collect and distribute local portions of sales and other taxes. The U.S. Constitution authorizes the federal government to collect various types of taxes from individuals.  The income tax is the most common form of federal taxation. The income tax rules allow the government to collect taxes from any person or business that earns money during the year. Gift tax is not as common as the income tax. The federal government imposes a tax when you make certain gifts to another person or entity. The tax only applies to large or high-value gifts you make. Estate tax applies to gifts you make at death, rather than while you are alive. This covers the money and property you leave to your heirs in a will or through some other method.    Employment taxes provide the necessary funds to operate social welfare programs such as Medicare andSocial Security. If you are an employee, you will see these taxes deducted from your paycheck in addition to your federal income tax withholding. The IRS (Internal Revenue Service) is the U.S. government agency responsible for federal income tax collection and tax law enforcement. At the federal level, money taxed on income is spent primarily on Social Security, Medicare, Medicaid, and defense. Individuals are subject to federal graduated tax rates from 10% to 39.6%. Corporations are subject to federal graduated rates of tax from 15% to 35%; a rate of 34% applies to income from $335,000 to $15,000,000. State income tax rates vary from 1% to 16%, including local income tax where applicable. Federal and many state individual income tax rate schedules differ based on the individual's filing status. 2013 Federal income tax brackets. (Source: Our Civic Responsibility The Federal Government collects taxes to pay for the many programs and services we enjoy as residents of the United States. Many of these services are so much a part of our daily lives that we never stop to think of how they are paid for. Schools, public universities, police departments, libraries, roads, bridges, parks, traffic lights, and so much more, are all paid for by taxes. The circle graph below shows revenues and expenditures for the Federal Government for 2008. The tax system in the United States is built on the idea of voluntary compliance. Paying taxes itself is not voluntary, but the government relies on taxpayers to voluntarily declare all of their income. Taxpayers also comply by obtaining the necessary tax forms, providing correct information, and filing their income tax returns on time. Tax evasion is the illegal act of not reporting income, underreporting income, or providing false information to the Internal Revenue Service. When people don’t report their earnings, they are participating in an underground economy. Examples of an underground economy include illegal activities such as gambling, and legal activities such as yard work or baby-sitting. Because these types of income are often unreported, they are not taxed. Unless each taxpayer declares and pays his or her fair share, federal services will suffer and honest taxpayers will have to pay more. There is a way, however, to reduce your taxes. Tax avoidance is lowering your taxes legally by claiming rightful tax deductions, credits and adjustments. This course will review some of the deductions and credits that may apply to teenagers in 5.5 Reducing Your Tax Burden. Review Tax Tutor: Understanding Taxes courtesy of 5.2 Taxes on Income If you’ve ever had a job, you've probably noticed your employer deducts taxes from your pay and you receive less than you earned. Gross pay is an individual's taxable income before any withholding and deductions. Basically, it is what you earned. Net pay is the amount of pay received after all deductions (compulsory and voluntary) have been subtracted from the gross amount. Compulsory deductions are federal income tax, state income tax, Social Security tax, and Medicare tax. Voluntary deductions can include premiums for health insurance and your contributions to a retirement account. Visit the PaycheckCity to calculate your net pay or "take home pay" by entering required information. Make sure to select New Jersey. You can enter any gross pay and keep the number of allowances 0 (zero). Notice the types of taxes and how much are withheld from your paycheck. Pay-As-You-Go Withholding Taxes Income taxes are collected on a “pay-as-you-earn” basis, and the money taken out of your paycheck is called withholding. Withholding is an amount of an employee's income that an employer sends directly to the federal, state, or local tax authority as partial payment of that individual's tax liability for the year. These taxes include federal income taxes, state income tax, and FICA tax (Federal Insurance Contributions Act) for Social Security and Medicare. Employers withhold taxes from every paycheck and send the money to the IRS on the employee’s behalf. At year’s end, this amount should be roughly equal to one’s tax liability, or how much you owe in taxes. If you paid too much tax over the year you get a refund, and if you paid too little you owe the government money when you file your tax return. Withholding benefits you, the taxpayer, and also the government. Without withholding, many would find it difficult to save enough money to pay their income taxes all at once. As well, government services might be disrupted and unreliable without continuous funding. The first pay-as-you-go tax withholding began in 1943 during World War II, and provided a steady stream of tax revenue to the government during wartime. The deductions for income tax can vary from person to person, based on salary and the number of allowances (i.e., dependents and filing status) that are claimed. Employees fill out a Form W4 (Employee's Withholding Allowance certificate) to let their employers know how much withholding to take out of their pay based on the number of allowances (exemptions) claimed. allowances refer to the number of people whom an employee support - including himself or herself. A high school student who works part-time and is claimed as a dependent by a parent might claim 0 (zero) exemptions. A married man might claim 0 when his spouse has claimed him as an exemption. How do self-employed people handle taxes? Since there is no withholding on self-employed earnings, they need to pay quarterly estimated taxes, including Social Security and Medicare, four times a year. Employee Withholding Taxes The Social Security tax is also called the FICA (Federal Insurance Contributions Act) tax. Social Security taxes provide the following benefits for employees and their dependents: retirement benefits, benefits for the dependents of retired workers, and benefits for the disabled and their dependents. The Medicare tax is used to provide medical benefits for certain individuals when they reach age 65. Workers, retired workers, and the spouses of retired workers are eligible to receive Medicare benefits upon reaching age 65. Federal income taxes finance national defense, veterans, foreign affairs, social programs, community development, law enforcement, and interest on the national debt. State and local taxes vary by state and municipalities. New Jersey has a state tax of between 1.4% and 10.75% depending on income level (2010). Other payroll taxes include State Unemployment Insurance (SUI), State Disability Insurance (SDI), and Family Leave Insurance (FLI). View the Tax Tutorial: Payroll Taxes and Federal Income Tax Withholding presentation, then completeSimulation 1: Completing Form W-4 courtesy of Wage Income, Form W-2 Everyone in the United States is required to file a tax return once a year if they earn income over a certain amount. Employers must send Form W-2s to each employee by January 31st, listing an employee's earnings and taxes withheld. If you've had several jobs during the year, you will receive several Form W-2s. A copy of each W2 is also sent to the Internal Revenue Service. Form W-2 (click to review) contains information on your earnings. Pay special attention to Box 1, where your wages are reported, and Box 2 listing how much federal income tax was withheld from your income. Once you receive your W-2, and any other tax forms related to earned interest or your investments, it's time to fill out your tax return. You will need to collect information on yourself, your income, taxes withheld already by your employer, interest earned and much more. Filing Taxes You are responsible for filing your taxes accurately and on-time, by April 15th of the next year. For example, your 2010 tax return is due by April 15, 2011. The form most people use is Form 1040, and there are several versions depending on how complicated your tax return is. Teenagers usually file a Form 1040-EZ because their taxes are simple. You will need to attach a copy of each W-2 you receive to your tax return. You can use a tax professional to prepare your taxes, such as an accountant, or purchase tax preparation software which is both easy to use and accurate. You might also find nonprofit and governmental agencies in your area that provide free tax assistance. All tax forms and information are available online at You can either mail taxes or file online (e-file). If you e-file, refunds can be electronically sent to your bank account. Filing Your Taxes Below is a basic list of actions and decisions you will need to make before filing your taxes. 1. What forms and information do I need to complete my tax return? A W-2 for wages, a 1099-INT for interest, a 1099-DIV for dividends and stock sales, etc. We will discuss the main forms used in this module. 2. Which filing status do I qualify for? Filing status determines the rate at which income is taxed. The five filing statuses are: single, married filing a joint return, married filing a separate return, head of household, and qualifying widow(er) with dependent child. Filing status will be discussed in this lesson. 3. Should I take the standard deduction or itemize my deductions?The standard deduction is a set amount given to everyone who files based on their filing status. This amount is subtracted from your income, and therefore reduces the amount of tax you pay. If you itemize your deductions you can deduct certain expenses like mortgage interest, property taxes, charitable contributions, etc. You have to choose either the standard deduction or to itemize your deductions. This will be discussed more in 5.5 Reducing Your Tax Burden. 3. How many exemptions can you take? An exemption is an amount that taxpayers can claim for themselves, their spouses, and eligible dependents (usually children). There are two types of exemptions, either personal or dependency, and each exemption reduces the income subject to tax. While both are worth the same amount, different rules apply to each. Exemptions will be covered in 5.5 Reducing Your Tax Burden. 4. What credits or other deductions can you take? Deductions reduce your income subject to tax, while credits reduce the amount of tax you pay dollar for dollar. For example, if you owe $500 in taxes and have a $200 credit you qualify for, you only pay $300 in taxes. Credits and deductions will be covered in 5.5 Reducing Your Tax Burden. Of course, filing your taxes involves much more than the four topics above. You should seek the help of a qualified tax professional, or use tax preparation software, to make sure you file correctly. Review the IRS's Tax Tutorial: Wage and Tip Income presentation and complete the Simulation 2: Using Your W-2 to File Your 1040EZ, courtesy of Also, please view the public record of President Barack Obama and First Lady Michelle Obama's 2009 tax return. Filing Status When you file your taxes you need to let the IRS know your filing status, which determines the rate at which your income is taxed. Most teenagers will only be able to choose the "single" filing status. Filing Status Single If on the last day of the year, you are unmarried or legally separated from your spouse under a divorce or separate maintenance decree, you are considered single. Married Filing Jointly You are married and both you and your spouse agree to file a joint return stating your combined income. Married filing jointly taxpayers have the lowest tax rate. Married Filing Separately You are married decide to file separate tax returns. Under very rare circumstances this filing status can be beneficial financially. Head of Household You must be unmarried on the last day of the year, have paid more than half the cost of keeping up your home for the year, and have had a qualifying dependent living with you in the home for more than half the year (usually a child). However, if your dependent is a parent they do not have to live with you. Qualifying Widower If your spouse died during the tax year, you can use married filing jointly as your filing status for that year. In subsequent years you can file as a qualifying widower if you qualify to use that status. Courtesy of Review the IRS's Tax Tutorial: Filing Status courtesy of 5.3 Taxes on Interest Interest is a fee the bank pays for borrowing your money. Banks pay you interest for using your money temporarily until you withdraw it from your account. When you open a savings account, money market account or a CD, the bank uses this money to make loans or other investments. This is different from interest you pay to the bank if you have a loan or credit card, which is not taxed. However, any interest you earn from your savings that can be withdrawn at any time is taxable income. Some interest, however, is tax-deferred (you pay taxes later) or tax-exempt (you never pay taxes on it). Any interest you pay, such as on credit cards or car loans, is not taxed. Interest income is reported to you on Form 1099-INT by your bank, credit union or other agency, and includes the amount of interest received during the year. The bank determines if your interest is taxable or not and will advise you on this form. You are responsible for including your taxable and non-taxable interest on your tax return, and paying any tax owed. While you will need Form 1099-INT to file your taxes, you do not have to attach it to your tax return. The IRS also receives a copy of your 1099-INT from your bank. Types of Interest Taxable Interest Primarily generated by savings accounts, interest-bearing checking accounts, money market accounts, taxable corporate bonds and certificates of deposit (CDs). Tax-deferred Interest Applies primarily to U.S. Savings Bonds, which are not taxable until they are redeemed between 17 and 30 years after purchase. Since you do not have access to the interest until they are redeemed, the interest is tax-deferred until that point. Interest income from Treasury obligations, like U.S. Savings Bonds, are also exempt from all state and local income taxes. Tax-exempt Interest Refers to interest earned on bonds used to finance government operations issued by a state or local government. These are generally referred to as municipal bonds. If you file a tax return, you are still required to show any tax-exempt interest you received on your return even if you don't owe taxes on it. Review the presentation Tax Tutor: Interest Income and complete Simulation: Using Your W-2 and Form 1099-INT to File Your 1040EZ, courtesy of Rates of Return on Interest Your financial plan, (a personal strat for achieving your financial goals thru saving and bugdetting) which we will discuss in Module 7 - Your Financial Plan, will take into account how your rate of return will be impacted by taxes. A rate of return takes into account your interest rate, taxes and inflation. Even if you have a good interest rate, if taxes and inflation are high, youractual interest rate may be much lower. Taxes and inflation can take a big bite out of the interest your earn on your savings. Depending on your situation, you may decide it's more advantageous to purchase tax-deferred or tax-exempt savings options to reduce your taxable income. Example: Rate of Return Let's look at the difference between taxable bonds and tax-exempt bonds in terms of their rate of return. Municipal bonds are tax-exempt, but they offer a lower interest rate. Corporate bonds are taxable, but they have a higher interest rate. We know that taxes reduce the rate of return on taxable bonds, so let's do a comparison of tax-exempt bonds and taxable bonds. Sally purchases a $100 municipal bond with a 6.2% interest rate. John buys a $100 corporate bond which pays 10% interest. They both have an income tax rate of 25%, Which bond will generate the most interest earned after taxes? If they both hold their bonds for one year, Sally will have earned $6.20 in interest, and John $10 in interest. Sally has no tax on her money, so she gets the entire $6.20. John has to pay 25% tax. $10 x 25% tax = $7.50 earned interest John made $1.30 more in interest with his corporate bond. However, if his tax rate had been higher he could have earned less than Sally. You have to look at your tax rate and the bond interest rates being offered before you decide between taxexempt and taxable bonds. 5.4 Taxes on Investments You are taxed on stocks and mutual fund investments in two ways: taxes on investments you’ve sold for a profit, and taxes on dividends distributed by investments you currently own. Most corporations use Form 1099-DIV to report the distributions and dividends you received during the year. This form lists which type of dividend was earned and in what amount. You will need this form when you file your taxes, but you do not have to attach it to your tax return. Dividends Dividends are distributions of property a corporation pays you because you own stock in that corporation, usually taking the form of cash or additional stock shares. Dividends are a result of a company making a profit, which it can then either reinvest in itself or offer to its shareholders in the form of a dividend. There are two main types of dividends -- ordinary dividends and qualified dividends. Both are reported on form 1099-DIV and each has a different tax treatment. Types of Dividends Ordinary Dividends The most common type of distribution from a corporation. They are paid out of the earnings and profits of the corporation. Ordinary dividends are added to your regular income and taxed at that rate, unless they are qualified dividends. Qualified Dividends A type of ordinary dividend that meet the requirements to be taxed as net capital gains. They are not added to your regular income, but taxed as a capital gain at a lower tax rate. Most shareholders have choices about how they manage their dividends. Some investors take the cash directly, while others reinvest their dividends as stock in the same company. Either way, you still owe taxes. Selling Investments with a Gain If you sell a stock or mutual fund for more than you paid for it, you've got a taxable capital gain. A capital gain is the difference between what you paid for the stock and what you sold it for. The amount an investor is taxed depends on their tax bracket and how long they owned the stock. If you hold the stock at least one year before you sell it, the gain will be taxed at a lower rate than ordinary income. The U.S. government offers this lower rate to encourage people to make long-term investments. Types of Capital Gains Short-term Capital Gains Applies to investments held for less than a year before being sold. Any gain is taxed at the investor's ordinary income tax rate. Long-term Capital Gains Applies to stock or other assets held a year or longer. Any gain is taxed at the lower capital gain rate. For most investors this rate is 15%, which is usually lower than their income tax rate. Capital gains are reported on a 1099-DIV. If you sell stock for a gain or loss, you need to attach a Schedule Dwith the details to your tax return. When you fill out Schedule D you will need to include when you purchased the stock, for how much, how many shares, and include the same information for when you sold the stock. Example: Capital Gains Dwayne purchased 100 shares of Bingo Corporation at $20 a share. He held the stock for 2 years and then sold all his shares at $30 a share. What was his capital gain and how will he be taxed? What if he held the stock only 6 months? Original cost of Bingo stock: $20 x 100 shares = $2000 Sales price of Bingo stock: $30 x 100 shares = $3000 $3000 - $2000 = $1000 capital gain Since Dwayne held the stock for more than one year, the $1000 in capital gain will be taxed at the lower capital gains rate. In his case, he will be taxed at 15%. Tax due: $1000 long-term capital gain x 15% = $150 If Dwayne had held Bingo stock only six months before selling, the $1000 in capital gain would be taxed as ordinary income. Dwayne's ordinary income is taxed at a rate of 25%. Tax due $1000 short-term capital gain x 25% = $250 Dwayne saved $100 in taxes by waiting more than a year before selling Bingo stock. Of course, there are many more scenarios for stock sales than the example above. You should speak with a reputable financial manager or stock broker before you buy or sell any stock. Selling Investments at a Loss If you sell a stock for less than what you paid for it, you have a capital loss. On your tax return, you get to deductthat amount from your income, up to $3,000 a year. If your capital loss is greater than $3,000, you can carry the deduction over to future years. If you have both capital gains and capital loss during one tax year, some of the gain is cancelled out by the loss. For this reason, toward the end of each calendar year, there is a tendency for many investors to sell their investments that have lost value. Example: Capital Loss Brittany purchased 4,000 shares of the Peachtree Corporation for $50 a share. The company started to lose money and after two years Brittany decided to sell her shares, which were now only worth $20 each. a) How much will she be able to deduct from her ordinary income as a capital loss? b) How many years will she take this deduction? c) What if Brittany sold another stock for a gain, how would this affect her capital loss? a) How much will she be able to deduct from her ordinary income as a capital loss? Let's figure out what Brittany's capital loss was. Original cost: 4,000 shares x $50 each = $20,000 Sales price: 4,000 shares x $20 each = $8,000 $20,000 (original cost) - $8,000 (sales price) = $12,000 capital loss Brittany can deduct a total of $12,000 from her income in capital loss. But this tax year she can only deduct $3,000; the rest can be deducted in subsequent years. b) How many years will she take this deduction? Brittany will be able to deduct $3000 off her ordinary income for the next four tax years, for a total of $12,000 deducted in capital loss. c) What if Brittany sold another stock for a gain, how would this affect her capital loss? During the same tax year, Brittany also sold Appletree Company stock for a long-term capital gain of $20,000. Since she also had a capital loss that year, she can subtract her $12,000 capital loss from the gain. $20,000 capital gain - $12,000 capital loss = $8,000 capital gain Brittany now only needs to pay taxes on $8,000 in long-term capital gain. The rest of her capital gain was erased by her capital loss. 5.5 Reducing Your Tax Burden The United States tax code allows for many ways to reduce the amount of income tax you pay, primarily through tax deductions, tax credits and exemptions. A tax deductionlowers the income on which tax is figured, while a credit lowers the tax owed itself. Tax credits usually save you more money than deductions. Tax exemptions usually reduce your taxable income based on how many people live in your household, although there are some exceptions. Most taxpayers qualify for all three reductions. The government allows these special tax treatments to support or encourage behaviors, education, spending patterns, and lifestyles considered desirable. Saving Through Tax Deductions One way to reduce the amount of tax you owe is through tax deductions. Simply put, these deductions are subtracted from your income, so they reduce the total amount of tax you pay. Most taxpayers have a choice of either taking a standard deduction or itemizing their deductions. Tax Deductions Standard Deduction A set amount given to everyone who files based on their filing status. This amount is subtracted from your income, and therefore reduces the amount of tax you pay. Itemized Deductions Instead of taking the standard deduction, you choose to subtract certain other deductions, such as medical care costs, mortgage interest, state taxes, charitable contributions, etc. If you own a home, it's usually better to itemize your deductions rather than taking the standard deduction. You can only choose one deduction option, either the standard deduction or itemized deductions. Whether you choose to itemize deductions on your tax return depends on how much you spent on certain expenses last year. Money paid for medical care, mortgage interest, state and local taxes, charitable contributions, casualty losses and miscellaneous deductions are all considered itemized deductions. If you add up all the allowable itemized deductions and this amount is greater than your standard deduction, then it is beneficial to itemize your deductions. You get to deduct the entire itemized amount from your income. Teenagers usually choose the standard deduction because they don't have significant itemized deductions. Standard Deductions for 2009 o o o $5,700 for Single taxpayers $11,400 for Married Filing Jointly $8,350 for Head of Household (taxpayer plus one or more dependents, usually children) o o $5,700 for Married Filing Separately $11,400 for Qualifying Widow(er) Standard Deductions for Dependents The IRS has special rules for dependents (usually children) that file their own tax returns because of interest income, but are also claimed on their parents' or another person's income taxes. If dependents have interest income of more than $300, their standard deduction is modified to take that into account. The IRS does not want parents hiding their money in bank accounts under their children's names, so there are special rules for dependents with interest income.  If the dependent earned less than $950, it doesn't matter what the combination of interest income and wages are, they can take a $950 standard deduction and not pay any taxes. If the dependent only earned wages, with interest income of less than $300, they get the full standard deduction of $5,700 with the single filing status. This scenario applies to most teenagers who work summers and file taxes, but are also claimed on their parents' tax returns at dependents. If the dependent has interest income greater than $300, they can only count the first $300 of it towards their standard deduction. The rest will be taxed.   Example: Standard Deduction for Dependents Sandra earned $2,500 last year working at a restaurant over the summer. She also has a savings account that earned $600 last year in interest. She is claimed as a dependent on her parents' tax return. What standard deduction can Sandra take? Sandra's total income is $3,100. Sandra can include wages of $2,500 + plus $300 in interest, for a total standard deduction of $2,800. The rest of Sandra's interest income is taxable. $3,100 - $2,800 = $300 taxable income Even though Sandra's total income of $3,100 is less than the standard deduction for singles of $5,700, since her interest income is more than $300 her standard deduction is reduced. Example: Standard Deduction Jayden earns $6,500 at a fast food restaurant in 2009. He has no interest income and is a dependent of his parents. If Jayden chooses the standard deduction for singles, he can subtract $5,700 from his income. He does not have any itemized deductions. Jayden's Income $6,500 income - $5,700 standard deduction = $800 income subject to tax Jayden now only owes taxes on $800 in income. The standard deduction reduced the amount of his income subject to tax. Since his tax rate is 10%, he will only owe $80 in tax. $800 income x 10% = $80 in tax Example: Itemized Deductions Patrick and Carol have always chosen the standard deduction when filing their taxes. However, last year they bought a house in Middletown, NJ, and think they might be able to reduce their taxable income more by itemizing their deductions. They added up their property taxes, mortgage interest and charitable contributions, for a total of $16,500 in itemized deductions. Their income is $67,000 and their standard deduction, if they choose to use it, is $11,400. Itemized deductions: $67,000 - $16,500 = $50,500 income subject to tax Standard deduction: $67,000 - $11,400 = $55,600 income subject to tax They will pay tax on less income if they itemize their deductions. There are a number of other additional deductions available such as moving expenses, student loan interest, and educator expenses (different from education credits). All of these deductions can be taken in addition to the standard or itemized deductions you take, and further reduce the amount of income you pay tax on. Review the IRS's Tax Tutor: Standard Deduction courtesy of the Saving Through Tax Credits Another way to reduce your tax burden is to use tax credits. A tax credit is a sum deducted from the total amount a taxpayer owes to the government. A tax credit may be granted for various types of taxes, such as an income tax or property tax. It may be granted in recognition of taxes already paid, as a subsidy. Tax credits generally save you more in taxes than deductions. Deductions only reduce the amount of your income that is subject to tax, whereas, credits directly reduce your tax bill. For example, if you complete your tax return and owe $1000 in tax, but qualify for a tax credit of $300, then the tax you owe is reduced to $700. Although some credits are available to people at all income levels, others have income restrictions. Tax Credits Some of the tax credits offered are:       Dependent children (Child Tax Credit) Child care expenses (Child Care Credit) Saving money in savings accounts (Saver's Credit) Going to college (Education Credits) Energy-saving improvements to your home (Energy-Saving Tax Credit) Earning income under a certain amount (Earned Income Credit) There are many other less common credits available as well. As incentive for taxpayers to protect the environment, the federal government offers a credit for the cost of purchasing solar panels and wind turbines for use in your home or for when you install energy-efficient windows. To help families wanting to adopt a child, the federal adoption credit can reduce your tax bill for the costs you incur that are necessary to adopt a child. Teenagers do not usually qualify for tax credits, although their parents may get Education Credits for costs related to their education. Example: Tax Credits Lynn's parents, Sue and Bob, earned $80,000 last year and filed a joint tax return. After reviewing their tax situation they found they owed $8,500 in tax. During the year the amount of $7,200 in federal taxes was taken out of their paychecks by their employers. They are responsible for the rest of the taxes owed ($8,500 - $7,200 = $1,300). However, Lynn is attending Rutgers University and they are entitled to an Education Credit in the amount of $2,400. How will the Education Credit impact the amount of taxes they owe? Sue & Bob's Taxes $8,500 Sue & Bob's taxes owed - $7,200 Sue & Bob taxes paid to federal government from paycheck withholding $1,300 amount owed in taxes Education Credit of $2,400 $1,300 taxes owed by Sue & Bob - $2,400 in Education Credit $0 taxes owed The Education Credit reduced their taxes owed to zero. Complete the IRS's Simulation: Tax Credit for Child and Dependent Care Expenses, courtesy of Tax Exemptions An exemption is an amount a taxpayer can claim for themselves, their spouses, and eligible dependents (usually children). Tax Exemptions reduce your taxable income based on the people you support, with restrictions. Generally, you can deduct $3,650 for each exemption you claim (2009). There are two types of exemptions, personal exemptions and dependent exemptions. Exemptions Personal Exemptions You can claim yourself and your spouse as a personal exemption. You can take $3,650 for each off your income. Dependent Exemptions Dependents are usually your legal children under age 19 who live with you, or full-time students under age 24. You must also provide greater than 50% of the child's financial support. Certain other people may qualify as dependents, such as an aged parent who you support, a disabled child of any age, or an unemployed friend or relative who lives with you. There are strict rules, however, for these uncommon situations. If your parents claim you as their dependent, you cannot claim a personal exemption on your tax returns. Most teenagers cannot claim their own personal exemption for this reason. Even as a dependent, however, teenagers still qualify for the standard deduction. 6.1 What is Insurance? Most of us work hard to buy a car, a house, or increase our savings. A disaster can strike at any time or place, and there is always a risk of losing what we have. Risk is the exposure to the chance of injury or loss. Life is about risk. All choices can involve risk and accidents can happen no matter how careful one is. Such events as hurricanes, tornadoes, fires, car accidents, and illnesses can be beyond our control. Sometimes our own behavior causes bad things to happen: not locking up your bike, car, or apartment; not wearing a helmet when you are riding a bike or a motorcycle; not wearing a seatbelt when you are driving a car. Making a habit of high-risk behavior will eventually catch up with you and may wrack your financial goals. Losing a house in a fire, replacing stolen items, or paying hospital bills, can leave us devastated not only emotionally but financially as well. Even so, it is not always possible to control risk, your behavior can frequently increase or decrease the potential of negative outcomes. Whether you are doing something to increase your risk, trying to avoid situations that involve a risk, or just going about your daily life, you can take steps to protect yourself, your family, and your financial assets. Risk management refers to how you deal with the chance of potential personal or financial loss. Risk Management Tools  Avoiding risk means you choose not to act on a risky behavior. For example, if you do not know anything about running a business, you can avoid the risk associated of owning one by working for someone else. Reducing risk is a more practical option. Reducing risk lowers the severity of loss or likelihood of loss occurring. Wearing protective gear when you are skiing, snowboarding, or skateboarding, wear a seat belt while driving a car, and installing smoke detectors are all examples of reducing risk. Accepting risk of loss, or choosing to self-insure is a good strategy for small risks where the cost of insuring against the risk will be greater over time than the total losses sustained. For example, you buy a new refrigerator and instead of taking out a warranty, you put some money aside to cover repairs if needed. Chances are you'll never need to get your refrigerator repaired, so you've saved money on purchasing a warranty, and you'll also have funds set aside just in case. Sharing (or transferring) risk is most often achieved by purchasing insurance. Many people choose this approach to manage big financial risks. The insurance policy you purchase by paying a premium protects you from catastrophic loss based on the plan you choose. It takes time and money to recover from big expenses, and most people do not have sufficient funds to manage. You might pay a premium to your insurance company for years and never use it, but having insurance gives a sense of peace and security because you never know when you might need it. Purchasing insurance can be optional. In some other instances, purchasing insurance is legally required - car insurance is one example. To play some high school sports, a form of group medical insurance may also be necessary.    What Can You Insure? You can insure just about anything -- singers can insure their voices, dancers can insure their legs against injury, major sporting events organizers take out policies against weather or other disasters -- the list goes on and on. The most common types of insurance are auto insurance, health insurance, homeowners insurance, life insurance, property insurance (boat, RV), and disability insurance if you get sick or injured. Other examples of insurance are malpractice insurance for doctors, travel insurance for travelers, even pet health and wedding insurance. Sometimes insurance can be a legal requirement, like auto insurance in most states. If you have a mortgage on your home, you are usually required to maintain adequate homeowner's insurance. Insurance Basics Insurance is a way to protect yourself and your investments. For example, if your house gets flooded in a storm and you don't have flood insurance, you might end up with no money to fix your house and no place to live. If you have insurance you can fix your house, or even build a new house. It may sound too good to be true, but insurance does come with a cost. When you purchase insurance you sign a contract, insurance policy, with the insurance company. The contract outlines the insurance company's responsibilities and your financial obligations, such as your premium and deductible. Contract Contents Coverage What damage the insurance company will pay for. Insurance companies are very detailed about what they will cover, so read the fine print of any contract you sign. Premium The amount paid by the policyholder for a contract with the insurer. Premiums are usually paid monthly or yearly. Deductible An amount of money you pay before your insurance company pays. If your deductible is $500, you pay the first $500 of any insurance claim. If your claim is less than $500, you pay the whole amount yourself. This deductible applies to each claim you file. Term The length of the contract. Miscellaneous Other details associated with the policy. Some people include additional insurance options at increased cost. For example, homeowners can include extra insurance for expensive jewelry, pools and other equipment not usually found in a home. Another option is insuring the replacement value of the contents of your home, meaning if your property gets damaged you get to purchase new items instead of only receiving the value of your used items. How can an insurance companies pay large amounts of money when they only receive relatively small premiums from customers? Insurance companies often have millions of policyholders who pay premiums, and they pool the collective risk. Most of the policyholders will never use their insurance, so many people pay for the losses of a few. Insurance companies allocate some funds to pay off claims, and the rest of the money is invested in stocks, bonds, and other financial products. This is how insurance companies make their profits. Example: Homeowner's Insurance Lisa recently bought a home and signed a homeowner's insurance contract with Fantastic Insurance Company for $500 a year. Her policy covered theft, fire, flood and accidental damage due to weather, and the deductible was set at $1000. Lisa chose a higher deductible in order to keep her yearly premium costs down. She also chose to add on replacement value for her home and its contents for an additional $125 a year. This means if the items in her home are damaged under the terms of the contract, they will be replaced with new items. For example, if Lisa's patio furniture gets destroyed by a falling tree, she gets new furniture rather than only the cash value of her used patio set. Her total premium for the year was $625. Three months after moving into her home, Lisa's house caught on fire and burned down. She lost everything. She was very grateful to have included the replacement value option in her policy. Building a new home for Lisa will cost $200,000, and her furnishings and personal possessions will cost $75,000 to replace. Her deductible is $1000, so that will be subtracted from the insurance payout. Total insurance payout is $200,000 + $75,000 - $1000 deductible = $274,000 If Lisa didn't have the replacement value option, she would have only received $30,000 to replace her furniture and personal belongings instead of $75,000. For the extra $125 a year to get replacement value, she got back $45,000! . Reducing Your Insurance Cost Purchasing insurance is an economic decision involving costs and benefits, and it is based on an individual's assessment of risk. The cost of your insurance policy will depend on many factors, such as a coverage limit and deductible. There are several strategies you can use to lower your insurance cost.  Choose a reasonable coverage limit. Ask the insurance company for a reasonable amount of your coverage for your situation. Higher deductible means lower premium. You will pay more if there's an incident, but your premiums will be lower through the year. Shop for your insurance policies. Sometimes you can save hundreds of dollars on the same coverage. Ask your insurance agent if there is anything yo can do to lower your risk, which will reduce your premiums. For example, having anti-theft systems can reduce your homeowner's insurance cost. Health and life insurance companies often offer better rates to nonsmokers.    Keep in mind that by reducing the coverage and taking higher deductibles you are assuming more financial responsibility. Make sure that your insurance deductible is not higher than the maximum amount you can afford to pay if you had to make a claim tomorrow. Look for an insurance company that has a reputation for good customer and claims service. Ask friends and family their opinions of the insurance company you are looking at. You can also check consumer web sites that sometimes rate how well insurance companies serve their clients. 6.2 Auto Insurance Everyone who drives needs car insurance. There are more than 6 million car accidents in the United States every year costing more than $230 billion dollars. The consequences of car accidents, such as injuries, death, and property damage, can leave the victims and their families devastated. Even a minor car accident can empty your savings account. If you hurt someone else while driving, there is no limit on how much they can sue you for. Driving without auto insurance is against the law in New Jersey. The consequences of being found guilty of driving without an auto insurance in New Jersey are severe: large fines, community service, license suspension up to two years, “insurance points”, and possible imprisonment. The law can impose liability upon the owner of the car, even if he was not driving it. Most states, like New Jersey, require some kind of auto insurance and minimum requirements vary from state to state. However, state-required minimum limits could leave you less financially protected than you want to be. If you have an auto loan or lease, a lender might also require additional collision and comprehensive coverage. Auto insurance costs a lot of money, but it can cost you a lot more if you don't have good coverage. After all, it is all about protecting yourself financially. Basic Auto Insurance Coverage Options Liability (in insurance) means responsibility for damages caused. Auto insurance includes two types of liability coverage: Bodily Injury Liability and Property Damage Liability. Bodily Injury Liability Pays for claims and lawsuits by people who are injured or die as a result of an accident you cause. It compensates others for pain, suffering and economic damages, such as lost wages. This coverage is typically given as two separate dollar amounts: (1) an amount paid per individual and (2) an amount paid for total injuries to all people injured in any one accident that you cause. Bodily Injury Liability does not cover expenses for you or family members listed on your insurance policy. Property Damage Liability Pays for claims and lawsuits by people whose property is damaged as a result of an auto accident you cause. These coverages can sometimes be purchased as a combined single limit, which offers a maximum limit of protection per accident of bodily injury and property damage liability combined. Property Damage Liability does not cover your car or property, or that of the family members listed on your insurance policy. Personal Injury Protection (PIP) Pays medical expenses, sometimes even lost wages, for you and other people under your policy regardless of fault. It is sometimes called no-faultcoverage because it pays your own medical expenses no matter who caused the auto accident. PIP has two parts(1) coverage for the cost of treatment you receive from hospitals, doctors and other medical providers and any medical equipment that may be needed to treat your injuries and (2) reimbursement for certain other expenses you may have because you are hurt, such as lost wages and the need to hire someone to take care of your home or family. If the accident is caused by another driver and you are not at fault, your insurance may seek reimbursement from the other driver's bodily injury liability insurance coverage if your medicals costs reach a certain threshhold. Collision Coverage Pays for damage to your vehicle as the result of a collision with another car or other object. Collision coverage pays you for damage that you cause to your automobile. You can also make a claim under your own collision coverage for damage to your car from an auto accident you did not cause. This may take less time than making a property damage liability claim against the driver who caused the auto accident. Your insurer then seeks reimbursement from the insurer of the driver who caused the auto accident. Collision coverage is usually the most expensive type of coverage, and most policies include a deductible. For example, if your deductible is $500, you will have to pay the first $500 towards any repairs and the insurance company will cover the rest. Standard policies cover repairs to up the fair market value (FMV) of your vehicle. If the repairs exceed the FMV, your vehicle will be declared totaled and you will get a check for the vehicle's fair market value. Comprehensive Auto Insurance Coverage Pays for damage to your vehicle that is not a result of a collision, such as theft of your car, vandalism, flooding, fire or a broken windshield. Comprehensive coverage also pays if you collide with an animal. This type of insurance, just like collision coverage, often includes a deductible and the damage is paid up to the fair market value. Uninsured/Underinsured Motorist Coverage Uninsured Motorist Coverage pays you for property damage or bodily injury if you are in an auto accident caused by an uninsured motorist (a driver who does not have the minimum level of insurance required by law). Claims that you would have made against the uninsured driver who caused the accident are paid by your own policy. Uninsured motorist coverage does not pay benefits to the uninsured driver. Underinsured Motorist Coverage pays you for property damage or bodily injury if you are in an auto accident caused by a driver who is insured, but who has less coverage than your underinsured motorist coverage. When damages are greater than the limits of the other driver's policy, the difference is covered by your underinsured motorist coverage. Definitions courtesy of the NJ Department of Banking and Insurance. There are a number of additional options available to supplement basic auto insurance coverage. These options, such as towing, road service, and rental car coverage when your vehicle is immobilized due to an accident, will add to your insurance premium. To learn about auto insurance in NJ visit the NJ Department of Banking and Insurance and the NJ Motor Vehicle Commission. Purchasing Auto Insurance As you can see, auto insurance can be very complicated. Make sure you talk to an insurance agent about how much coverage you need. The cost of car insurance rates vary widely. People shopping for car insurance should contact several companies and ask for rate quotes, so they can get the best deal. You might choose to buy through a local insurance agent who can give you advice on coverage and can help you if you have a claim. Or you might get rate quotes and buy your insurance over the phone or online. The auto insurance company will ask you a series of questions and provide a quote of its best estimate of how much they will charge you for one year of car insurance. This quote is based on your risk factors, which can significantly affect your auto insurance premium. It's important to be aware of these risk factors so you can minimize their impact. Risk Factors Age Statistically, drivers under the age of 25 are at greater risk of being in an accident than those over age 25. Marital Status A married person usually pays less than a single person with an identical driving record. Location People living in urban communities tend to have higher premiums than people living small towns and rural areas, because of heavier traffic and more car accidents. How often you use your Car The more you drive, the bigger the odds of a car accident, therefore you will pay a higher premium. Most insurers will ask how many miles you drive for your daily commute to work. Type of Car The more expensive car you have the more money the insurance company will have to pay for damages or replacement, therefore your insurance premium will be higher. You will also pay a higher premium for a car model that is statistically shown to be involved in more car accidents, such as sports cars. However, you may also qualify for safety feature discounts, for example, for antilock brakes and antitheft equipment. Driving Record Speeding tickets, reckless driving, driving while intoxicated (DWI), and any other traffic violations will result in higher premiums. Some insurance companies will count these violations against you for as long as five years from when the incident occurred. Therefore, keeping your driving record clean will save you money. Your auto insurance premium may also depend on you credit history, education, and occupation. Once you decide on a company, you will be asked to fill out detailed application form. If the insurance company accepts your application, you will be issued a policy explaining what is and what is not covered, and the premium. Items that are specifically listed as not being covered are called exclusions. An example of exclusion is personal belongings and any equipment not permanently installed in the vehicle. Auto insurance is generally paid twice a year. However, for a small additional fee, most companies allow smaller payments, either monthly or quarterly. Do you only need the required minimum coverage or would additional coverage be beneficial? It is always important to weigh the benefits versus the cost. Let's look at some of the things you should consider before purchasing auto insurance. It's also important to understand your policy and its terms before you sign any contract. Reducing Your Auto Insurance Costs Amount of Coverage Before you buy auto insurance you need to decide how much coverage you need. If you buy more coverage than you need, you may be paying more than you have to. Comparison Shop When it comes to buying auto insurance, there are a wide range of choices. You can check local insurance companies or go online and compare prices and policies of major insurance companies. If you are requesting an insurance quote online and providing personal information, be sure you are on a secure web site. Discounts Ask about all possible discounts. Some insurance companies offer a good student discount, multiple car and drivers discount, or discounts for clients who take a defensive driving course. Deductibles You can make certain deductible choices to reduce your insurance premium. A higher deductible and lower Personal Injury Protection often means lower premiums. For example, if you have a $500 deductible on your collision insurance, that means you pay the first $500 of any repair costs. However, if you raise this deductible to $1000 your premium could be significantly less, although if you do have an accident you'll pay more yourself. Keep Your Driving Record Clean Many companies offer a discount if you are accident-free for a certain length of time. Also, speeding and other moving violations can raise your rate. It pays off to be a careful driver. If your insurance company drops you and you can't find other insurance, there is another option. Each state has created a risk pool for eligible high-risk drivers. All auto insurance providers have to participate in the program. Insurance premiums for assigned-risk pools are higher than what you might otherwise pay. Contact the NJ Department of Banking and Insurance if you find yourself in this situation. Visit the Auto Insurance Purchasing Planner by the NJ Department of Banking and Insurance. Assigned-Risk Policies If you have had speeding tickets or caused some accidents in the past you might find yourself in the situation where none of the insurance companies you contact will accept you. How can you register and drive your car in this case? You probably will have to get insurance from your state's insurer of last resort - the assigned-risk pool.An assigned-risk auto insurance policy is one that covers high-risk drivers. Every company that sells auto insurance in your state must participate in the program. Assigned-risk insurance policies are very expensive. The number of driving violations determines the rate that the driver will pay. Try to maintain a perfect driving record for several years, so you can get out of the assigned-risk pool and qualify for regular insurance. Car Accidents If you are in a car accident make sure you are safe first. In case of a minor accident, move the vehicle off the road. If the car cannot be moved or is someone inside is injured, turn off the ignition and turn on the hazard lights. Call the police and ambulance, if appropriate. Contact your insurance agent as soon as possible. You will have to file a claim requesting benefit payments according to your policy. Providing accurate details can speed up the process. Be honest with your insurer, as the failure to do so may result in your policy being canceled, or even legal prosecution. Depending on the accident and the insurance company, the claim may be processed by an insurance agent or an insurer’s claims adjuster. You may need to provide the claim adjuster with documentation such as copies of your auto repair and medical bills, or a copy of the police report to support your claim. As a result of the investigation, your insurance company will make a decision regarding what will be covered and how much it will pay. 6.3 Home and Property Insurance Whether you’re a homeowner, condo owner or renter, home and property insurance (or renter's insurance) protects furnishings, clothes, appliances and most personal possessions from theft, fire, damage. You might not think about home or renter's insurance now, but once you live away from home, in a dorm or apartment, you might consider purchasing insurance coverage for your personal belongings. Homeowner's Insurance There are four main categories of coverage in all homeowners policies: structural damage coverage, personal property coverage, liability coverage, and additional living expense coverage.  Structural Damage Coverage Those who own their homes need structural damage coverage in case the house is damaged or destroyed by a disaster. Perils are things or events that can damage or destroy a home or its contents. A home insurance policy lists the perils it covers, which may include fire, lightening, wind, hail, frozen plumbing, theft, explosion, vandalism, riots, falling aircraft and few others. Perils that most home insurance policies do not cover are floods and earthquakes. The coverage may be purchased if needed, but the cost is high for locations that are at increased risk. Some policies cover damage to other buildings on the property, such as a separate garage, some not. There are different coverage packages available and each package protects against certain specified perils. Make sure you understand your insurance policy and talk to the insurance agent if you have any questions.  Personal Property Coverage The contents of your home are your personal property. This includes furniture, appliances and clothing. Most homeowners policies will automatically cover your personal property, depending on the carrier, up to 50% of the amount of insurance that you have on the home itself. For example, if your home is insured for $200,000, then the personal property, or contents of the home, is insured for $100,000. Some people pay extra for added coverage. The costs of the home and belongings can be paid in one of two ways depending on the type of coverage chosen:   Actual Cash Value (ACV) pays the depreciated value of the damaged property. Replacement Cost (RC) pays the amount it costs to replace the damaged property with something of a similar type and quality at its current market value. This type of coverage is more expensive. Liability Coverage  Are you covered by insurance if your dog bites a neighbor? How about if your baseball goes through a neighbor's window or your tree falls on a neighbor's fence? And what if you're sued when someone slips and falls on your front walk? The answers are in the liability section of your homeowners policy. Liability coverage protects you and your family in case someone gets hurt in your home or on your property. It also offers some limited coverage for damage that you, your family members, or your pet cause off your property. Liability coverage will pay for your legal defense if you are sued for something that is covered under the policy. Most homeowner's insurance include liability coverage.  Personal Liability Insurance is used to cover you against lawsuits for injuries or property damage caused by the policyholder, family member, and pets. This coverage applies whether you are at home or elsewhere. Liability insurance usually pays for your defense in court, if necessary and for any damages the court says you must pay - up to the maximum amount allowed in the policy. Most homeowners policies provide a standard amount of liability coverage of $100,000, but most experts recommend at least $300,000 of liability coverage. Medical Coverage is a second form of liability insurance that covers medical costs in the event that someone is injured on your property regardless of fault and does not want to sue you. Medical payments covered could include doctor's fees, x-rays, hospital stays, and similar expenses. It is usually limited to an amount between $1,000 and $5,000.  You always want to make sure that you have enough home insurance liability coverage in case you are found negligent in causing injury or damage to another person. You should note, though, that you're typically covered only for negligence (carelessness); you aren't covered for intentional injuries and damage. The liability insurance section of your homeowners policy contains an exclusions section that denies or precludes coverage in specific instances. These exclusions are listed and described. Make sure you understand your insurance policy.  Additional Living Expenses Coverage (ALE) This coverage will pay for living expenses if you have to live elsewhere while damage to your home is repaired. The amount of coverage for ALE differs from insurance company to company and depends on the specific homeowner’s policy. Many policies provide coverage equal to about 20% of the amount of insurance on the home. For example, if the dwelling coverage is $500,000, ALE coverage would be $100,000. Some policies also have time limits; i.e. once the covered event occurs, the policyholder’s ALE coverage will cover expenses for a certain period beyond that date. Homeowner's policies offer a choice of three levels of protection: basic form (HO-1), broad form (HO-2), and special form (HO-3) (see below). Renter's Insurance If you're a renter, you may think you do not need insurance at all. Think again! Your landlord probably has insurance on the building, but your landlord's policy doesn't cover any of your personal property. Tenant's form (HO-4, see below)) is designed to provide the coverage renters need most. At a minimum renter’s insurance will cover your personal property such as furniture, clothing and electronics in the event of theft, fire or natural disaster. Renters insurance may also provide protection for you in the event that someone is injured while at your residence. There are several options available with renter's insurance which can give you a lot of flexibility depending on your needs and how much you want to spend on it. The personal property coverage will cover you against loss or damage to your personal possessions due to theft, fire, water, smoke, vandalism, lightening, plumbing, etc. People who have renter's insurance need to estimate the value of their belongings to determine appropriate coverage. It is important to determine an accurate value for your personal property or you may find yourself undercovered. The personal liability protection will protect you in case you are sued due to an injury incurred by someone while visiting your residence. It will also pay for your defense in court if needed. If the additional living expenses coverage is a part of your renter's insurance policy, the insurance will pay for you to live elsewhere while it is repaired. Condominium Insurance Homeowners in a condominium own their individual living spaces and they share ownership of the overall building and common areas, such as lawn areas and elevators. The condo owners' association usually has an insurance policy for the building and shared spaces. Individual owners need their own separate policies for things not covered by the association's insurance. You will need the coverage provided by a condominium for (HO-6) policy (see below). Manufactured Home Insurance If you own a manufactured or mobile home you might need insurance policy specially designed for these homes. Coverage varies but usually includes structural damage, limited personal property, and liability protection. How Much Coverage Do I Need? That is probably the most important question in setting up your home insurance. And there is no simple answer. Just think about what would you do if something happens to your house or apartment? Where would you go? How would you repair or rebuild your home? A qualified insurance agent or insurance company representative can guide you in your choices. But, here are six basic questions everyone should ask before buying or renewing a homeowners insurance policy:   What will be the cost of rebuilding my home? How much is the personal property in my home worth in the event of a total loss? Take an inventory of your personal possessions. An up-to-date inventory of all your possessions will help you to determine how much insurance to purchase. In addition, having this list will help get your claim settled faster. There are various inventory forms offered online that will help you to get strawed. How much liability protection do I need? What level of additional living expense do I need in case I have to move temporarily to a motel or apartment? Should I buy a separate flood and/or earthquake insurance policy? Do I qualify for any discounts?     The type and amount of coverage you need also depends upon your personal finance and whether you have a mortgage on your property. Banks and other borrowers who lend money for home loans require borrowers to have a homeowner's insurance for at least amount of the mortgage. Keeping The Cost of Home Insurance Down  Shop around. It will take some time, but could save you a good sum of money. Ask your friends, check the Yellow Pages, consumer guides, insurance agents, companies, and online insurance quote services. This will give you an idea of price ranges and tell you which companies have the lowest prices. But don't consider price alone. The insurer you select should offer a fair price and deliver the quality service you would expect if you needed assistance in filing a claim. Raise your deductibles. The higher your deductible, the more money you can save on your premiums. But remember, your deductible should not be higher than the amount you can pay in case you need to file a claim. Buy more than one type of insurance from the same company, such an auto and home insurance. Make your home more disaster resistant. For example, you can use fire-resistant building materials or buying stronger roofing material. Improve you home security. You can usually get discounts of at least 5 percent for a smoke detector, burglar alarm or dead-bolt locks. Maintain a good credit record. Insurers are increasingly using credit information to price homeowners insurance policies. Review the limits of your policy and the value of your possessions at least once a year. You want your policy to cover any major purchases or additions to your home. But you do not want to spend money for coverage you do not need.       Click on the Assessment tab. 6.4 Health Insurance Most people need health insurance to pay for medical expenses, preventive care and hospitalization. You might pay for private health insurance and hardly use it, but if you need medical attention one day, you'll be glad you have it. A private health insurance policy is a contract between an insurance company and either an individual or their employer. The type and amount of health care costs covered by the health insurance company are specified in advance, and the individual insured also has certain financial obligations. Most Americans get their private health insurance through their employers, but some purchase their own individual plans. The U.S. government also provides limited health care coverage under certain circumstances, in the form of Medicare and Medicaid. Health insurance companies pool collective risk for a large group of people's medical costs. Some individuals will incur a lot of medical expenses, while others, typically younger people, will incur little or no costs. Everyone still pays for health insurance whether they use it or not, so in a way healthy people are subsidizing the sick and keeping their insurance costs reasonable. There are a number of key terms you should be aware of when learning about health insurance. Key Health Insurance Terms Premium The amount the policy-holder or his sponsor (e.g. an employer) pays to the health plan each month to purchase health coverage. Deductible The amount that the insured must pay out-of-pocket before the health insurer pays its share. For example, a policy-holder might have to pay a $500 deductible per year, before any of their health care is covered by the health insurer. It may take several visits to the doctor or prescription refills before the insured person reaches the deductible and the insurance company starts to pay for care. Co-payment The amount that the insured person must pay out of pocket before the health insurer pays for a particular visit or service. For example, an insured person might pay a $45 co-payment outof-pocket for a doctor's visit, or to obtain a prescription. A co-payment must be paid each time a particular service is obtained. Coinsurance A set percentage of the total cost of care the injured person must also pay, in addition to any co-payments. For example, a member might pay 20% of the cost of surgery over and above a co-payment, while the insurance company pays the other 80%. If there is a maximum limit on coinsurance in the policy, the policy-holder could end up owing very little. However, they could also owe a great deal of money depending on the actual cost of the services they obtain. Exclusions Not all services are covered. The insured person is generally expected to pay the full cost of non-covered services out of their own pocket. Coverage Limits Some health insurance policies only pay for health care up to a certain dollar amount. The insured person may be expected to pay any charges in excess of the health plan's maximum payment for a specific service. In addition, some insurance company schemes have annual or lifetime coverage maximums. In these cases, the health plan will stop payment when they reach the benefit maximum, and the policy-holder must pay all remaining costs. Out-of-Pocket Maximums Similar to coverage limits, except that in this case, the insured person's payment obligation ends when they reach the out-of-pocket maximum, and the health company pays all further covered costs. Out-of-pocket maximums can be limited to a specific benefit category (such as prescription drugs) or can apply to all coverage provided during a specific benefit year. Capitation An amount paid by an insurer to a health care provider, for which the provider agrees to treat all members of the insurer. For example, a doctor may charge $125 for a office visit but agrees to accept only $50 from the insurance company for the same service. In-Network Provider A health care provider on a list of providers preselected by the insurer. The insurer will offer discounted coinsurance or co-payments, or additional benefits, to a plan member to see an innetwork provider. Generally, in-network providers have a contract with the insurer to accept rates further discounted from the "usual and customary" charges the insurer pays to out-ofnetwork providers. Prior Authorization A certification or authorization that an insurer provides prior to medical service occurring. Obtaining an authorization means that the insurer is obligated to pay for the service, assuming it matches what was authorized. Many smaller, routine services do not require authorization. Explanation of Benefits A document sent by an insurer to a patient explaining what was covered for a medical service, and how they arrived at the payment amount and patient responsibility amount. Types of Private Health Care Plans There are many private health care plans available. No single plan will cover all services and costs associated with medical care. Some health services, like chiropractic care or massage therapy, are limited or not covered at all. You have to know your policy, what is covered and your share of the payment. Medical expenses can add up quickly, and having a good health plan can help save you money. Health Insurance Plans Fee-for-Service Health Plans These plans are the traditional type of health insurance coverage. Under this plan you can choose any doctor (including specialists) and go to any hospital in the United States. This type of plan usually involves a yearly deductible, coinsurance and/or co-pay. Managed Care Plans Plans that control how much health care you use. Managed care plans usually cost less than fee-for-service health plans. Health Maintenance Organizations (HMOs) A type of managed care plan. HMOs usually pay for treatment and procedures that are shown to be effective. You are also required to choose hospitals and doctors who work with the HMO. If you need to see a specialist or have a certain procedure done you will need a referral from your primary care doctor or approval from your HMO. Without approval you might end up paying the whole bill. HMO plans vary in services and costs. Preferred Provider Organizations (PPOs) A combination of a traditional fee-for-service health plan and an HMO. Like with HMOs, you can choose from a limited number of doctors and hospitals, but you also can visit out-ofnetwork doctors and receive partial coverage. Point-of-Service Plans (POS) Plans that require permission, known as a referral, from your primary care physician to see other doctors in the network. However, you can also see a health care provider out-ofnetwork and still get some coverage. Health care plans also fall into two main categories of coverage, basic or major medical coverage. Basic medical coverage usually includes routine doctors’ visits, medical tests, and hospitalization. Major medical insurance usually provides benefits for broader range of medical expenses such as organ transplants, long-term rehabilitation, and home health care. Sometimes health insurance policies combine basic and major medical insurance coverage into one plan. There are also dental, vision, prescription, and disability coverage insurance options available. Government-sponsored Health Care Health insurance plans can be private or government sponsored. Medicaid is government-funded health care which provides medical assistance to individuals and their families with low incomes. This program is jointly funded by federal and state governments. Medicare is also government funded, but typically provides for individuals ages 65 and over. Since Medicare does not cover every medical cost, many senior citizens buy additional supplementary insurance to help them pay the high cost of health care. Purchasing Health Insurance If your parents have health insurance, you are most likely covered under their policy. In 2010, the U.S. Congress voted to allow young adults up to age 27 to be covered on their parents' health insurance policy regardless of whether or not they are full-time students. At some point, however, you will need to buy your own health insurance coverage. The best way to get health insurance is through your employer, which uses a group health insurance plan to pool risk and reduce costs. Most employees contribute towards their health plan premiums, although sometimes employers pay part or all of your premium. The most expensive type of plan is when you have to buy insurance on your own, known as an individual plan. If your employer does not offer health insurance, you can purchase an individual plan for yourself or your family. These plans come with a high price tag, since there is no pooling of risk. Depending on such factors as age and preexisting medical conditions, the cost and benefits will vary from person to person. If you have choices, examine your options carefully before you purchase individual insurance. If you have insurance through your employer and lose your job, you can continue your insurance coverage for a certain period of time under the Consolidated Omnibus Budget Reconciliation Act (COBRA), which became law in 1986. COBRA gives you the right to continue with your insurance coverage, but you will be required to pay the full premium your employer previously paid. However, the full premium is still usually less expensive than purchasing an individual plan. When shopping for health insurance, take into consideration all the related expenses such as co-pays, deductibles, coinsurance and your premium. The key terms at the beginning of this module will give you an idea of the various factors to consider. The lowest premium does not mean the cheapest plan. Choose a plan based on your needs, with the best price for the benefits you are most likely to use. Click on the Assessment tab. 6.5 Life Insurance & Estate Planning If you have someone who depends on your income, then life insurance is an important part of your financial planning. The primary purpose of life insurance is to financially support children or a spouse after the policy holder’s death. Even if you do not have people depending on you right now, one day you might get married and have children, and life insurance will be something to consider. Life insurance policies require that a policy holder name beneficiaries. A beneficiary is anyone who is named to receive benefits from a will, insurance policy, etc. When you apply for life insurance, just like with auto and health insurance, your premium will depend on many factors. . Types of Life Insurance There are many different types of life insurance, and the amount of insurance you buy depends on your circumstances, including your mortgage, the age of your children, your spouse's income, etc. A financial planner or an insurance agent can help you to determine the best type of insurance for you and how much you need. Temporary Life Insurance, also known as term life insurance, lasts a specified term of 5, 10, or 20 years. It costs less than permanent life insurance and has no cash value. When the policyholder dies, the beneficiaries receive the policy's face value in cash. For example, if an individual purchased $100,000 in term life insurance coverage and died before the term was up, their beneficiaries would receive $100,000, the face value of the policy. Some term policies can be renewed or converted to a permanent life insurance policy. In either case your premium will go up and you might be required to complete additional medical screening before you renew or convert your current policy. . Whole Life Insurance, or permanent life insurance, provides lifelong coverage. It is much more expensive than term insurance when it is initially purchased. The yearly premium stays level for the life of the policy. This type of policy also has a cash value which the policy holder can borrow against. When the policy holder dies, his or her beneficiaries receive the policy's face value and cash value, since the insurance company invests the policy holder's premiums. The longer the policy is in force, the larger its cash value. . What can influence the cost of life insurance?       Age. Health condition. Life style. (Are you a smoker or non-smoker?) Hobbies. (Are you a recreational sky diver?) Occupation (Are you an accountant or a NASCAR driver?) Type of policy. (Are you applying for a term life or permanent insurance policy? Is it a group or individual plan?) Sources of Life Insurance As with other types of insurance, both group and individual life insurance policies are available. Group life policies are often offered by employers. Some groups, for example, labor unions, often offer life insurance plans for their members. There are many insurance companies that offer individual life insurance policies. Talk to your family, friends, and do some research online. You need to choose an insurance company that is strong and reputable that offer life insurance policies with no hidden terms and clear explanation of limitations or exclusions. Look for an insurance company that provide adequate help in filing a claim, good customer support, and help you understand your policy. Companies such as A.M. Best and Standard & Poor's rate insurance companies’ financial strength. . Annuity Another insurance program that acts somewhat like an investment is an annuity. People purchase annuity contracts from insurance companies. Some people do not want to depend on volatile stocks or low-interest savings accounts to secure future income. An annuity offers a fixed future income based on the sum paid into the account and interest earned on the principal. If you buy an annuity you will receive in return a series of periodic payments, usually from the time you retire, through the remainder of your life span or for a fixed number of years. There are various types of annuities. If you decide to invest in annuities, you should discuss different options with an insurance agent and decide which one will be right for you. Annuity payments supplement Social Security and payments from other retirement accounts. Annuities may also help you meet some of your mid- and long-range goals, such as planning for your retirement and for a child's college education. Annuities are tax-differed, which means you pay no taxes on the earning until you withdraw the money. . What types of Insurance Do I Need? . In module 6 we have discussed different types of insurance: auto, home and property, health, and life insurance. There are many other types of insurance, for example, disability, travel, pet health, malpractice, and even wedding insurance. People need insurance for a variety of reasons. At your age, the most two types of insurance you most likely need are auto insurance (if you have started to drive) and health insurance. Auto insurance is required by law in the State of NJ. It is illegal to drive without auto insurance. Given the high costs of medical care - even routine check-ups and illnesses - virtually everyone needs health insurance coverage. Medical emergencies are very expensive. An accident on a ski slope can cost you thousands of dollars. If you are involved in a serious accident you might find yourself owing tens of thousands of dollars in medical bills. If your parents have health insurance, it will cover you until you are 26 years old. After you graduate and start working, you might consider purchasing health, disability, and home and property insurance. Once you get married and have family, life insurance also becomes important. As your life changes, so should your insurance coverage. The cheapest and easiest way to get health, life, and disability insurance coverage is often through your employer. It really worth to look not only at the salary a company is offering you but its employee befits as well. If your employer does not offer any insurance to employees, you can always get a private plan from an insurance company. The recommendations discussed in this module will better prepare you for buying insurance you need. . Estate Planning As people go through life they usually accumulate wealth and property, get married and have children. Your life can change very quickly and unexpectedly. Estate planning helps you to make important financial and personal decisions in case of a physical disability, mental disability or death. It is important to make a plan for how your wealth should be distributed. If you become disabled or die without a will, the State you live in will decide how to manage or distribute your assets and who your children should live with. Estate planning often involves the use of trusts or wills. A will is a written document containing your directions for distributing your estate (all the property, investments and cash that you own) after your death. In your will you identify your property and name your beneficiaries. A trust is another method of distributing your estate. It is a legal document that gives one person the power to manage the assets of another either during their lifetime or upon the death of the original owner. There are many important reasons why everyone should have a will or trust. Reasons to Make a Will or Trust   To provide security for your family and those you are responsible for. To make sure all your assets are passed on to the people you choose; not having the State decide who receives your assets. To have a smooth transfer of assets. To appoint a person you trust to manage the distribution of your assets. To appoint a guardian for your children.   