Author: Varvara Stankova

The national debt, also known as public debt, is the total amount owed to creditors by a country.

What Does National Debt Represent?

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Debt may take many forms, ranging from credit card bills and vehicle loans to mortgages and the $5 you owe to a buddy. Debt is typically the result of expenditure surpassing income for both individuals and businesses.

So, how can a country build its national debt? It’s comparable to how people and businesses accumulate debt. National debt increases when a country’s yearly expenditures exceed its annual revenue, although other variables influence governments differently than regular borrowers.

Each country has an annual budget that includes funds for defense, infrastructure, social programs, and other things. Taxes and other types of national income, such as custom costs, are the primary sources of budget support. They do not, however, always cover the entire country’s annual expenses.

Governments issue bonds, also known as Treasury securities or Treasury bonds, to cover income shortfalls and maintain a continuous and predictable source of budget funding. The national debt is the total outstanding value of all Treasury bonds issued by the government.

What is the Amount of US National Debt?

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The current national debt of the United States is $33.69 trillion, according to the US Department of the Treasury. It is a substantial sum, amounting to nearly $94,000 per individual.

Ordinary people, on the other hand, are not required to repay their portion of the national debt. Debt payment consumes a set amount of the annual budget.

There’s a real-time representation of the national debt, known as the “National Debt Clock.” This iconic digital billboard, located in New York City, provides a visual and constantly updating display of the current national debt.

The United States Congress sets a limit on the amount of debt the government can incur, known as the “debt ceiling.” When the debt approaches this limit, it sparks debates and potential government shutdowns. These situations can have far-reaching consequences for financial markets and the economy.

National Debt vs. Budget Deficit

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A budget deficit happens when a country’s yearly budget spending exceed its total annual income. National debt, on the other hand, is the total outstanding value of all government-issued Treasury bonds.

In the United States, Congress is in charge of approving the federal government’s yearly budget. The Treasury, which reports to the White House and is part of the executive branch, collects taxes, gets other income, and sells US Treasury securities, often known as Treasury bonds.

The US budget deficit arises when the yearly budget approved by Congress exceeds the Treasury’s collection of taxes and other income. A budget surplus occurs when income surpasses spending.

The Treasury sells bonds on a regular basis to fund the budget. It issues many forms of debt securities with varying durations and maturity periods, but they are all government liabilities. Investors anticipate monthly interest payments and the repayment of the principal amount when the securities mature.

The US national debt is the total value of all outstanding Treasury bonds. Because the Treasury sells bonds regardless of budget fluctuations, the link between national debt and budget deficit is partly indirect.

What is the Debt-to-GDP Ratio?

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The Gross Domestic Product (GDP) of a country is the total value of all products and services generated in that country in a given year.

The debt-to-GDP ratio is computed by dividing a country’s total national debt by its total GDP over a year.

Total National Debt / GDP = Debt-to-GDP Ratio

The US national debt is $33.69 trillion, and the US GDP is $26.24 trillion. By dividing the former by the latter, we obtain a debt-to-GDP ratio of 128.6% for the United States. 

While this may appear to be a high debt-to-GDP ratio, it is not the highest in the world. Japan now has the highest debt-to-GDP ratio.

Definition:
A subsidiary is a company owned by another company, which is referred to as a parent company or a holding company.

Understanding the concept

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Subsidiaries are typically companies owned by a larger organization called a parent or holding company. The parent company has a controlling stake in the subsidiary. If a subsidiary is wholly owned by a larger company, it is called a wholly owned subsidiary. Usually, a subsidiary retains legal and financial independence, but is subject to significant control by the parent company. By acquiring several subsidiaries, the parent company can become a conglomerate.

Example:

Since 2015, the largest subsidiary of Alphabet Inc is Google. This allows Google to focus on Internet-related business, and the Alphabet Inc. Holding company to develop other business areas.

A subsidiary company arises when a holding company acquires more than half of the shares of a given company. A subsidiary may have multiple owners, but it has only one parent company. A fully controlled parent company is called a “wholly owned subsidiary”. Subsidiaries may also be parent companies of other subsidiaries, and such a structure may have several levels of subsidiaries. Large corporations can have subsidiaries both at the national level and internationally to carry out activities in different countries.

For example, Microsoft Corporation owns several subsidiaries around the world, including Microsoft de Argentina S.A. in Argentina and Microsoft Deutschland GmbH in Germany.

What is the purpose of the subsidiary?

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A subsidiary is a means to achieve the goals of the parent company. The subsidiary has the following objectives:

1. Using tax advantages
The parent company can use the profits of one subsidiary to compensate for the losses of another, which reduces the total taxable income. It is also possible to create a subsidiary in another state or country with a more favorable tax system.

2. Optimization of operations
A subsidiary located in a particular country or region can manage day-to-day operations more efficiently than a parent company located elsewhere.

3. Reduction of liability
The transfer of ownership and management of assets to a subsidiary allows the parent company to retain limited liability associated with these assets. In the field of commercial real estate, it is common practice to create a limited liability subsidiary (LLC) by the parent company in order to acquire and manage large assets, such as warehouses for storing products or office buildings in the city center.

4. Specific assets
Some subsidiaries can be acquired to obtain specific assets, avoiding the need to repeat their successful formula.

How does the subsidiary work?

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For the operation of a subsidiary, it is necessary that the parent company owns more than half of the shares of the subsidiary and controls its activities. If the ownership share is less than half, the company is considered to be associated or affiliated. It is important to know that the financial statements of a subsidiary company differ from those of an associated company.

When creating a subsidiary, it is recommended to contact a state accountant with experience in transferring assets and knowledge of the tax code. The assets and liabilities of the parent company are usually separated from the subsidiary, which protects against creditors’ claims.

How is a subsidiary created?

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The process begins with approval by the current management of the parent company. Then a vote must be held, and if a majority of votes support the creation of a subsidiary, the director draws up the decision in writing. For a subsidiary, you can choose one of the two most common types of commercial organizations – a corporation or an LLC.

Different states may have different rules and requirements for the registration and organizational structure of an LLC, so you need to contact a Certified Public Accountant (CPA) and consult the State Chancellery website to get more information about the requirements for your state.

How does the subsidiary function?

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The subsidiary often receives a controlling stake from the parent company, which thus provides the start-up capital. This capital is necessary to start the company’s operations.

The parent company usually defines in the charter of the subsidiary the rules of its internal management and its role as the owner. All changes in the charter require the approval of the parent company.

After the election and creation of the board of directors of the subsidiary, the parent company no longer interferes in its activities and the board can function as an independent organization.

The financial statements of the subsidiary are maintained separately from the financial statements of the parent company. However, the subsidiary’s balance sheet and profit and loss statements are often combined together with the parent company’s reports.

Why is a subsidiary being created?

The creation of a subsidiary company allows you to combine the benefits for the parent company. The parent company can control the subsidiary, protect its interests and have separate financial statements. In addition, the consolidation of accounting books makes it possible to compensate for profits with losses and reduce income taxes.

A subsidiary may also provide the parent company with advantages in the form of orderly operations and competitive advantages at the expense of its property, equipment or research and development department. In addition, the subsidiary provides tax benefits and protection from creditors and lawsuits.

What are the advantages and disadvantages of a subsidiary?

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One of the notable advantages of subsidiaries is the ability to keep the parent company and the subsidiary as separate entities. This means that the parent company is not legally responsible for the obligations and debts of the subsidiary. Instead, the liability of the parent company is limited to the initial capital, which is exchanged for equity and a controlling stake in the company.

Due to this, the assets of the parent company are usually protected from creditors, provided that there is a clear distinction between the operations of the parent company and the operations of the subsidiary. Such prudent investments allow the parent company to use other growth opportunities.

However, there are some disadvantages. Large-scale organizations, including subsidiaries, require a significant amount of documentation and are subject to bureaucracy. To truly separate these two organizations, each board of directors must act independently. This can delay the decision-making process and the implementation of actions.

What is the difference between a subsidiary and other structures of the company?

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Below are a few common terms that have a similar meaning, but differ from the subsidiary:

Affiliate/Associate
A firm is considered affiliated when the parent company has a controlling stake. However, the subsidiary has full ownership of the parent company.

DBA
Unlike a subsidiary, a DBA is not a separate company. It’s really the same company, just operating under a different name. (Doing Business As)

Branch
A branch or division refers to a part of the company that does not operate in the main office. A subsidiary is a separate company.

Sister company
All sister companies are subsidiaries, but not all subsidiaries are sister companies. A sister company is related to another subsidiary because they both have the same parent company. However, a parent company can only have one subsidiary, in which case the subsidiary does not have its own sister companies.

Holding company
A holding company is a term that refers to a parent company, not a subsidiary. The holding company has enough shares to control the subsidiary(stocks), but it does not participate in its daily activities.

For many homeowners, their property is not just a place to hang their hats; it’s also a valuable financial asset that can be leveraged to meet various financial goals. One way to unlock the potential of homeownership is through a Home Equity Line of Credit (HELOC).

This financial tool has gained popularity in recent years, offering homeowners a flexible way to tap into the equity they’ve built up in their homes. In this article, we’ll explore what a HELOC is, how it works, and the benefits and considerations associated with this financial option.

What is a HELOC?

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A Home Equity Line of Credit (HELOC) is a revolving credit line that allows homeowners to borrow against the equity in their homes. Home equity is the difference between the market value of a property and the outstanding mortgage balance.

Over time, as homeowners make mortgage payments and their property’s value appreciates, they build up equity. A HELOC enables them to access a portion of this equity as a loan that can be used for various purposes.

How does HELOC work in steps?

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A Home Equity Line of Credit (HELOC) operates in several steps, allowing homeowners to access funds based on the equity they have in their homes. Here’s a step-by-step breakdown of how a typical HELOC works:

1. Access to funds

Before applying for a HELOC, homeowners must assess their eligibility. Lenders consider factors such as credit score, loan-to-value ratio, and income to determine if you qualify for a HELOC.

2. Repayment Terms

Homeowners submit an application to a lender offering HELOCs. The lender will review the application and supporting documents, such as income verification and property appraisals.

Once approved, the lender will specify the terms of the HELOC, including the credit limit and interest rate.

3. Draw Period

The HELOC typically consists of two main periods: the draw period and the repayment period. During the draw period (which typically lasts 5-10 years), homeowners can access funds from the HELOC up to the approved credit limit.

Borrowers can choose how and when to use the funds. They can write checks, use a credit card linked to the HELOC, or make electronic transfers from the HELOC account.

4. Borrowing Funds

Homeowners can borrow funds from the HELOC as needed, up to the credit limit, just like using a credit card or taking a cash advance. Interest is only paid on the outstanding balance, and the minimum monthly payment often covers the interest charges during the draw period.

5. Repayment Period

After the draw period, the repayment period begins, typically lasting 10-20 years. During this period, homeowners must repay both the principal and interest on the outstanding balance. Monthly payments are typically higher during the repayment period compared to the draw period.

6. Variable Interest Rates

HELOCs typically have variable interest rates, which means the interest rate can fluctuate over time. The rate is often tied to a financial benchmark, such as the prime rate. Your monthly payments can vary based on changes in the interest rate.

7. Closing the HELOC

Once the repayment period is complete, and you’ve paid off the outstanding balance, the HELOC is considered closed. Homeowners can also choose to close the HELOC before the end of the repayment period, if desired.

8. Potential Renewal

Some HELOCs may offer options for renewal, allowing homeowners to access funds again after the initial draw and repayment periods are completed. Renewal terms may vary by lender.

Benefits of a HELOC

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Flexibility

HELOCs offer immense flexibility for homeowners. You can use the funds for various purposes, such as home renovations, debt consolidation, education expenses, or unexpected medical bills.

Lower Interest Rates

HELOCs often have lower interest rates compared to credit cards or personal loans, making them an attractive option for borrowing.

Interest Deductibility

In some cases, the interest paid on a HELOC may be tax-deductible if the funds are used for qualified home improvements. However, tax laws and deductions can change, so it’s essential to consult a tax advisor.

Access to Equity

HELOCs allow homeowners to access a portion of their home equity without having to sell their property, providing a financial safety net.

Considerations Before Getting a HELOC

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As with any secured loan, there’s a risk of losing your home if you can’t make the payments. Careful consideration is needed when using a HELOC.

The interest rate on a HELOC can change, which may result in fluctuating monthly payments. Consider how rising rates could impact your budget.

It’s crucial to understand the repayment terms and ensure you can make the required payments during the draw and repayment periods.

Like any financial product, HELOCs come with closing costs and fees, which can add to the overall cost of borrowing.

With the convenience of a revolving credit line, it’s essential to maintain financial discipline and avoid over-borrowing, which can lead to financial stress.

Difference Between a Home Equity Line of Credit (HELOC) and a Home Equity Loan

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Both HELOCs and home equity loans are financial products that allow homeowners to access the equity they’ve built in their homes, but they differ in terms of how you receive the funds and how you repay them:

Access to Funds

A Home Equity Line of Credit provides a revolving line of credit, much like a credit card. You can borrow and repay as needed during the draw period, which is typically 5-10 years.

A home equity loan provides a lump sum of money upfront. You receive the entire loan amount at once.

Repayment Terms

HELOC: During the draw period, you typically make interest-only payments. After the draw period, you enter the repayment period and must repay both the principal and interest over a set number of years.

Home Equity Loan: With a home equity loan, you start making both principal and interest payments right away. The repayment term is typically fixed, and the loan is amortized over a specified number of years.

Interest Rates

HELOC: HELOCs often come with variable interest rates, which can fluctuate over time. The interest rate is usually tied to a benchmark, like the prime rate.

Home Equity Loan: Home equity loans typically have fixed interest rates, providing predictability in your monthly payments.

How to Calculate Home Equity

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To calculate your home equity, follow these steps:

Determine Your Property’s Market Value: You can get an estimate of your home’s current market value by hiring a professional appraiser or using online tools, consulting a local real estate agent, or checking recent sales of comparable properties in your neighborhood.

Calculate Your Outstanding Mortgage Balance: Contact your mortgage lender or check your mortgage statement to find out your remaining mortgage balance.

Subtract the Mortgage Balance from the Market Value: Subtract the outstanding mortgage balance from the estimated market value. The result is your home equity.

Mathematically, the formula for calculating home equity is:

Home Equity=Market Value of the Property−Outstanding Mortgage BalanceHome Equity=Market Value of the Property−Outstanding Mortgage Balance

For example, if your home is estimated to be worth $300,000, and you have an outstanding mortgage balance of $200,000, your home equity would be $100,000.

Conclusion

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In conclusion, a Home Equity Line of Credit (HELOC) can be a valuable financial tool for homeowners, offering flexibility and potential benefits. However, it’s important to carefully assess your financial situation, needs, and risk tolerance before applying for a HELOC.

Consulting with a financial advisor or mortgage specialist can help you make an informed decision on whether a HELOC is the right choice for you. When used responsibly, a HELOC can unlock the financial potential of your home and help you achieve various personal and financial goals.

Definition:

Dividend yield is a ratio, expressed as a percentage, that compares a company’s annual dividend (the total amount of dividends paid by the company in the last financial year) to its share price.

What is the dividend yield?

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The dividend yield is a tool for comparing a company’s dividend to its share price. It is the annual dividend divided by the share price, where the annual dividend can either be the total dividend paid in the last financial year, the most recent dividend multiplied by four (reflecting four financial quarters), or the total dividend paid in the last four quarters per share. 

A high dividend yield can mean that a stock brings investors a tidy sum compared to its share price. However, higher dividends do not always indicate high investment potential. Dividend yields tend to change most in response to fluctuations in a company’s share price, rather than based on its dividend value. 

For example, a company whose shares are suddenly falling in value may have a very high dividend yield, or a company whose share price is rising rapidly may have a low dividend yield. This helps to show why it is important to use dividend yields as just one tool for evaluating potential investments.

How do I determine the dividend yield?

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The dividend yield is the percentage determined by dividing a company’s total annual dividend by its share price. To calculate a company’s dividend yield, we need to calculate its total annual dividend and then divide it by the share price at a certain point in time.

For example, consider Apple’s dividend yield for 2022. Apple’s total annual dividend can be determined in several different ways:

– Taking Apple’s most recent dividend and multiplying it by four (since Apple pays four dividends a year). 

– By adding up Apple’s last four quarterly dividends.

– By adding up the four dividends for Apple’s last completed financial year (aka fiscal year). 

For this example, we add up Apple’s last four dividend payments to calculate its annual dividend and its closing share price on 7 May 2023 to calculate its share price.

Let’s calculate: Apple’s annual dividend = the sum of the four dividends paid by Apple for the year: 23 cents paid in the last 4 quarters *4 = $0.92 annual dividend

Apple share price of 7 May 2023 = $172.89

Annual dividend of $0.92 divided by share price of $172.89 = yield of 0.53%

Dividend yield vs. total yield

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Dividend yield is one component of the total return equation, which is a way of quantifying the total monetary benefit or detriment of investing in equities. 

The total return is the sum of the dividend yield (if the shares pay dividends) plus the percentage change in the share price.

Total return percentage (over a period of time) = % dividend yield + % price change over that period.

For example, if a share yields a dividend yield of 3% and its shares increase by 7% this year, the total yield would be 10%.

The total yield can also be negative. If a share pays a dividend of 2%, but its value has fallen by 7%, the total return will be -5%.

The total return can change frequently and significantly depending on a company’s share price. It can also change, for example, in response to significant changes in that company’s dividend, which will affect the dividend yield.

Dividend yield vs. payout ratio

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The payout ratio and dividend yield are two different ratios that can be useful tools when evaluating potential equity investments. The payout ratio shows what percentage of a company’s profits that company spends on dividends (it is calculated by dividing the annual dividend per share by the company’s earnings per share). Meanwhile, the dividend yield is the amount of dividend on a stock divided by its price.

What are the limits to the dividend yield?

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High dividend yields do not always correlate with sound investments. Dividend yields depend both on the amount of the company’s dividend and on its share price, which can change suddenly and dramatically. As a result, dividend yields can suddenly increase (if the stock falls) or decrease (if the stock rises). 

However, in these cases, a high dividend yield may not correlate with a positive company trajectory and a low dividend yield may not correlate with a negative company trajectory. 

A company’s dividend yield may also become less accurate to calculate as more time passes since the company last paid a dividend or declared a dividend (e.g., a company’s plans to reduce its dividend yield may indicate how an investor assesses the relevance of its last dividend calculation).

It helps to show why it is important to consider many indicators and signals when evaluating potential equity investments. Here are a few indicators other than dividend yields which can be useful when valuing a stock:

1. The company’s profit and revenue growth story.

2. Dividend history of the company (if it pays any)

3. Company debt and debt history.

4. A company’s credit rating (aka creditworthiness of the company).

Which companies have high dividend yields?

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It is important to calculate the dividend yield for each individual company to understand how one dividend-paying stock compares to another. However, there are some patterns in the characteristics of companies that tend to have high or low dividends. Here are three common patterns among companies with high dividend yields:

Maturity

Companies that are more established and stable tend to have higher dividend yields. These are often consumer companies that see sustained demand from consumers that is not affected by seasonal changes.

Certain sectors

Think about core products and services. Examples of these types of companies are those that sell products that people use widely and frequently and are reluctant to cut back on their budgets, even under personal financial stress or in a weak economy. Examples of such products are consumer packaged goods such as food, drink or hygiene products, and products such as tobacco or alcohol. Utility companies are another example of services that tend to enjoy stable demand and high dividend yields.

Companies with income management

Some companies, such as REITs (real estate investment trusts), business development companies and general limited partnerships, are usually set up in such a way that the US Treasury requires them to pass most of their profits to shareholders. As part of this requirement (the company does not have to pay taxes on the income it sends to shareholders in the form of dividends, but the shareholder must account for this income in their taxes as ‘ordinary’ income). Because these companies have such high dividends, they tend to have high dividend yields as a result.

Note on technology shares

Many technology companies do not offer dividends at all. Among those that do, the general rule remains that the more mature a company is, the higher its dividend yield.

Understanding the weighted average

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A weighted average is an average that takes into account the importance of each number you average. When you find the average (or mean) of a set of numbers, usually all you have to do is add up the numbers and then divide the sum by the number of values you have added. The weighted average assigns importance (or weight) to each number.

Averages are standard statistical tools that can be used to find an approximate midpoint in a set of numbers. The problem with finding the average of a set of numbers is that it does not take into account the relative importance of those numbers.

Weighted averages remedy this deficiency by assigning importance to each number and taking this importance into account when calculating the average. Weighted averages are valuable because they provide more information than a simple average, without requiring much additional information – only the information needed to assign weights to each number.

What is the weighted average method?

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The weighted average method is a method of determining the average cost of a product or investment. Companies often use this method to track the value of inventory. Investors can use it to track the cost basis for investments where first-in-first-out (FIFO) or last-in-first-out (LIFO) cost bases are not used.

The advantage of using the weighted average method is that it is easier to track. Systems such as FIFO or LIFO require individual tracking of each unit. This means that businesses must track each unit of each item in the inventory and investors must track the underlying value of each stock they own.

The disadvantage of the weighted average cost method is that it is less accurate. If a business buys raw materials at very different prices, the weighted average will not adequately reflect the lowest or highest cost. This could result in the company setting the price of goods too low, resulting in a loss of money on sales that used the components bought at the high price. Theoretically, sales of goods produced by cheaper supply batches will compensate for this loss, but this is not always the case.

When do you use weighted averages?

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One scenario in which it is useful to use the weighted average method is when a single event can have several positive or negative outcomes, but the magnitude of the positive or negative outcome is variable.

Weighted averages can be subjective. Each number in a set must have a weight. How to assign weights is usually an individual decision. Two people with the same dataset may assign weights quite differently, resulting in two different weighted averages. As typical averages do not include subjective weights, they cannot be biased in the same way.

How to calculate a weighted average?

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To calculate weighted averages, you need to start with a set of numbers. Weighted averages are often used to calculate grades for a class, so provide a set of grades that looks something like this.

When you have a set of numbers, you have to assign a weight to each one. The list of tasks includes homework, tests and exams. You can make a table with grades and type of assignment, for example:

The syllabus states that homework is assessed at 25% of the final grade, quizzes at 35% and exams at 40%. The next step is to multiply each grade by the appropriate weighting.

Finally, sum the results and divide them by the sum of the weights to find the final weighted average.

25% + 28,7% + 24,5% + 23,75% + 40% + 25% + 21% + 28,8% = 216,75%

0,25 + 0,35 + 0,35 + 0,25 + 0,4 + 0,25 + 0,35 + 0,4 = 2,6

216,75% / 2,6 = 83,365%

How do I use Excel to find a weighted average?

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One of the most significant disadvantages of using weighted averages is that the calculations can be complicated. But it is easy to calculate in Excel.

Start by creating two columns, one containing each number and the other containing the weight of each number. Then use the SUMPRODUCT function to multiply each number by its weight and sum the results.

Then use the SUM function to find the sum of all weights. Finally, divide the SUM of the numbers by the AMOUNT of the weights to find the weighted average.

How does a reverse mortgage work?

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As the name suggests, reverse mortgages are the opposite of conventional mortgages. Instead of borrowing money from a lender, you borrow money secured by equity that you already have in your home. Anyone aged 62 and over can get a reverse mortgage, and they are often reserved for people who may have retired and are living without a monthly salary. Reverse mortgages can help homeowners pay for a range of costs, including regular living expenses, home accommodations or paying for their children’s college tuition. Reverse mortgages have their advantages and disadvantages, so it’s important to listen to both sides of the story before making a decision.

The process of making a reverse mortgage

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There are several different ways to receive payment when making a reverse mortgage:

Lump Sum: Get all the money after all the paperwork for your loan has been signed.

Tenure: Receive equal monthly payments each month until at least one borrower lives in the house, or until the money runs out.

Frequency: Receive equal monthly payments for a predetermined period of time.

Credit Line: Access the credit line so you can borrow money if needed.

Modified tenure: Get equal monthly payments while at least one borrower lives in the house, plus a line of credit to potentially borrow more money.

Modified deadline: Get equal monthly payments for a predetermined period of time, plus a line of credit if you need to borrow more money.

The reverse mortgage is paid either when the recipient of the loan moves out of the house or when he dies. At this time, the money must be returned. This is usually done with the money raised from the sale of the house.

The types of a reverse mortgage

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Home Equity Conversion Mortgage (HECM) is the most popular type of reverse mortgage. It is insured by the federal government and is only available through creditors approved by the Federal Housing Administration (FHA).

The FHA limits the amount of money you can borrow on this type of mortgage to the current limit of $970,800 for 2022.

This type of loan has no restrictions on income or medical requirements. It can also be used for any reason, which is part of what makes it popular.

A single-purpose reverse mortgage is a loan from a state, local or non-profit agency. You can only use it for one reason, such as paying property taxes or renovating your home, and the lender must approve the loan designation.

You may be eligible for a private reverse mortgage (aka “jumbo reverse mortgage”) if the value of your home exceeds the lending limit for HECM (currently $970,800 in 2022).

While this type of mortgage allows you to borrow more money, it is not insured by the federal government and you are likely to pay a higher interest rate.

The pros and cons of a reverse mortgage

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As with any major financial decision, there are both advantages and disadvantages to getting a reverse mortgage. It is important to weigh both sides before making a final decision.

Pros

That could be one of the only ways you get money if you’re over 62 and struggling financially.

Reverse mortgage payments (especially in the case of HECM) can be used for a variety of purposes.

You can stay in the house you worked so hard to create.

Cons

Reverse mortgages often come with high fees and interest rates. Fees are charged for shipping, maintenance, recording and other closing costs. The average fixed-rate reverse mortgage rate in 2022 was 4.81%, according to the U.S. Department of Housing and Urban Development (HUD).

When you take out a reverse mortgage, you reduce the equity in your home. This could mean you have fewer assets to leave to your heirs and the likelihood that your family will have to sell your home to repay the loan.

if you don’t pay home insurance and property taxes, you risk losing your home. Failure to pay any of these payments may result in foreclosure.

Because older people are often easy targets for fraudsters, there are a number of fraudulent schemes specifically designed for reverse mortgages. We’ll look at them in more detail in the next section.

The rules for a reverse mortgage

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Since HECMs are regulated by the FHA, there are rules related to these loans.

The first rule is that you must be at least 62 years old or older. You have to live in this house as your primary residence, and you have to own most or all of it, according to HUD. Lenders may have special requirements for how much equity you need, but you usually have to own at least half.

You should also consult with a HUD-approved counselor before taking out a reverse mortgage so they can discuss the pros and cons of this type of credit.

In addition, you must continue to pay property taxes, homeowner insurance and any homeowner association fees. Failure to comply with these requirements can result in the loss of your home.

Fees and interest rates for reverse mortgages

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Because HECM credits are federally regulated and insured, HUD sets the following fees:

Mortgage insurance premiums: Pay 2% of the loan balance at closing and 0.5% of the loan balance each year.

Down payment: Pay whichever is more – $2,500 or 2% of the first $200,000 home value plus 1% of the home value over $200,000. The maximum amount is $6,000.

Third party fees: Additional fees may include valuation, title retrieval, insurance, checks, among others.

Service charges: Lenders provide a range of regular services as long as you have credit, such as sending you payments and statements, and making sure you pay insurance and property tax. The maximum amount of this fee is $30 if the interest rate is fixed or adjusted once a year, or $35 if the rate is adjusted monthly. For single-target reverse mortgages, interest rates and fees tend to be lower than for HECMs.

But with your own reverse mortgage, you’re likely to pay higher interest rates to offset the lack of mortgage insurance.

How to avoid reverse mortgage scams

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Unfortunately, there are people looking for ways to trick unsuspecting seniors into depriving them of their hard-earned money and home. These scammers are often strangers, but sometimes close people.

These scammers can take the form of contractors or home goods suppliers urging older people to take out reverse mortgages to pay for redevelopment and repairs they don’t need.

Under another common scenario, a financial adviser can persuade a homeowner to take out a reverse mortgage to pay for shares or insurance products that may not be in their best interests.

Unfortunately, in some scams, children or other loved ones of the elderly convince them to take out a reverse mortgage for their own benefit.

Here are some ways to avoid falling victim to reverse mortgage fraud:

– Seek advice on reverse mortgages before making a purchase.

– Be careful if anyone (including a loved one or financial adviser) asks you to grant them power of attorney.

– Don’t sign anything you don’t understand.

– Do not accept unsolicited offers.

– Never agree to a reverse mortgage that requires you to transfer ownership of your home.

– A good way to avoid fraud could be to use the list of creditors HUD maintains.