Demystifying Debt in 20 Minutes | Dean H. | Skillshare

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Demystifying Debt in 20 Minutes

teacher avatar Dean H., the accidental educator

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Taught by industry leaders & working professionals
Topics include illustration, design, photography, and more

Watch this class and thousands more

Get unlimited access to every class
Taught by industry leaders & working professionals
Topics include illustration, design, photography, and more

Lessons in This Class

5 Lessons (20m)
    • 1. Course intro

    • 2. Loan finance intro

    • 3. Loan insights part 1

    • 4. Loan insights part 2

    • 5. Other costs of debt

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About This Class

Speaking of Debt...

Debt is a subject that touches most of us in one way or another. 

This course highlights some important things about debt that are hardly ever spoken of, when a decision to enter debt is being made. 

The word ‘debt’ hardly conjures positive emotions, partly because its implications are often brought to bear with hindsight, after a commitment is made. This affects the level of trust between those concerned. 

This short course explores what debt is in essence, and – importantly – some of the various ways it is promoted to consumers. It delves into some of the intricacies about loans that are good to know and concludes with a discussion of debt costs that are often overlooked. 

Debt is ubiquitous. Its effects, pervasive. Yet many don’t understand this topic beyond the fact that they are in debt, or willing to be.

The idea here is to inform and educate, enabling you and I to make sound judgements for ourselves, or seek professional advice where appropriate. 

This course is not financial advice. 

My name is Dean and in this short course I share the main lessons I’ve learned on debt through my education, career and personal journey with debt. 

Meet Your Teacher

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Dean H.

the accidental educator


Hello, I'm Dean. 

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1. Course intro: welcome to this course. This course is really just about debt, what it is, how it looks and how it works, if I may now. The reason I felt a course like this is so important is that the content I see being available on the subject of debt is more instructional. It addresses the how to aspect of things rather than educational. And that's one thing I really wanted to focus on with this course. I believe people can make their own decisions if they understand the issues now. Although I have a finance background, I feel this is something that everyone should know. I've tried to keep this as general. That's possible, so it's fairly easy to grasp. But realistically, you can go as deep as you want with this topic. It's a beginner level course, so no prior knowledge required. I trust you get a lot of value out of it. 2. Loan finance intro: I want to preface this by saying loans are called very different things, depending on the reason for them and the thes specific, soapy arrangement that's being entered into for it. For instance, if you're purchasing home and you want to get it financed using a whole load, that's gonna be called a mortgage. But if you're just taking some money from the bank to spend on, you know your personal needs. That's probably going to be called a personal law. But if you want to buy a vehicle with it when he called an asset finance loan or vehicle loan. But if you just want the money available and accessible on demand, that's credit card loan or credit card balance. So they're all the same thing, their whole loans. But just depending on the specifics off the arrangement. Like I said, you're going to have a different name. Apply to each one so loans at some of the most common forms off debt, and in this session we just want to go through some of the basics of loans and different parts of loans and how they relate to each other. The principal first and foremost, is the amount of the loan. This is essentially how much you're borrowing. If that makes sense, how much you're being given. It is often close to the amount of whatever you're financing with the loan, but it's not necessarily an exact match. The interest is the amount that is charged on the outstanding principal. Every so often, depending on the arrangement off alone, the interest might be charged monthly might be charged weekly. A key feature about the interest is that it reflects a risk element to it. It reflects the lender's assessment off the borrower's ability to make repayments. So if I am given a 6% interest rate and the next person is given a 5% interest rate, it means that I'm viewed as a higher risk. The term off the loan is the duration that that it runs for. A typical vehicle loan might last for 5 to 7 years, and home loan might go forward very to 35 years. Loans have different terms. Now. The number of repayments is really a function of the term of the loan and the arrangement that that's been made. If I enter a home loan arrangement and it's a 30 year term, and I agree to make monthly repayments back. Just means I'm making 360 repayments over the 30 year period. That's the number off repayments, and that's how we worked that out. Obviously, you'd be making a bit more if it's weekly repayments or fortnight leaving payments as opposed to monthly repayments. The final figure here is the actual payment amount, and this is a figure that's worked out mathematically such that when you're making the last payment, it literally brings the loan balance down to zero, and I'll give you an example. Here. Let's take a loan off $10,000 and the interest rate is 12% by the way. Interest is always quoted per year. That's per Adam, so the interest rate is 12% on a loan of $10,000 we want to make this repayment over three years, and we're making one payment each year. Based on that information, a $10,000 loan, 12% interest rate payment frequency of once a year and a long term off three years. The repayment amount every year would come to $4163.49. So at the end of the first year, an interest would be charged on. That's 12% on the principle of 10,000 and that brings the ballast to 11,200. And at the end of the first year, payment of $4163.49 it's made. That brings the bandits down to 7000 and $36.51. Now we're in the second year. Interest is charged on this new balance, and the amount is $844.38 bringing the revised violence to $7880.89. At the end of the second year. The payment is made once again a $4163.49. Now that brings the balance down to 3000 $717.40 not once again. At the end of the third year, an interest charge off 12% applies on this buns and the interest charge would be $446 and nine cents. It brings the battles up to $4163.49. Notice how the balance just before the final payment would always be equal to the actual payment itself, because the last payment will always wipe the balance out. So when this payment is made $4163.49 it brings the balance down to now. So that's just the mechanics of how loans work and how the repayments are calculated. And that's just something to be aware of its purely mathematical. There is a formula that I'll share with you that that shows you how to work out the payment based on payment frequency, the loan amount of principle on the term of the no, you don't have to crime any of that, but you just need to be aware of it. 3. Loan insights part 1: in the session. We're going to be illustrating some of the intricacies about loan arrangement and will be using this spreadsheet for that purpose. Now, let's just assume, for argument's sake, that we're looking to purchase a vehicle that's valued at $25,000 or go ahead and enter that here. And, um, in the spirit of making assumptions, let's just say that the brokerage fees and the application fees come to about $500. 5000 and the taxes and registration of the vehicle won't come to about $2000 altogether. The coaster looking like 27 a half 1000. And let's assume we want to put it out down. Payment off 5500. So that's 5.5 1000 all considered. We're gonna have to take a loan of $22,000 to finance this vehicle, and that is the principle amount. So that's what will be referring to as the principal of going forward. I'm going to go ahead and the CME that the credit report has come back on the offer is for an 8% interest rate, and we've chosen to pay this off weekly, and we've kills in a long term off seven years now we've got some totals in front of us. We could see that the in the first column. The principle is 22,000. But over the lifetime off this loan, that seven year period, we're looking at interest payments totalling $66,748. That's going to be the interest charged over the life off this loan over the seven year period. Now you noticed, looking at the very first note that the repayment on a weekly basis are $78.98. This repayment figure does incorporate everything that we've entered up to this point. It does incorporate the 8% interest rate, the fact that repayment a weekly the fact that the long term miss for seven years that's just some of these numbers. To see how it impacts the loan and the repayment figure, I'll go ahead and dial in an interest rate of 5%. Here and notice are repayments come down to $71.66 and the interest charged over the seven year period also comes down to 4000 and 85. That's if you look at the first column there with the totals. I'll go ahead and dial in 9% interest charge for argument's sake. So now we're looking at repayments off $81.51. And the interest off the lifetime off the loan over that seven year period actually goes up to 7671. So you could see the relationship here is quite straightforward. Ah, higher interest rate results in a higher repayment figure, as well as a higher interest charge over the lifetime off the loan, I'll go ahead and just bring that back to 8% interest. But that's also explore the effect off changing the loan duration on the repayment amount. So if we change this to a five year loan, I noticed that we're going to pay only $4709 over the five year period. And it's not that it's not that $6748 figure over five years. It's about 4700. But notice how much the weekly repayments are going to be. We're looking at 100 and $2.73 so that's an inverse relationship between the term off the loan and the repayment figure. I'll doubt this back to a seven year known. I just want to check the balance here after 3.5 years. So I doubt that in here. Now, let's have a look at the very first column. We know that over the lifetime off, the long we're going to be paying 6748 in interest over the seven year period. But what's interesting to notice that in the first half of the loan in the 1st 3.5 years would have paid $4903. So the point here is that the interest payments are not evenly spread out across the loan. It's actually more in the first half of the loan term and a lot less in the second half. There's a reason for this. This is because the interest is charged on the principle and in the early stages off the loan, the principle is at its greatest. So we're gonna get more interest being charged in these early stages on because repayments go first towards the interest charge and then towards the principle. We're going to see a lot more interest in the first half of any loan, then in the second half and for the same reason as you can see more off. The principle is repaid in the latter stages off the loan other than in the early stages were repaying in the second half of the off the long term $12,529 towards the principle and compare that to in the first half of the loan term. 9471. So so with every loan, you'll find that the interest payments of front ended the principal repayments are back ended. If that makes any sense, it's purely mathematical. But it's always good to have that understanding as to why are the interest charges more in the first part of alone? And the principal is repaid more in the second part of the loan 4. Loan insights part 2: now here, we're going to be looking at yet another example just to further illustrate on things about loans. And this time we're going to go ahead and assume that we're looking at a home loan. Let's assume a purchase price off 650,000 and we'll go ahead and just to see him, that loan establishment and other related ones. Off fees are 2800 and we'll go ahead and assume taxes are 26,000. Insurance is 8000 and research is 6000. And and that just gives us a general idea off. You know, the costs associated with buying a property. I'm going to assume a down payment off 65,000. So that brings the total loan amount down to 627,000 and 800. That becomes the principal. Now let's assume the credit report has come back, and with offers of 5.5% interest rate, let's go ahead and assume that we're looking at monthly repayments and we have chosen a loan term off 30 years of the close to 35. I want you to look at the totals that we have in front of us here for the principal off 627,800. We're looking at repayments over the 30 year period in excess, off 1.2 million. So that's a 1,283,249. So the interest component over that 30 year span is 655,000 449. So that gives you an idea off. How much more interest were generally looking at when you extend the loan term. Now, let's have a quick look at what the numbers are looking like at the halfway months. I'm gonna enter 15 here for 15 years. Once again, we see that the interest charges front ended in sense, that we're paying more interest in the early stages off the loan term than we are in the latter stages. We could see that approximately 2/3 of repayments go towards interest in the 1st 15 years, and approximately 1/3 of repayments go towards interest in the latter 15 years. So that's just something we're recapping on from the last lesson. Now there's something else I would like to point out here notice that we've chosen monthly repayments. But if we go ahead and shoes weekly repayments, I want you didn't notice the total interest that's being paid on this loan. It's 655,000 449. The principal amount of 627,800 will not change. But notice that change when I adjust the payment frequency to weekly. You know this that the total interest that's being paid over the lifetime of this loan has come down to 654,562. Just to illustrate this a bit more, I'm going to go ahead and compare weekly to annually. We're comparing interest totals over the lifetime off the bone here. So 6 54,000 when we're paying on a weekly basis and on an annual basis. 6 68 6 68 annually, 6 54 weekly. We're looking at almost 14,000 in interest saving if you choose to pay weekly as opposed annually. So the lesson here is that when you're making repayments less frequently, the interest charged over the lifetime off the loan is a bit more, and that's because the outstanding balance has a bit more time to accrue interest before payment comes in Onda. As a result, the interest charges a bit more when you're making repayments less frequently, as opposed to more frequently. 5. Other costs of debt: up to this point. We've taken a deep dive into loan arrangements, and we've just explode them through to detailed examples. Now, besides the interest charged, there are other close that may apply to debt arrangements. And I want to talk about three specific ones here. Transaction costs may be charged. Typically, whenever payment is process it they may be referred to as Heyman processing fees or a different name, but they're generally charged when, when you transact, you may also have a payment option that doesn't involve transaction costs, so that's just something to be aware of. Another close that may apply to loan arrangements would be account keeping fees much the same way a bank which charge you for keeping your account open. Your loan providers may in the same manage hard you for just keeping that loan account, and it may be charged monthly or annually, depending on the arrangement. Now there's 1/3 category, of course, that I want to talk about, and these are contingent costs. They typically kick in if you're falling behind on your payments whenever payments are not being made on schedule or they're falling behind schedule these particular costs, I'll tend to apply, and they can be quite quite significant now. Not all debt arrangements have and interest confident you'll often find, especially with smaller debts, that they can be marketed as interest free before an interest charge kicks in. Or they may just be interest free indefinitely. It's good to understand that this doesn't necessarily mean that they don't have a cost to them. Somewhere. Somehow you're gonna have to pay for that service. Usually you'll find that you know the transaction fees and the account keeping fees and all the other fixed fees are significant enough to offset the savings on the interest side. I'll give you an example here. Payment service advertises small loans up to $1000 to be repaid over 12 months in 12 equal instalments interest free. As part of this process, a loan application feed off $100 applies, and for each month the account is open. An account upkeep fee of $4 applies. Also, every payment attracts the transaction fee off $2.50. Now let's work out how expensive this loan arrangement is, or this debt arrangement is in fees only. So the application fees $100 the account keeping fee. You've kept the account open for 12 months of effectively Viscount Keeping fee applies for 11 consecutive months. So that's $44 the payment process envious $30 because that's $2.50 multiplied by 12 months . All up, we're looking at $174 so that's quite significant. Even though this is an interest free debt, you're actually paying 17.4% in fees for $1000 long. So it's just something to be mindful off. Whenever you're entering to an arrangement that's interest free. You want to make sure you're enquiring around this specific costs. Most significant ones would be. The application costs the account keeping fees as well as the transaction costs. The default female may not apply, but that's just something to be aware off.