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Accounting: Assessing the Net Cost of Debt 1 Views


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00:00

Accounting Allah shmoop assessing the net cost of death We're

00:07

going to dive deeper into debt land as we go

00:10

further into the jungle the mighty jungle But for the

00:13

moment well all we care about our metrics We used

00:16

to establish appropriate debt levels forgiven company like appropriate What

00:21

is really appropriate Let's start by bringing clarity to this

00:24

notion of quote appropriate debt levels unquote with some rational

00:29

thinking about loans in general Well first let's make up

00:32

a little personal story that hits home Over the course

00:36

of three years you have saved forty thousand dollars by

00:39

working weekends In addition Tio you're normal weeks at work

00:43

is a professional ferret breeder Surprisingly high demand in the

00:47

industry you find just the right home underground pool that's

00:50

an intentional underground pool Firehouse pole to slide down killer

00:55

stereo system Price tag Three hundred grand So you do

00:58

quick math on your fifty thousand dollars a year salary

01:02

Can you afford the home well on fifty grand in

01:05

income or gross income or total income You pay about

01:09

ten grand in taxes CNet forty grand after tax like

01:13

that But if you have a big fat mortgage oddly

01:17

York tax bill will feel a little easier to pay

01:20

Why Well because the interest you pay on your mortgage

01:24

is tax deductible How does that work Well you decide

01:27

on an adjustable rate mortgage and get a teaser rate

01:30

of S A four percent to start which goes up

01:32

to six per cent in two years and then just

01:35

floats as lie Boer plus two hundred basis points meaning

01:39

it's taking the best interest rate they send out there

01:42

in London from the Queen who loans money or that

01:45

their central bank Really Then he add two percent to

01:47

it and that's your rate that live or think offloads

01:49

all the time moves up and down up and down

01:51

Okay well a basis point By the way Just saying

01:54

is generally the most granular unit as applied to interest

01:58

rates for consumer It takes one hundred basis points to

02:01

equal one percent so you can think of a basis

02:05

point as one hundredth of a percent or coin Oh

02:08

one percent They're used in common parlance to simplify the

02:12

more granular details of the cost of renting money like

02:15

pennies When you pay your rent check to the landlord

02:18

you know the man or the woman so you're good

02:21

but not the best So you pay two percent more

02:24

than live or like live or would be the price

02:27

if the country of Dubai was renting money from England

02:29

or something who feel like that So then after those

02:32

two years pass and you're just lie bore plus two

02:35

hundred basis points Well at that point if Lie board

02:37

went all the way down to one percent well you'd

02:39

pay three percent in monthly interest if live or ballooned

02:43

up to be seven percent Well then you'd pay nine

02:46

percent interest All right Yeah simple So you put forty

02:49

grand down and you borrow two hundred sixty thousand dollars

02:52

as a mortgage and you pay for percent interest to

02:55

start That's ten thousand four hundred dollars a year in

02:58

interest payments all deductible So you're really now paying taxes

03:02

about eight grand instead of ten grand That fifty thousand

03:06

dollars a year salary is really forty two thousand dollars

03:09

in your pocket and you paid out twelve thousand dollars

03:12

in the thirty year mortgage payments Your payment is about

03:16

a thousand bucks a month because you have to pay

03:18

down a bit of the principle you owe each each

03:20

month really But thirty grand is left to pay taxes

03:23

of five grand a year and still you know live

03:26

even maybe furnish your place a bit Well you have

03:29

twenty five thousand dollars to pay your car loan E

03:31

drink Clothe yourself a fur heave water insurance whatever else

03:36

you need for your pet there And then the economy

03:38

heats up two years later and you get a raise

03:41

of five thousand dollars to now earn fifty five grand

03:44

a year You're feeling pretty good right now You know

03:46

how these shmoop videos they never end well Your taxes

03:49

go to about ten thousand dollars from the eight thousand

03:52

dollars that they were two years earlier So after attacked

03:55

you have forty five grand which you now have to

03:57

spend The economy is hot Jobs are aplenty So the

04:00

governments of the world decide that they're nervous about elation

04:04

getting out of hand Oh yeah right Interest rates rise

04:08

to combat inflation like central banks of the world and

04:11

US fed all raise rates to try to cool down

04:14

the economy And woe is you fly Bore has just

04:17

jumped to six percent Big jump It means you're now

04:20

paying eight percent interest The semi good news is that

04:24

well in the last two years you paid down about

04:26

ten thousand bucks of principle So now you owe only

04:29

two hundred fifty thousand dollars on your mortgage but at

04:32

eight percent interest on two hundred fifty thousand dollars Your

04:35

payments are now two thousand dollars a month for twenty

04:38

four grand a year Yes they're all deductible So take

04:42

your fifty five thousand dollars salary Your take home W

04:45

two and subtract twenty four thousand bucks from it And

04:48

you pay taxes as if you'd earned thirty one grand

04:51

I'ii not much in taxes maybe in five six grand

04:54

But you still have your five thousand dollar a year

04:57

real estate taxes And now all of a sudden things

04:59

air tight despite you having gotten a big fat raise

05:03

Yeah it's a tough here Here's the math You earn

05:05

fifty five thousand dollars a year pretax but then subtract

05:08

six thousand in taxes Twenty four thousand in mortgage interests

05:11

An additional four thousand year in mandatory principal pay down

05:15

Because that's just how you structured your adjustable loan You

05:18

rolled the dice You took the risk on the Fed

05:19

You thought rates would never go up much but they

05:23

did You also have five thousand dollars in real estate

05:25

taxes and your fixed recurring expenses out thirty nine thousand

05:30

dollars Well that only leaves you sixteen thousand bucks toe

05:33

live on car payment Ramen noodles Yeah pet food whatever

05:37

Well that three hundred fifty dollars a month car payment

05:40

is starting to feel really heavy food Yeah well how

05:43

much our ramen noodles again by the bulk Found or

05:46

ton Maybe And then a robot knocks on your company's

05:49

door one day and replaces you There are jobs for

05:52

you if you move So you have to sell your

05:54

home quickly find another job or start posting for extra

05:58

You know jobs on Craigslist This is how people go

06:02

bankrupt people And more or less it's how companies go

06:06

bankrupt as well Net cost a debt appropriate means you

06:09

can pay it down quickly if things should go arise

06:13

So uh you know good luck with that

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