What is the practical interpretation of the maximum indebtedness setting? Does this equate to a credit line up to this amount that I can borrow at the real rate entered under Assumptions?
How is it amortized?
Where does the interest expense amount hit?
How do the borrowings factor into the Regular Asset calculation?
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Hi, We assume that the interest rate that you have to pay on the borrowing (up to the amount you enter in this field) is, indeed, the same rate as the return on regular assets specified under Economic Assumptions. So if your regular assets are negative, you'll see negative real asset income. Everything is treated the same as in the case of positive regular assets, expect the sign is reversed and we don't permit negative regular asset income to reduce your taxable income.
An alternative to using the maximimum indebtedness field to specify that you can borrow is to enter the borrowing you intend to do as 1) a higher value of initial regular assets (e.g., $25,000 if you are going to borrow $25,000) plus 2) special expenditures in future years equalling the annual repayment of principal plus interest. Telling the program in this manner that you intend to borrow permits you to assume a higher interest rate on your borrowing than you can earn on your regular assets.
best, Larry
Does this equate to a credit line up to this amount that I can borrow at the real rate entered under Assumptions?
How is it amortized?
Where does the interest expense amount hit?
How do the borrowings factor into the Regular Asset calculation?
Hi Professor (or others),
What you say above makes sense, but the nominal rates of return I assume on my regular assets are quite low -- I'd put it in muni bonds and the like, as these will be short-term savings -- while if I had to borrow it would likely be on a credit card. So the assumption seems a bit off...the alternative described by Professor Kotlikoff above (involving special expenditures) also makes sense, but I'm wondering if there is another way to enter an assumed rate of return on indebtedness.
Thanks.
Nope, there isn't, but there certainly could be. You'll need to go to the Suggestions for Improvement forum and make a new feature request.
The reason it wasn't done is that it produces an asymmetry in the handling of savings. When savings are positive, you get x%/year, when savings are negative you get y%/year. A middling amount of work to change but it won't happen at all without getting into the queue (and getting some support as well). Additionally, there could be tax issues as well that a solution of this type doesn't take into account, e.g., borrowing on your home IS tax deductible, borrowing on your credit card ISN'T (IIRC).
Best,
Dick Munroe