What Is After-Tax Income?

After-tax income is the net income after the deduction of all federal, state, and withholding taxes. After-tax income, also called income after taxes, represents the amount of disposable income that a consumer or firm has available to spend.

Understanding After-Tax Income

Most individual tax filers use some version of the IRS Form 1040 to calculate their taxable income, income tax due, and after-tax income. To calculate after-tax income, the deductions are subtracted from gross income. The difference is the taxable income, on which income taxes are due. After-tax income is the difference between gross income and the income tax due. 

Consider the following example: Abi Sample earns $30,000 and claims $10,000 in deductions, resulting in a taxable income of $20,000. Their federal income tax rate is 15%, making the income tax due $3,000. The after-tax income is $27,000, or the difference between gross earnings and income tax ($30,000 – $3,000 = $27,000).

Individuals can also account for state and local taxes when calculating after-tax income. When doing this, sales tax and property taxes are also excluded from gross income. Continuing with the above example, Abi Sample pays $1,000 in state income tax and $500 in municipal income tax resulting in an after-tax income of $25,500 ($27,000 – $1500 = $25,500).

Calculating After-Tax Income for Businesses

Computing after-tax income for businesses is relatively the same as for individuals. However, instead of determining gross income, enterprises begin by defining total revenues. Business expenses, as recorded on the income statement, are subtracted from total revenues producing the firm’s income. Finally, any other relevant deductions are subtracted to arrive at taxable income.

The difference between the total revenues and the business expenses and deductions is the taxable income, on which taxes will be due. The difference between the business’s income and the income tax due is the after-tax income.

After-Tax and Pretax Retirement Contributions

The terms after-tax and pretax income often refer to retirement contributions or other benefits. For example, if someone makes pretax contributions to a retirement account, those contributions are subtracted from their gross pay. After deductions are made to the gross salary amount, the employer will calculate payroll taxes.

Medicare contributions and Social Security payments are calculated on the difference after these deductions are taken from the gross salary amount. However, if the employee makes after-tax contributions to a retirement account, the employer applies taxes to the employee’s gross pay and then subtracts the retirement contributions from that amount.

What Is the 3-6-3 Rule?

The 3-6-3 rule is a slang term that refers to an unofficial practice in the banking industry in the 1950s, 1960s, and 1970s that was the result of non-competitive and simplistic conditions in the industry.

The 3-6-3 rule describes how bankers would supposedly give 3% interest on their depositors’ accounts, lend the depositors money at 6% interest, and then be playing golf by 3 p.m. In the 1950s, 1960s, and 1970s, a huge part of a bank’s business was lending out money at a higher interest rate than what it was paying out to its depositors (as a result of tighter regulations during this time period).

Understanding the 3-6-3 Rule

After the Great Depression, the government implemented tighter banking regulations. This was partially due to the problems–namely corruption and a lack of regulation–that the banking industry faced leading up the economic downturn that precipitated the Great Depression. One result of these regulations is that it controlled the rates at which banks could lend and borrow money. This made it difficult for banks to compete with each other and limited the scope of the services they could provide clients. As a whole, the banking industry became more stagnant.

With the loosening of banking regulations and the widespread adoption of information technology in the decades after the 1970s, banks now operate in a much more competitive and complex manner. For example, banks may now provide a greater range of services, including retail and commercial banking services, investment management, and wealth management.

For banks that provide retail banking services, individual customers often use local branches of much larger commercial banks. Retail banks will generally offer savings and checking accounts, mortgages, personal loans, debit/credit cards, and certificates of deposit (CDs) to their clients. In retail banking, the focus is on the individual consumer (as opposed to any larger-sized clients, such as an endowment).

Banks that provide investment management for their clientele typically manage collective investments (such as pension funds) as well as overseeing the assets of individual customers. Banks that work with collective assets may also offer a wide range of traditional and alternative products that may not be available to the average retail investor, such as IPO opportunities and hedge funds.

For banks that offer wealth management services, they may cater to both high net worth and ultra-high net worth individuals. Financial advisors at these banks typically work with clients to develop tailored financial solutions to meet their needs. Financial advisors may also provide specialized services, such as investment management, income tax preparation, and estate planning. Most financial advisors aim to attain the Chartered Financial Analyst (CFA) designation, which measures their competency and integrity in the field of investment management.

What Is an 80-10-10 Mortgage?

An 80-10-10 mortgage is a loan where first and second mortgages are obtained simultaneously. The first mortgage lien is taken with an 80% loan-to-value (LTV) ratio, meaning that it is 80% of the home’s cost; the second mortgage lien has a 10% LTV ratio, and the borrower makes a 10% down payment.

This arrangement can be contrasted with the traditional single mortgage with a down payment amount of 20%.

The 80-10-10 mortgage is a type of piggyback mortgage.

Understanding an 80-10-10 Mortgage

​​​​​​​When a prospective homeowner buys a home with less than the standard 20% down payment, they are required to pay private mortgage insurance (PMI). PMI is insurance that protects the financial institution lending the money against the risk of the borrower defaulting on a loan. An 80-10-10 mortgage is frequently used by borrowers to avoid paying PMI, which would make a homeowner’s monthly payment higher.

In general, 80-10-10 mortgages tend to be popular at times when home prices are accelerating. As homes become less affordable, making a 20% down payment of cash might be difficult for an individual. Piggyback mortgages allow buyers to borrow more money than their down payment might suggest.

The first mortgage of an 80-10-10 mortgage is usually always a fixed-rate mortgage. The second mortgage is usually an adjustable-rate mortgage, such as a home equity loan or home equity line of credit (HELOC).

Benefits of an 80-10-10 Mortgage

The second mortgage functions like a credit card, but with a lower interest rate since the equity in the home will back it. As such, it only incurs interest when you use it. This means that you can pay off the home equity loan or HELOC in full or in part and eliminate interest payments on those funds. Moreover, once settled, the HELOC remains. This credit line can act as an emergency pool for other expenses, such as home renovations or even education.

An 80-10-10 loan is a good option for people who are trying to buy a home but have not yet sold their existing home. In that scenario, they would use the HELOC to cover a portion of the down payment on the new home. They would pay off the HELOC when the old home sells.

HELOC interest rates are higher than those for conventional mortgages, which will somewhat offset the savings gained by having an 80% mortgage. If you intend to pay off the HELOC within a few years, this may not be a problem.

When home prices are rising, your equity will increase along with your home’s value. But in a housing market downturn, you could be left dangerously underwater with a home that’s worth less than you owe.

Example of an 80-10-10 Mortgage

The Doe family wants to purchase a home for $300,000, and they have a down payment of $30,000, which is 10% of the total home’s value. With a conventional 90% mortgage, they will need to pay PMI on top of the monthly mortgage payments. Also, a 90% mortgage will generally carry a higher interest rate. 

Instead, the Doe family can take out an 80% mortgage for $240,000, possibly at a lower interest rate, and avoid the need for PMI. At the same time, they would take out a second 10% mortgage of $30,000. This most likely would be a HELOC. The down payment will still be 10%, but the family will avoid PMI costs, get a better interest rate, and thus have lower monthly payments.

What Is an Asset-Backed Commercial Paper (ABCP)?

An asset-backed commercial paper (ABCP) is a short-term investment vehicle with a maturity date that is typically between 90 and 270 days. A bank or other financial institution typically issues the security itself. The notes are backed by the company’s physical assets such as trade receivables. Companies will use an asset-backed commercial paper to fund short-term financing needs.

Understanding Asset-Backed Commercial Paper (ABCP)

Asset-backed commercial paper (ABCP) is a short-term money-market security that is issued by a special purpose vehicle (SPV) or conduit, which is set up by a sponsoring financial institution. The maturity date of an ABCP is set at no more than 270 days and issued either on an interest-bearing or discount basis.

The note is backed by the corporation’s collateral, which might include future payments to be made on credit cards, auto loans, student loans, and collateralized debt obligations (CDOs). These expected payments are collectively known as receivables. The proceeds of an ABCP issue is used primarily to obtain interests in various types of assets, either through asset purchase or secured lending transactions.

Commercial Paper (CP) vs. Asset-Backed Commercial Paper (ABCP)

The primary difference between commercial paper (CP) and asset-backed commercial paper (ABCP) is that commercial paper is not backed by assets. Commercial paper (CP) is a money market security issued by large corporations to raise money to meet short-term obligations. With a fixed maturity of less than one year, the commercial paper acts as a promissory note that is backed only by the high credit rating of the issuing company.

Investors purchase the commercial paper at a discount to face value and are repaid the full face value of the security at maturity. Since standard commercial papers are not backed by collateral, only firms with excellent credit ratings from a recognized credit rating agency will be able to sell commercial papers at a reasonable price. A type of commercial paper that is backed by other financial assets is called an asset-backed commercial paper.

A company or bank looking to enhance liquidity may sell receivables to an SPV or other conduits, which, in turn, will issue them to its investors as asset-backed commercial paper. The ABCP is backed by the expected cash inflows from the receivables. As the receivables are collected, the originators are expected to pass the funds to the conduit, which is responsible for disbursing the funds generated by the receivables to the ABCP noteholders.

ABCP Interest Payments

During the life of the investment, the sponsoring financial institution that set up the conduit is responsible for monitoring developments that could affect the performance and credit quality of the assets in the SPV. The sponsor ensures that ABCP investors receive their interest payments and principal repayments when the security matures.

The interest payments made to ABCP investors originate from the pool of assets backing the security, e.g., monthly car loan payments. When the collateralized paper matures, the investor receives a principal payment that is funded either from the collection of the credit’s assets, from the issuance of new ABCP, or by accessing the credit’s liquidity facility.

Special Considerations

While most ABCP programs issue commercial paper as their primary liability, funding sources have been extensively diversified lately to include other types of debt. This includes medium-term notes (MTNs), extendible commercial paper, and subordinated debt to provide credit enhancement.

One significant concern about ABCPs and related investments stems from the possibility of liquidity risk. If the market value of the underlying assets decreases, then the safety and value of the ABCP might also suffer.

It’s important for ABCP investors to understand the composition of the underlying assets and how the value of those assets might be impacted by market stresses, such as a downturn in the economy. The inability in some circumstances for investors to sell their investments quickly to minimize losses is just one of the risks associated with asset-backed commercial paper.