CHAPTER 7: USING CONSUMER LOANS

1
CHAPTER 7 USING CONSUMER LOANS
2
Consumer Loans

• Formal, negotiated contracts
• Specify the terms for borrowing
• Specify the repayment schedule
• One-time transaction
• Normally used to pay for big-ticket items

3
Types of Consumer Loans

• Auto
• Durable goods
• Education loans
• Personal loans
• Consolidation loans

4
Student Loans

• Federally sponsored loans
• Stafford loans (Direct Federal Family Education
  LoansFEEL)
• Perkins loans
• Supplemental Loans for Students (SLS)
• Parent Loans (PLUS)

5
Obtaining a Student Loan
It all starts with a FASFA!

• Demonstrate financial need
• Make satisfactory progress in school
• No defaults on other student loans!

6
Repaying Student Loans

• Low interest rates
• With Stafford Perkins loans interest doesnt
  accrue until youre out!
• Consolidate your loans and repay
• Extended repayment plan
• Graduated repayment schedule
• Income-contingent repayment plan
• Dont default!

7
Repaying Consumer Loans

• Single Payment or Installment
• Fixed or Variable Interest Rate

8
Where Can You Get Consumer Loans?

• Traditional financial institutions
• Commercial banks
• Credit Unions
• Savings and Loan Associations
• Consumer finance companies
• Specialize in high-risk borrowers
• Together with banks and credit unions make 75
  of consumer loans

9
Other sources include

• Sales finance companies
• Third party financing
• Include captive finance companies, such as GMAC
• Life insurance companies
• Loan against cash value of certain types of
  policies
• Friends and relatives
• Pawn shops

10
Managing Your Credit

• Shop carefully before borrowing
• Compare loan features
• Finance charges and loan maturity
• Total cost of transaction
• Collateral requirements
• Other features, such as payment date, prepayment
  penalties and late fees

11
Keep Track of Your Credit!

• Keep inventory sheet of debt
• Know total monthly payments
• Know total debt outstanding
• Check your debt safety ratio

Total monthly consumer debt pmts Monthly
take-home pay
12
Repaying Your Loan

• 1. Single payment loans
• 2. Installment loans

BANK
13
1. Single Payment Loans

• Specified time period, usually less than 1 year.
• Payment due in full at maturity.
• Payment includes principal and interest.
• May require collateral.
• Loan rollover may be possible if borrower is
  unable to repay in time.

14
Calculating Finance Charges on Single-Payment
Loans

• Simple Interest Method
• Calculated on the outstanding balance.
• Discount Method
• Interest calculated on the principal,
• Then subtracted from loan amount remainder goes
  to borrower.
• Finance charges are paid in advance.
• APR will be higher than stated interest rate.

15

• Example
• Calculate the finance charges and APR on a 1000
  loan for 2 years at an annual interest rate of
  12. (Assume interest is the only finance
  charge.)

16
Using the Simple Interest Method

• Interest Principal x Rate x Time
• 1000 x .12 x 2

Finance Charges 240

• Borrower receives loan amount (1000) now
• And pays back loan amount plus finance charges
  (1000 240) at end of time period.
• Most consumer friendly methodAPR will be the
  same as the stated rate.

17
Using the Simple Interest Method

• Annual Percentage Rate
• Average annual finance charge
• Average loan balance outstanding
• APR (240? 2)
• 1000
• 120
• 1000
• .12

12
18
Using the Discount Method

• Interest Principal x Rate x Time
• 1000 x .12 x 2

Finance Charges 240

• Finance charges calculated the same way as in
  simple interest method
• But are then subtracted from loan amount (1000
  240).
• Borrower receives the remainder (760) now and
  pays back the loan amount (1000) at end of time
  period.

19
Using the Discount Method

• Annual Percentage Rate
• Average annual finance charge
• Average loan balance outstanding
• APR (240? 2)
• (1000 240)
• 120
• 760
• .158

15.8
20
Comparing the Two Methods
21
2. Installment Loans

• Repaid in a series of equal payments.
• Each payment is part principal and part interest.
• Maturities range from 6 months to 710 years or
  longer.
• Usually require collateral.

22
Calculating Finance Charges on Installment Loans

• Simple Interest Method
• Calculated on the outstanding (declining) balance
  each period.
• Add-On Method
• Finance charges calculated on original loan
  balance
• And then added to principal.
• Costly form of consumer credit!

23

• Example
• Calculate the finance charges and APR on a 1000
  loan to be repaid in 12 monthly installments at
  an annual interest rate of 12. (Assume interest
  is the only finance charge.)

24

• Calculator
• (Set on 12 P/YR and END mode)
• 1000 /- PV
• 12 I/YR
• 12 N
• PMT 88.85

Use Exhibit 7.6 (Table calculated using 1000
loan) Find payment for 12 months at 12
interest 88.85
Note Use the AMORT feature on your calculator
to create following table.
25
Mo. Beg. Bal. PMT Interest Principal End. Bal.

• 1 1,000.00 88.85 10.00 78.85 921.15
• 2 921.15 88.85 9.21 79.64 841.51
• 3 841.51 88.85 8.42 80.43 761.08
• 4 761.08 88.85 7.61 81.24 679.84
• 5 679.84 88.85 6.80 82.05 597.79
• 6 597.79 88.85 5.98 82.87 514.92
• 7 514.92 88.85 5.15 83.70 431.22
• 8 431.22 88.85 4.31 84.54 346.68
• 9 346.68 88.85 3.47 85.38 261.30
• 10 261.30 88.85 2.61 86.24 175.06
• 11 175.06 88.85 1.75 87.10 87.96
• 12 87.96 88.85 0.89 87.96
  0

26
Using the Simple Interest Method

• Simple interest is figured on the outstanding
  loan balance each period.
• Each payment causes the outstanding loan balance
  to decrease.
• Each subsequent payment, then, will incur a lower
  finance charge, so
• More of the next payment will go towards repaying
  the principal or outstanding loan balance!

27
Simple Interest Method Continued

• This is the method financial calculators use when
  solving for interest.
• When simple interest method is used, whether for
  single payment or installment loans,
• Stated Rate APR
• In this example, APR 12 and
• rate per period 12 ? 12
• 1 per month.

28
88.85 x 12 1,066.20 Loan amount
1,000.00 Interest paid 66.20
Total amount paid over the 12-month period
29
Using the Add-On Method

• Calculate finance charges on the original loan
  amount
• 1000 x .12 x 1 120
• Add these charges to principal
• 120 1000 1,120
• Divide this amount by the number of periods to
  arrive at payment
• 1,120 ? 12 93.33

30
Add-On Method Continued

• Use financial calculator to figure APR for the
  Add-On Method using the payment just determined
  and solve for interest

Set on 12 P/YR and END mode 1000
/- PV 93.33 PMT 12 N I/YR 21.45
31
93.33 x 12 1,120.00 Loan amount
1,000.00 Interest paid 120.00
Total amount paid over the 12-month period
32
Comparing the Two Methods
33
More on Loans

• Carefully examine Installment Purchase
  Contractit contains the terms of the loan.
• Finance charges must include not only interest
  but also any other required charges.
• Total charges, not just interest, must be used to
  calculate APR.

34
Other Loan Considerations

• Prepayment penalties
• Does the lender use Rule of 78s?
• Credit life insurance and disability requirements
  
• Avoid if possible and get term insurance
  instead!
• Buy on time or pay cash?
• May be better to pay cash If you have it!

35

THE END!