Transcript Document 7195097

7-1
CHAPTER 7:
USING CONSUMER LOANS
7-2
Consumer Loans
Formal, negotiated contracts
Specify the terms for borrowing
Specify the repayment schedule
One-time transaction
Normally used to pay for bigticket items
7-3
Types of Consumer Loans
Auto
Durable goods
Education loans
Personal loans
Consolidation
loans
7-4
Student Loans
Federally sponsored loans:
 Stafford loans (Direct & Federal
Family Education Loans—FFEL)
 Perkins loans
 Supplemental Loans for Students
(SLS)
 Parent Loans (PLUS)
Obtaining a Student Loan:
* It all starts with a FASFA!
– Demonstrate financial
need
– Make satisfactory
progress in school
– No defaults on other
student loans!
7-5
7-6
Repaying Student Loans
 Low interest rates
 With Stafford & Perkins loans —
interest doesn’t accrue until you’re out!
 Consolidate your loans and repay:
– Extended repayment plan
– Graduated repayment schedule
– Income-contingent repayment plan
 Don’t default!
7-7
Repaying Consumer Loans
Single Payment
or Installment
Fixed or Variable
Interest Rate
Where Can You Get
Consumer Loans?
7-8
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
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
7-9
7-10
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
7-11
Low Rate or a Rebate?
 Example: buying a new car with a
price of $20,000, with two financing
options:
– 1.9% financing (60 months) from car
dealer
– $2,500 rebate, then 10% (60 months)
financing from your bank
 Which option should you choose?
7-12
1.9% financing
$2,500 rebate
Find monthly
payment
Find monthly
payment
20,000 +/PV
1.9
I/YR
60
N
PMT
$349.68
17,500 +/10
60
PMT
PV
I/YR
N
$371.82
1.9% financing is the better deal
because of the lower monthly payments.
7-13
If we were to make a
monthly payment of
$349.68, we would need
to borrow from the bank:
If we take the $2,500
rebate, we would
need to borrow:
$349.68
10
60
PV
$20,000 – $2,500
= $17,500
from the bank.
PMT
I/YR
N
$16,458
1.9% financing is the better deal because it
represents a lower cost in present value .
7-14
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
7-15
Keep Track of Your Credit!
Use Worksheet 7.1 to track your
consumer debt
A desirable debt safety ratio
should be 20% or lower,
otherwise you are relying too
heavily on credit.
7-16
Repaying Your Loan
1. Single payment loans
2. Installment loans
BANK
7-17
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.
Calculating Finance Charges on
Single-Payment Loans:
7-18
 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.
7-19
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.)
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 method—APR
will be the same as the stated rate.
7-20
7-21
Using the Simple Interest Method:
Annual Percentage Rate =
Average annual finance charge
Average loan balance outstanding
APR = ($240 2)
$1000
=
$120
$1000
= .12 = 12%
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.
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7-23
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%
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Comparing the Two Methods:
Method
Stated Finance Amount Amount
Rate
Charge Rec’d Repaid
APR
Simple
Interest
12%
$240
$1000
$1240
12%
Discount
12%
$240
$ 760
$1000
15.8%
7-25
2. Installment Loans:
Repaid in a series of equal
payments.
Each payment is part principal
and part interest.
Maturities range from 6 months
to 7–10 years or longer.
Usually require collateral.
7-26
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!
7-27
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.)
7-28
Use Exhibit 7.6
Calculator
(Table calculated
using $1000 loan)
(Set on 12 P/YR and
END mode:)
Find payment for
12 months at
12% interest:
$88.85
1000 +/12
12
PMT
PV
I/YR
N
$88.85
[Note: We can use a spreadsheet to
create the following table.]
Mo. Beg. Bal.
1
2
3
4
5
6
7
8
9
10
11
12
$1,000.00
$ 921.15
$ 841.51
$ 761.08
$ 679.84
$ 597.79
$ 514.92
$ 431.22
$ 346.68
$ 261.30
$ 175.06
$ 87.96
PMT
$88.85
$88.85
$88.85
$88.85
$88.85
$88.85
$88.85
$88.85
$88.85
$88.85
$88.85
$88.85
7-29
Interest Principal End. Bal.
$10.00
$ 9.21
$ 8.42
$ 7.61
$ 6.80
$ 5.98
$ 5.15
$ 4.31
$ 3.47
$ 2.61
$ 1.75
$ 0.89
$78.85
$79.64
$80.43
$81.24
$82.05
$82.87
$83.70
$84.54
$85.38
$86.24
$87.10
$87.96
$921.15
$841.51
$761.08
$679.84
$597.79
$514.92
$431.22
$346.68
$261.30
$175.06
$ 87.96
$
0
7-30
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!
7-31
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.
7-32
Total amount paid over the 12month period:
$88.85 x 12
= $1,066.20
Loan amount
Interest paid
= – 1,000.00
= $ 66.20
7-33
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
Add-On Method Continued:
7-34
 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 +/93.33
12
I/YR
PV
PMT
N
21.45%
7-35
Total amount paid over the 12month period:
$93.33 x 12
= $1,120.00
Loan amount
Interest paid
= – 1,000.00
= $ 120.00
7-36
Comparing the Two Methods:
Method
Stated Finance Amount Amount
Rate
Charge Rec’d
Repaid
APR
Simple
Interest
12%
$ 66.20
$1000
$1,066.20
12%
Add-On
12%
$120.00
$1000
$1,120.00 21.45%
7-37
More on Loans:
 Carefully examine Installment
Purchase Contract—it 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.
7-38
Other Loan Considerations:
 Prepayment penalties
– Does the lender use Rule of 78s?
 Rule of 78s (sum-of-the-digits method)
– Charge more interest in earlier months of the
loan
– Producing a much higher principal balance
than the regular installment payment would
result in
 Credit life insurance and disability
requirements
– Avoid if possible and get term insurance
instead!
7-39
Other Loan Considerations:
 Buy on time or pay cash?
– Use Worksheet 7.2 for this analysis
– If all of the following conditions are
satisfied, you should pay cash:
• You have sufficient amount of cash to pay off
the item
• Paying off the item does not exhaust your
savings
• It costs more to borrow than you can earn in
interest from the savings
• Also should consider the tax features