Chapter Fifteen

1. Chapter Fifteen Consumer Loans, Credit Cards, and Real Estate Lending

2. Key Topics • Types of Loans for Individuals and Families • Unique Characteristics of Consumer Loans • Credit Cards and Credit Scoring • Disclosure Rules and Discrimination • Consumer Loan Pricing and Refinancing

3. Introduction p. 439 • Consumer debt has become one of the fastest growing forms of borrowing money - $14 trillion in US • Banks lending to households depends on their need for a source of funds – checkable and savings deposits • Consumer credit is often among the most profitable services a lender can offer • However, services directed at consumers can also be among the most costly and risky financial products

4. Types of Loans Granted to Individuals and Families p. 440 • Consumer loans are classified by 1. Purpose – what the borrowed funds will be used for 2. Type – whether the borrower must repay in installments 分期付款 fēnqífùkuǎn(monthly payments) or repay in one lump sum

5. Types of Loans Granted to Individuals and Families p. 440 • Residential Loans (Real Estate Loans) • Credit to finance the purchase of a home or fund improvements on a private residence • Usually a long-term loan, typically bearing a term of 15 to 30 years • Secured by the property. Property is the collateral itself. • May carry either a fixed interest rate or a variable (floating) interest rate • Banks are the leading residential mortgage lenders today

6. Types of Loans Granted to Individuals and Families (continued) p. 440-441 • Nonresidential Loans (not home loans) • Installment分期付款 fēnqífùkuǎn Loans • Short-term to medium-term loans, repayable in two or more consecutive payments (usually monthly or quarterly) • Used to buy big-ticket items (e.g., automobiles, furniture, and home appliances) or to consolidate (combine) existing household debts

7. Types of Loans Granted to Individuals and Families (continued) p. 440-441 • Nonresidential Loans • NoninstallmentLoans • Short-term loans individuals and families get for immediate cash needs that are repayable in a lump sum • May be for relatively small amounts and include charge accounts that often require payment in 30 days or less • May also be made for a short period (usually six months or less) to wealthier individuals and can be quite large

8. Types of Loans Granted to Individuals and Families (continued) p. 441-442 • Credit Card Loans and Revolving Credit • Very popular form of credit today is credit cards. Economies of scale • Many credit cards have variable (changing) rates of interest • Installment users of credit cards are far more profitable due to the interest income they generate • Card providers also earn discount fees (usually 1 to 7 percent of credit card sales) from merchants who accept their cards

9. Types of Loans Granted to Individuals and Families (continued) • New Credit Card Regulations • Regulations slow the expansion of card offers to customers with low credit ratings • There was evidence that some customers were charged high fees but encouraged to make only low minimum payments • Resulted in negative amortization 折旧 zhéjiù

10. Characteristics of Consumer Loans p. 444 • Lenders regard consumer loans as profitable credits with “sticky” interest rates • Contract interest rates often do not change with market conditions as do interest rates on most business loans • As a result, many consumer loans are subject to significant interest rate risk • Consumer loans are usually priced so high that market interest rates on borrowed funds and default rates on the loans themselves would have to rise before consumer credit becomes unprofitable.

11. Characteristics of Consumer Loans (continued) • Why are interest rates so high on most consumer loans? • Consumer loans are among the most costly and most risky to make per dollar of loanable funds committed to them • Consumer loans tend to be cyclically 循环 (xúnhuán) sensitive

12. Characteristics of Consumer Loans (continued) Individuals or Households borrowing money are less concerned about the interest rate. • They are more concerned about the size of the monthly payment rather than the interest rate that they are charged • Education and income levels materially influence consumers’ use of credit

13. Evaluating a Consumer Loan Application p. 445 • Character and Purpose • Key factors in analyzing any consumer loan application are the character of the borrower and the borrower’s ability to pay. Consumer lenders nearly always check with one or more credit bureaus concerning the customer’s credit history • In the case of a borrower without a credit record or with a poor track record of repaying loans, acosignermay be requested to support repayment

14. Evaluating a Consumer Loan Application (continued) • Other Important Items For Lenders • Income Levels • Deposit Balances • Employment and Residential Stability • Debt and exposure 曝光 (pùguāng) to debt. • How to Qualify for a Consumer Loan • Home ownership or ownership of any form of real property • Maintain strong deposit balances • The most important thing to do – truthfully answer all of the loan officer’s questions

15. Credit Scoring Consumer Loan Application p. 450 • The idea of credit scoring is that lenders and statisticians can identify the reasons that separate good loans from bad loans • The same factors that separated good loans from bad loans in the past will separate good loans from bad ones in the future within an acceptable risk of error • Such an automated credit determining system removes personal judgment from the lending process

16. Credit Scoring Consumer Loan Application (continued) p. 452-453 • The FICO System • Developed by the Fair Isaac Corporation • Most famous of all credit-scoring systems currently in use • Scores range from 300 to 850 with higher values denoting less credit risk to lenders • FICO score are based on five different types of information (most important to least important): • The borrower’s payment history • The amount of money owed • The length of a prospective borrower’s credit history • The nature of new credit being requested • The types of credit that the borrower has already used

17. FICO – MY CREDIT SCORE

18. EXPLANATION OF CREDIT SCORE 1.  Proportion of balances to credit limits is too high on bank / revolving accts   • Consumers who use a high percentage of their available credit (generally known as utilization) have a higher risk of delinquency (falling behind on payments) and charge-off (loan default) over time. Lower use of available credit allows consumers who have the need to temporarily carry higher loan balances to do so, because they have available credit on their accounts. Consumers with heavier credit usage cannot absorb changes to their financial situation as easily, which can lead to higher risk over time. Keeping credit balances lower in relation to available credit will help reduce the negative impact on a credit score over time.

19. EXPLANATION OF CREDIT SCORE 2.  Proportion of loan balances to loan amounts is too high   • Consumers who use a high percentage of their available credit (generally known as utilization) have a higher risk of delinquency (falling behind on payments) and charge-off (loan default) over time. Lower use of available credit allows consumers who have the need to temporarily carry higher loan balances to do so, because they have available credit on their accounts. Consumers with heavier credit usage cannot absorb changes to their financial situation as easily, which can lead to higher risk over time. Keeping credit balances lower in relation to available credit will help reduce the negative impact on a credit score over time

20. Laws and Regulations Applying to Consumer Loans (continued) p. 454 • Customer Disclosure Requirements • Truth-in-Lending Act • Fair Credit Reporting Act • Fair Credit Billing Act • Fair Debt Collection Practices Act • Outlawing Credit Discrimination • Equal Credit Opportunity Act • Community Reinvestment Act

21. Laws and Regulations Applying to Consumer Loans (continued) p. 456 • Predatory 掠夺 (lüèduó) lending • A bad practice among some lenders where lenders may require excessive fees • Subprime Loans • Granting loans to borrowers who have below-average credit scores • The Home Ownership and Equity Protection Act was passed in 1994 to protect home buyers from loan agreements they could not afford • Subprime lending is difficult to regulate

22. Real Estate Loans p. 457-458 • Depository institutions and finance and insurance companies make real estate loans to fund the buying of real property • Homes, apartment complexes, shopping centers, office buildings, and land • One of the most rapidly growing areas of lending over the past decade. Almost 1/3 of all bank assets. • Real estate lending is different from other loans • Real estate loans can be among the riskiest forms of credit extended to customers

23. Real Estate Loans (continued) • Differences between Real Estate Loans and Other Loans • The average size of a real estate loan is usually much larger than the average size of other loans • Mortgage loans tend to have longer maturities versus other types of loans • Maturities of 15 years to 30 years are typical for single-family homes • With real estate lending, the condition and value of the subject property are nearly as important as the borrower’s income • Appraisals are critical to the loan decision and must meet industry standards and government regulations

24. Real Estate Loans (continued) p. 459-460 • Home Equity Lending • Homeowners can borrow the equity in their homes • Equity is defined as the difference between a home’s estimated market value and the amount of the mortgage loans against it • Two main types of home equity loans: • Traditional Home Equity Loan (HEL) a fixed rate with installments 2. Prime Equity Loan (PEL) – interest only based on rate set by Fed – 3.25% for past 7 years.

25. Real Estate Loans (continued) • The Most Controversial of Home Mortgage Loans: Interest-Only and Adjustable Rate Mortgages and the Recent Mortgage Crisis • When housing prices were soaring upward during the recent housing boom, how could lenders make high priced homes affordable? • More families were encouraged to sign up for adjustable-rate loans (ARMs) during a period when market interest rates were at historic lows

26. Quick Quiz • What are the principal differences among residential loans, nonresidential installment loans, noninstallment loans, and credit card or revolving loans? Slides 5-9, p. 440-442 • Why do interest rates on consumer loans typically average higher than on most other kinds of loans? Slides 10-11 p. 444-445 • What are the principal advantages to a lending institution of using a credit-scoring system? Are there any significant disadvantages to a credit-scoring system? Slides 15-16 p. 450-453

27. Quick Quiz • What features of a consumer loan application should a loan officer examine most carefully? Slides 12-14 p. 445-447 • What laws exist today to give consumers fuller disclosure about the terms and risks of taking on credit? Slide 17-18 p. 454-455 • What is home equity lending, and what are its advantages and disadvantages for banks and other consumer lending institutions? Slides 21-22 p. 459-462