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Lecture 6 I. Using consumer loans I. Basic Features of Consumer Loans Formal, negotiated contracts Specify - terms for borrowing - repayment schedule One-time transaction Normally used to pay for big-ticket items Types of Consumer Loans Auto Durable goods Student loans Personal loans

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lecture 6

Lecture 6

I. Using consumer loans

i basic features of consumer loans
I. Basic Features of Consumer Loans
  • Formal, negotiated contracts
  • Specify- terms for borrowing- repayment schedule
  • One-time transaction
  • Normally used to pay for big-ticket items
types of consumer loans
Types of Consumer Loans
  • Auto
  • Durable goods
  • Student loans
  • Personal loans
  • Consolidation loans
sources of consumer loans
Sources of 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.
other sources include
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
ii shopping for loans
II. Shopping for Loans
  • Shop carefully before borrowing
  • Compare loan features
    • Finance charges and loan maturity
    • Total cost of transaction
    • Collateral requirements
    • Other features, such as prepayment penalties
keep track of your credit
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
single payment loans
Single Payment Loans:
  • Is repaid in full with a single payment on a given due date
  • Specified time period,usually less than 1 year.
  • Payment includes principal and interest.
  • May require collateral.
calculating finance charges on single payment loans
Calculating Finance Charges on Single-Payment Loans:
  • Simple Interest Method
    • calculated on the outstanding balance
  • Discount Method- not widely used anymore- interest calculated on the principal- then subtracted from loan amount; remainder goes to borrower- finance charges are paid in advance
slide10
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
Using the Simple Interest Method:

Interest = Principal x Rate x Time

= $1000 x .12 x 2

Finance Charges = $240

using the simple interest method12
Using the Simple Interest Method:

Annual Percentage Rate =

average annual finance charge

average loan balance outstanding

APR = ($240  2)  $1000

= $120  $1000

= .12 =

12%

installment loans
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.
calculating finance charges on installment loans
Calculating Finance Charges on Installment Loans:
  • Simple Interest Method
    • calculated on the outstanding (declining) balance
  • Add-On Method
    • finance charges calculated on original loan balance and
    • then added to principal
    • costly form of consumer credit!
slide15
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.)

using the simple interest method16
Using the Simple Interest Method:
  • Interest is figured on the outstanding loan balance each period.
  • Each payment causes principal to decrease.
  • Each subsequent payment, then, will incur a lower finance charge, so
  • More of the next payment will go towards repaying the principal.
simple interest method continued
Simple Interest Method Continued:
  • This is the method used when computing with financial calculator.
  • With simple interest method Stated Rate = APR
  • In this example,APR = 12% and rate per period = 12% 12 = 1% per month.
slide18

Mo. Beg. Bal. PMT Int. 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

slide19

Total amount paid over the 12-month period:

$88.85 x 12 = $1,066.20

Loan amount = – 1,000.00

Interest paid = $ 66.20

using the add on method
Using the Add-On Method:
  • Finance charges are calculated 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

slide21

Total amount paid over the 12-month period:

$93.33 x 12 = $1,120.00

Loan amount = – 1,000.00

Interest paid = $ 120.00

more on loans
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.
other loan features to ask about
Other Loan Features to Ask About:
  • Acceleration clause
  • Garnishment of wages
  • Repossession of collateral
  • Balloon payment
  • Prepayment penalties
  • Credit life insurance requirements (avoid if possible and get term insurance instead)