1 / 24

Lecture 6

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

albert
Download Presentation

Lecture 6

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. Lecture 6 I. Using consumer loans

  2. 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

  3. Types of Consumer Loans • Auto • Durable goods • Student loans • Personal loans • Consolidation loans

  4. 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.

  5. 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

  6. 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

  7. 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

  8. 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.

  9. 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

  10. 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.)

  11. Using the Simple Interest Method: Interest = Principal x Rate x Time = $1000 x .12 x 2 Finance Charges = $240

  12. Using the Simple Interest Method: Annual Percentage Rate = average annual finance charge average loan balance outstanding APR = ($240  2)  $1000 = $120  $1000 = .12 = 12%

  13. 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.

  14. 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!

  15. 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.)

  16. 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.

  17. 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.

  18. 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

  19. Total amount paid over the 12-month period: $88.85 x 12 = $1,066.20 Loan amount = – 1,000.00 Interest paid = $ 66.20

  20. 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

  21. Total amount paid over the 12-month period: $93.33 x 12 = $1,120.00 Loan amount = – 1,000.00 Interest paid = $ 120.00

  22. Comparing the Two Methods:

  23. 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.

  24. 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)

More Related