Consumer Math

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# Consumer Math - PowerPoint PPT Presentation

Consumer Math. Test Review Chapters 6,7, and 8. A First Look at Credit Cards and Open Credit. Credit involves receiving cash, goods, or services with an obligation to pay later. Open credit (revolving credit) is a line of credit extended before the purchase.

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Presentation Transcript

### Consumer Math

Test Review

Chapters 6,7, and 8

A First Look at Credit Cardsand Open Credit

Credit involves receiving cash, goods, or services with an obligation to pay later.

Open credit (revolving credit) is a line of credit extended before the purchase.

Unpaid balance plus interest carries over to next month.

Higher balances on credit lines, higher costs.

Interest Rates

Annual Percentage Rate (APR)—the true simple interest rate paid over the life of the loan.

APR for all consumer loans must be disclosed.

Fixed APR vs. variable APR

Teaser Rates

Compound interest

Cash advances at ATMs are just like taking out a loan.

Higher interest rate charged immediately on cash advances

Up-front fee of 2-4% of the amount advanced.

Pay down the balances for purchases before paying down the higher interest rate cash balance.

Annual Fee

A fixed annual charge imposed by a credit card.

Over 70% of biggest credit card issuers do not charge an annual fee.

Many don’t charge the fee if the card is used at least once a year.

Merchant’s discount fee—the percentage of the sale that the merchant pays to the credit card issuer.

Late Fee

Over-the-Limit Fee

Penalty Rate

Pros and Cons of Credit Cards

Convenience

Used as identification

Phone and internet purchases

Temporary funds

Use product before paying for it

Bill consolidation

Pay less today and earn interest elsewhere

Extended warranties, travel insurance, and rewards.

Pros and Cons of Credit Cards

Too easy to spend money

Too easy to lose track of spending

High interest rate

Obligating future income

Heavy budgetary problems with uncontrolled spending

The Choice: What’s Best for You

Credit user—carries an unpaid balance from month to month.

Convenience user—pays off the credit card balance each month (avoids interest).

Convenience and credit user—generally pays off all the balance

Amount You Owe and Your Available Credit (30%)

Length of Credit History (15%)

Types of Credit Used (10%)

New Credit (10%)

Summary

Main form of open credit is the credit card which you can use to make charges up to a certain point as long as you pay off the minimum amount of your debt each month.

Costs of open credit include interest rate, cost of cash advances, annual fee, penalty fees.

Choices of open credit lines include different types of credit cards and charge accounts.

Single-payment loans

Variable-rate installment loans

Unsecured fix-rate loans

Secured loans

First Decision: Single-Payment versus Installment Loans
• Single-Payment or Balloon Loan—paid back in a single lump-sum payment with interest at maturity.
• Bridge or interim loan– short-term loan.
• Installment loan—repayment of both principal and interest at various intervals.
• Loan amortization—with each payment, the interest portion covered decreases and principal portion covered increases.
Second Decision: Secured versus Unsecured Loans

Secured loan—guaranteed by an asset which typically lowers the rate of the loan.

Unsecured loan—not guaranteed by an asset or collateral

Third Decision: Variable-Rate versus Fixed-Rate Loans
• Fixed-rate interest rate loan—stays fixed for entire duration of the loan, not tied to market interest rates.
• Variable-rate or adjustable interest rate loan—interest rate varies based on the market interest rate.
• Prime rate—the interest rate that banks charge to their most creditworthy, or “prime” customers
• Convertible loan—variable-rate loan that can be converted to a fixed-rate loan.

Shorter term loan means lower interest rate and larger monthly payments

Longer term loan means smaller monthly payments and higher interest rate

Understand the Terms of the Loan: The Loan Contract

Security agreement

Note

Default

Acceleration clause

Deficiency payments clause

Recourse clause

Special Types of Consumer Loans
• Home Equity Loan or Second Mortgage – secured loan using equity in home as collateral.
• Interest is tax deductible
• Lower interest than other consumer loans.
• Puts your home at risk.
• Limits future financing flexibility.
Special Types of Consumer Loans
• Automobile Loan – loan secured by auto.
• Duration usually for 24, 36, or 48 months or even 5 to 6 years.
• Low-cost auto loan rates used to push slow-selling vehicles or older models.
• Repossession if default on loan.
Getting the Best Rate on Your Consumer Loans
• Inexpensive sources—family, home equity loans, cash value life insurance loans.
• More expensive sources—credit unions, S & Ls, and commercial banks.
• Most expensive sources—retail stores, finance companies or small loan companies
Should You Borrow or Pay Cash?
• Debt is expensive
• Don’t borrow to spend.
• Use cash rather than credit.
• If benefits outweigh costs, borrowing makes sense.

Step 1: Differentiate Want From Need

• Financing Alternatives:
• Cheapest—cash
• Investigate all financing options before buying.
• Keep financing out of the negotiations.
• The shorter the term, the higher the monthly payments.

• Leasing: ideal for financially stable, want new car every few years, drive less than 15,000 miles annually, good credit, no down payment
• Closed-end or walk-away lease
• Purchase option
• Open-end lease

Many people equate home ownership with financial success.

Housing costs can take up over 25% of after-tax income.

Home ownership is also an investment – biggest investment you will ever make.

• A House:
• Most potential for capital appreciation.
• Cooperatives and Condominiums:
• Homeowner’s fee
• Planned unit developments
• Apartments and other rental housing

One-time Costs:

• Down payment
• Closing/settlement costs
• Points
• Loan origination fee
• Application fee
• Appraisal fee
• Title search fee

Recurring Costs

• Monthly mortgage payments
• PITI

Maintenance and Operating Costs:

• Decision based on lifestyle
• Financial and lifestyle flexibility
• Compare costs for each alternative
• Longer stay and appreciation, itemized taxes, forced savings
Financing the Purchase—The Mortgage

Sources of mortgages:

• S&Ls and commercial banks
• Credit unions, mutual savings banks
• Mortgage bankers—originate mortgage loans, sell to banks, pension funds, insurance companies and collect payments
• Mortgage brokers—middlemen comparison shop for a fee to secure mortgage loans for borrowers but do not originate the loans
Fixed-Rate Mortgages

Monthly payment doesn’t change regardless of market interest rate changes.

Can lock in low rates for the life of the loan.

An assumable loan can be transferred to a new buyer.

Prepayment privilege allows early cash payments to be applied to principal.

Interest rate of ARM fluctuates with level of current interest rates.

Initial Rate—”teaser rate”—low for only a short time period then adjusted upward.

Interest rate index—rates on ARMs are tied to an index not controlled by the lender, such as 6- or 12-month U.S. Treasuries.

Specialty Mortgage Loan Options

Balloon Payment Mortgage Loan – small monthly payments for 5-7 years, then entire loan due.

Graduated Payment Mortgage – payments set in advance, rising for 5-10 years, then level off.

Growing Equity Mortgage – designed to let homebuyer pay off mortgage early.

Specialty Mortgage Loan Options

Shared Appreciation Mortgage – borrower receives below-market interest rate, lender receives a portion of future appreciation.

Interest Only Mortgage – interest only payment for initial set period, then pay both interest and principal for remainder of loan.

Specialty Mortgage Loan Options
• Option Payment ARM Mortgages – can make different types of mortgage payments each month
• Options include:
• Amount less than interest due
• Interest only
• Payment amount of 150- or 30-year fixed-rate loan