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CHAPTER 7:  USING CONSUMER LOANS Clip Art    2001 Microsoft Corporation. All rights reserved.
Consumer Loans <ul><li>Formal, negotiated contracts </li></ul><ul><li>Specify the terms for borrowing </li></ul><ul><li>Sp...
Types of Consumer Loans <ul><li>Auto </li></ul><ul><li>Durable goods </li></ul><ul><li>Education loans </li></ul><ul><li>P...
Sources of Consumer Loans : <ul><li>Traditional financial institutions </li></ul><ul><ul><li>Commercial banks </li></ul></...
Other sources include: <ul><li>Sales finance companies </li></ul><ul><ul><li>Third party financing </li></ul></ul><ul><ul>...
Managing Your Credit <ul><li>Shop carefully before borrowing </li></ul><ul><li>Compare loan features </li></ul><ul><ul><li...
Keep Track of Your Credit ! <ul><li>Keep inventory sheet of debt. </li></ul><ul><li>Know total monthly payments. </li></ul...
Repaying Your Loan <ul><li>1. Single payment loans </li></ul><ul><li>2. Installment loans </li></ul>BANK Clip Art    2001...
1.  Single Payment Loans : <ul><li>Specified time period, usually less than 1 year. </li></ul><ul><li>Payment due in full ...
Calculating Finance Charges on Single-Payment Loans: <ul><li>Simple Interest Method </li></ul><ul><ul><li>Calculated on th...
<ul><li>Example : </li></ul><ul><li>Calculate the finance charges and APR on a  $1000  loan for  2  years at an annual int...
Using the Simple Interest Method: <ul><li>Interest = Principal x Rate x Time </li></ul><ul><li>  = $1000 x .12 x 2 </li></...
Using the Simple Interest Method: <ul><li>Annual Percentage Rate =  </li></ul><ul><li>average annual finance charge </li><...
Using the Discount Method: <ul><li>Interest = Principal x Rate x Time </li></ul><ul><li>  = $1000 x .12 x 2 </li></ul>Fina...
Using the Discount Method: <ul><li>Annual Percentage Rate =  </li></ul><ul><li>average annual finance charge </li></ul><ul...
Comparing the Two Methods :
2.  Installment Loans : <ul><li>Repaid in a series of equal payments. </li></ul><ul><li>Each payment is part principal and...
Calculating Finance Charges on Installment Loans: <ul><li>Simple Interest Method </li></ul><ul><ul><li>Calculated on the  ...
<ul><li>Example : </li></ul><ul><li>Calculate the finance charges and APR on a  $1000  loan to be repaid in  12  monthly i...
<ul><li>Set on  12  P/YR  </li></ul><ul><li>and END mode: </li></ul><ul><li>1000 +/- PV </li></ul><ul><li>  12 I/YR </li><...
<ul><li>1 $1,000.00 $88.85 $10.00   $78.85 $921.15 </li></ul><ul><li>2 $  921.15 $88.85   $ 9.21   $79.64 $841.51 </li></u...
Using the Simple Interest Method: <ul><li>Simple interest is figured on the outstanding loan balance  each period . </li><...
Simple Interest Method Continued: <ul><li>This is the method financial calculators use when solving for interest. </li></u...
$88.85 x 12 =  $1,066.20 Loan amount = – 1,000.00  Interest paid =  $  66.20 Total amount paid over the 12-month period:
Using the Add-On Method: <ul><li>Calculate finance charges on the original loan amount: </li></ul><ul><li>$1000 x .12 x 1 ...
Add-On Method Continued: <ul><li>Use financial calculator to figure APR for the Add-On Method using the payment just deter...
$93.33 x 12 =  $1,120.00 Loan amount = – 1,000.00  Interest paid =  $  120.00 Total amount paid over the 12-month period:
Comparing the Two Methods :
More on Loans : <ul><li>Carefully examine Installment Purchase Contract—it contains the terms of the loan. </li></ul><ul><...
Other Loan Features to Ask About : <ul><li>Acceleration clause </li></ul><ul><li>Garnishment of wages </li></ul><ul><li>Re...
THE END!
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  1. 1. CHAPTER 7: USING CONSUMER LOANS Clip Art  2001 Microsoft Corporation. All rights reserved.
  2. 2. Consumer Loans <ul><li>Formal, negotiated contracts </li></ul><ul><li>Specify the terms for borrowing </li></ul><ul><li>Specify the repayment schedule </li></ul><ul><li>One-time transaction </li></ul><ul><li>Normally used to pay for big-ticket items </li></ul>
  3. 3. Types of Consumer Loans <ul><li>Auto </li></ul><ul><li>Durable goods </li></ul><ul><li>Education loans </li></ul><ul><li>Personal loans </li></ul><ul><li>Consolidation loans </li></ul>Clip Art  2001 Microsoft Corporation. All rights reserved.
  4. 4. Sources of Consumer Loans : <ul><li>Traditional financial institutions </li></ul><ul><ul><li>Commercial banks </li></ul></ul><ul><ul><li>Credit Unions </li></ul></ul><ul><ul><li>Savings and Loan Associations </li></ul></ul><ul><li>Consumer finance companies </li></ul><ul><ul><li>Specialize in high-risk borrowers </li></ul></ul><ul><ul><li>Together with banks and credit unions make ~75% of consumer loans. </li></ul></ul>
  5. 5. Other sources include: <ul><li>Sales finance companies </li></ul><ul><ul><li>Third party financing </li></ul></ul><ul><ul><li>Include captive finance companies, such as GMAC </li></ul></ul><ul><li>Life insurance companies </li></ul><ul><ul><li>Loan against cash value of certain types of policies </li></ul></ul><ul><li>Brokerage firms </li></ul><ul><li>Pawn shops </li></ul><ul><li>Friends and relatives </li></ul>
  6. 6. Managing Your Credit <ul><li>Shop carefully before borrowing </li></ul><ul><li>Compare loan features </li></ul><ul><ul><li>Finance charges and loan maturity </li></ul></ul><ul><ul><li>Total cost of transaction </li></ul></ul><ul><ul><li>Collateral requirements </li></ul></ul><ul><ul><li>Other features, such as prepayment penalties and late fees </li></ul></ul>
  7. 7. Keep Track of Your Credit ! <ul><li>Keep inventory sheet of debt. </li></ul><ul><li>Know total monthly payments. </li></ul><ul><li>Know total debt outstanding. </li></ul><ul><li>Check your debt safety ratio— </li></ul><ul><ul><li>total monthly consumer debt pmts </li></ul></ul><ul><ul><li>monthly take-home pay </li></ul></ul>
  8. 8. Repaying Your Loan <ul><li>1. Single payment loans </li></ul><ul><li>2. Installment loans </li></ul>BANK Clip Art  2001 Microsoft Corporation. All rights reserved.
  9. 9. 1. Single Payment Loans : <ul><li>Specified time period, usually less than 1 year. </li></ul><ul><li>Payment due in full at maturity. </li></ul><ul><li>Payment includes principal and interest. </li></ul><ul><li>May require collateral. </li></ul><ul><li>Loan rollover may be possible if borrower is unable to repay in time. </li></ul>
  10. 10. Calculating Finance Charges on Single-Payment Loans: <ul><li>Simple Interest Method </li></ul><ul><ul><li>Calculated on the outstanding balance. </li></ul></ul><ul><li>Discount Method </li></ul><ul><ul><li>Interest calculated on the principal, </li></ul></ul><ul><ul><li>Then subtracted from loan amount; remainder goes to borrower. </li></ul></ul><ul><ul><li>Finance charges are paid in advance. </li></ul></ul><ul><ul><li>APR will be higher than stated interest rate. </li></ul></ul>
  11. 11. <ul><li>Example : </li></ul><ul><li>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.) </li></ul>
  12. 12. Using the Simple Interest Method: <ul><li>Interest = Principal x Rate x Time </li></ul><ul><li> = $1000 x .12 x 2 </li></ul>Finance Charges = $240 <ul><li>Borrower receives loan amount ($1000) now— </li></ul><ul><li>And pays back loan amount plus finance charges ($1000 + $240) at end of time period. </li></ul><ul><li>Most consumer friendly method—APR will be the same as the stated rate. </li></ul>
  13. 13. Using the Simple Interest Method: <ul><li>Annual Percentage Rate = </li></ul><ul><li>average annual finance charge </li></ul><ul><li>average loan balance outstanding </li></ul><ul><li>APR = ($240  2) </li></ul><ul><li> $1000 </li></ul><ul><li>= $120 </li></ul><ul><li> $1000 </li></ul><ul><li>= .12 = </li></ul>12%
  14. 14. Using the Discount Method: <ul><li>Interest = Principal x Rate x Time </li></ul><ul><li> = $1000 x .12 x 2 </li></ul>Finance Charges = $240 <ul><li>Finance charges calculated the same way as in simple interest method— </li></ul><ul><li>But are then subtracted from loan amount ($1000 – $240). </li></ul><ul><li>Borrower receives the remainder ($760) now and pays back the loan amount ($1000) at end of time period. </li></ul>
  15. 15. Using the Discount Method: <ul><li>Annual Percentage Rate = </li></ul><ul><li>average annual finance charge </li></ul><ul><li>average loan balance outstanding </li></ul><ul><li>APR = ($240  2) </li></ul><ul><li> ($1000 – $240) </li></ul><ul><li>= $120 </li></ul><ul><li> $760 </li></ul><ul><li>= .158 = </li></ul>15.8%
  16. 16. Comparing the Two Methods :
  17. 17. 2. Installment Loans : <ul><li>Repaid in a series of equal payments. </li></ul><ul><li>Each payment is part principal and part interest. </li></ul><ul><li>Maturities range from 6 months to 7–10 years or longer. </li></ul><ul><li>Usually require collateral. </li></ul>
  18. 18. Calculating Finance Charges on Installment Loans: <ul><li>Simple Interest Method </li></ul><ul><ul><li>Calculated on the outstanding (declining) balance each period. </li></ul></ul><ul><li>Add-On Method </li></ul><ul><ul><li>Finance charges calculated on original loan balance, </li></ul></ul><ul><ul><li>And then added to principal. </li></ul></ul><ul><ul><li>Costly form of consumer credit! </li></ul></ul>
  19. 19. <ul><li>Example : </li></ul><ul><li>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.) </li></ul>
  20. 20. <ul><li>Set on 12 P/YR </li></ul><ul><li>and END mode: </li></ul><ul><li>1000 +/- PV </li></ul><ul><li> 12 I/YR </li></ul><ul><li> 12 N </li></ul><ul><li>PMT $88.85 </li></ul>Use the financial calculator to compute payment: Set on 1 P/YR and END mode: 1000 +/- PV 12/12 I/YR 12 N PMT $88.85 [Note: Use the AMORT feature on your calculator to create following table.]
  21. 21. <ul><li>1 $1,000.00 $88.85 $10.00 $78.85 $921.15 </li></ul><ul><li>2 $ 921.15 $88.85 $ 9.21 $79.64 $841.51 </li></ul><ul><li>3 $ 841.51 $88.85 $ 8.42 $80.43 $761.08 </li></ul><ul><li>4 $ 761.08 $88.85 $ 7.61 $81.24 $679.84 </li></ul><ul><li>5 $ 679.84 $88.85 $ 6.80 $82.05 $597.79 </li></ul><ul><li>6 $ 597.79 $88.85 $ 5.98 $82.87 $514.92 </li></ul><ul><li>7 $ 514.92 $88.85 $ 5.15 $83.70 $431.22 </li></ul><ul><li>8 $ 431.22 $88.85 $ 4.31 $84.54 $346.68 </li></ul><ul><li>9 $ 346.68 $88.85 $ 3.47 $85.38 $261.30 </li></ul><ul><li>10 $ 261.30 $88.85 $ 2.61 $86.24 $175.06 </li></ul><ul><li>11 $ 175.06 $88.85 $ 1.75 $87.10 $ 87.96 </li></ul><ul><li>12 $ 87.96 $88.85 $ 0.89 $87.96 $ 0 </li></ul>Mo. Beg. Bal. PMT Interest Principal End. Bal.
  22. 22. Using the Simple Interest Method: <ul><li>Simple interest is figured on the outstanding loan balance each period . </li></ul><ul><li>Each payment causes principal to decrease. </li></ul><ul><li>Each subsequent payment, then, will incur a lower finance charge, so </li></ul><ul><li>More of the next payment will go towards repaying the principal. </li></ul>
  23. 23. Simple Interest Method Continued: <ul><li>This is the method financial calculators use when solving for interest. </li></ul><ul><li>When simple interest method is used, whether for single payment or installment loans, </li></ul><ul><li>Stated Rate = APR </li></ul><ul><li>In this example, APR = 12% and rate per period = 12%  12 </li></ul><ul><li>= 1% per month </li></ul>
  24. 24. $88.85 x 12 = $1,066.20 Loan amount = – 1,000.00 Interest paid = $ 66.20 Total amount paid over the 12-month period:
  25. 25. Using the Add-On Method: <ul><li>Calculate finance charges on the original loan amount: </li></ul><ul><li>$1000 x .12 x 1 = $120 </li></ul><ul><li>Add these charges to principal: </li></ul><ul><li>$120 + $1000 = $1,120 </li></ul><ul><li>Divide this amount by the number of periods to arrive at payment: </li></ul><ul><li>$1,120  12 = $93.33 </li></ul>
  26. 26. Add-On Method Continued: <ul><li>Use financial calculator to figure APR for the Add-On Method using the payment just determined and solve for interest: </li></ul>Set on 12 P/YR and END mode: 1000 +/- PV 93.33 PMT 12 N I/YR 21.45% Set on 1 P/YR and END mode: 1000 +/- PV 93.33 PMT 12 N I/YR 1.79% x 12 = 21.45%
  27. 27. $93.33 x 12 = $1,120.00 Loan amount = – 1,000.00 Interest paid = $ 120.00 Total amount paid over the 12-month period:
  28. 28. Comparing the Two Methods :
  29. 29. More on Loans : <ul><li>Carefully examine Installment Purchase Contract—it contains the terms of the loan. </li></ul><ul><li>Finance charges must include not only interest but also any other required charges. </li></ul><ul><li>Total charges, not just interest, must be used to calculate APR. </li></ul>
  30. 30. Other Loan Features to Ask About : <ul><li>Acceleration clause </li></ul><ul><li>Garnishment of wages </li></ul><ul><li>Repossession of collateral </li></ul><ul><li>Balloon payment </li></ul><ul><li>Prepayment penalties </li></ul><ul><li>Credit life insurance requirements (avoid if possible and get term insurance instead) </li></ul>
  31. 31. THE END!
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