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  • 1. CHAPTER 7: USING CONSUMER LOANS Clip Art  2001 Microsoft Corporation. All rights reserved.
  • 2. Consumer Loans
    • Formal, negotiated contracts
    • Specify the terms for borrowing
    • Specify the repayment schedule
    • One-time transaction
    • Normally used to pay for big-ticket items
  • 3. Types of Consumer Loans
    • Auto
    • Durable goods
    • Education loans
    • Personal loans
    • Consolidation loans
    Clip Art  2001 Microsoft Corporation. All rights reserved.
  • 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
    • Brokerage firms
    • Pawn shops
    • Friends and relatives
  • 6. Managing Your Credit
    • Shop carefully before borrowing
    • Compare loan features
      • Finance charges and loan maturity
      • Total cost of transaction
      • Collateral requirements
      • Other features, such as prepayment penalties and late fees
  • 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. Repaying Your Loan
    • 1. Single payment loans
    • 2. Installment loans
    BANK Clip Art  2001 Microsoft Corporation. All rights reserved.
  • 9. 1. Single Payment Loans :
    • Specified time period, usually less than 1 year.
    • Payment due in full at maturity.
    • Payment includes principal and interest.
    • May require collateral.
    • Loan rollover may be possible if borrower is unable to repay in time.
  • 10. Calculating Finance Charges on Single-Payment Loans:
    • Simple Interest Method
      • Calculated on the outstanding balance.
    • Discount Method
      • Interest calculated on the principal,
      • Then subtracted from loan amount; remainder goes to borrower.
      • Finance charges are paid in advance.
      • APR will be higher than stated interest rate.
  • 11.
    • 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.)
  • 12. Using the Simple Interest Method:
    • Interest = Principal x Rate x Time
    • = $1000 x .12 x 2
    Finance Charges = $240
    • Borrower receives loan amount ($1000) now—
    • And pays back loan amount plus finance charges ($1000 + $240) at end of time period.
    • Most consumer friendly method—APR will be the same as the stated rate.
  • 13. Using the Simple Interest Method:
    • Annual Percentage Rate =
    • average annual finance charge
    • average loan balance outstanding
    • APR = ($240  2)
    • $1000
    • = $120
    • $1000
    • = .12 =
    12%
  • 14. Using the Discount Method:
    • Interest = Principal x Rate x Time
    • = $1000 x .12 x 2
    Finance Charges = $240
    • Finance charges calculated the same way as in simple interest method—
    • But are then subtracted from loan amount ($1000 – $240).
    • Borrower receives the remainder ($760) now and pays back the loan amount ($1000) at end of time period.
  • 15. Using the Discount Method:
    • Annual Percentage Rate =
    • average annual finance charge
    • average loan balance outstanding
    • APR = ($240  2)
    • ($1000 – $240)
    • = $120
    • $760
    • = .158 =
    15.8%
  • 16. Comparing the Two Methods :
  • 17. 2. 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.
  • 18. Calculating Finance Charges on Installment Loans:
    • Simple Interest Method
      • Calculated on the outstanding (declining) balance each period.
    • Add-On Method
      • Finance charges calculated on original loan balance,
      • And then added to principal.
      • Costly form of consumer credit!
  • 19.
    • 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.)
  • 20.
    • Set on 12 P/YR
    • and END mode:
    • 1000 +/- PV
    • 12 I/YR
    • 12 N
    • PMT $88.85
    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.
    • 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
    Mo. Beg. Bal. PMT Interest Principal End. Bal.
  • 22. Using the Simple Interest Method:
    • Simple 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.
  • 23. Simple Interest Method Continued:
    • This is the method financial calculators use when solving for interest.
    • When simple interest method is used, whether for single payment or installment loans,
    • Stated Rate = APR
    • In this example, APR = 12% and rate per period = 12%  12
    • = 1% per month
  • 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. Using the Add-On Method:
    • Calculate finance charges 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
  • 26. Add-On Method Continued:
    • Use financial calculator to figure APR for the Add-On Method using the payment just determined and solve for interest:
    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. $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. Comparing the Two Methods :
  • 29. 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.
  • 30. 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)
  • 31. THE END!