On October 23rd, 2014, we updated our
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Consumer Cash Loan Credit
When consumers obtain retail credit, they get goods or services,
which they then pay for over time along with a finance charge.
When consumers obtain cash credit, they get cash, which they
then pay back over time along with a finance charge.
Some Reasons for Using Cash Credit
Instead of Retail Credit
• Consolidate other debts
o to lower monthly payments
o to reduce costs
o to clear up a delinquency
o to improve credit rating
o to get rid of debt with unfavorable terms
• Direct cash credit may carry a lower interest rate than is
available in a proposed retail purchase.
• Retail credit may not be available for what they want to use
the cash for: ordinary living expenses, vacation, taxes, large
transactions between individuals,
• Personal preference and habits
• Close ties to a particular financial institution
Financial Institutions That Make Consumer Cash Loans
• Commercial banks
• Credit unions
• Consumer finance companies
• Industrial banks
• Savings and loans (thrifts)
• Insurance companies
There is a growing convergence between the types of
financial institutions. Banks can create bank holding
companies that then buy or create subsidiaries which operate
like other kinds of financial institutions. The large holding
companies refer to themselves as financial services
companies, hoping to provide every kind of financial service
you might possibly need or want.
Installment loans require a specific application, a written
agreement, and terms specifying regular monthly
payments of a fixed amount for a given length of time at
an agreed upon interest rate. Because the credit plan
ends at a specific date, installment loans are considered
closed-end credit plans.
Conventional installment loans. These loans are often
secured by the item being purchased, e.g. autos, boats,
etc. But bigger expenses can be financed this way:
vacations, weddings, dental and medical bills, etc.
Home equity loans. This is an installment loan secured
by a second mortgage on the consumer’s home. It uses
as collateral the equity in the property the owner has
built up over time. The amount that can be borrowed is
frequently well under the equity that exists, but banks or
finance companies willing to take bigger risks will loan
more than the equity (for a higher interest rate, of
Home equity loans are popular because
a) interest charges on consumer credit is not tax
b) interest rates on mortgages (even second
mortgages) is usually much less than on
unsecured credit, like credit cards.
Student loans. These are installment loans used to pay
education expenses. Banks found these loans attractive
because of federal subsidies and guarantees.
Open-End Revolving Loans
Open-end credit plans do not expire at some specified
time. Borrowers still make regular monthly payments at
a specified interest rate, but the size of the payment will
depend on how much the borrower has borrowed and/or
paid back during a month.
Cash advances. Credit cards can usually be used to
simply obtain cash rather pay for a purchase at a retail
establishment. Cash advances usually carry higher
interest rates than purchases. (Credit card purchase rates
are usually higher than installment credit loan interest
rates to begin with.) Banks consider cash advances
riskier than purchases because they have no idea what
the consumer is going to use the cash for. Cash advances
also incur an immediate cash advance fee as well as start
accruing interest immediately.
The cash advance credit limit on a credit card can be less
than the purchase credit limit.
Overdraft plans. Overdraft plans allow a consumer to
simply write a check on the consumer’s checking
account for more than the balance. This goes beyond
simply overdraft protection, which merely protects the
consumer from small inadvertent overdrafts. The
consumer has a prearranged agreement with the bank to,
in effect, take out a loan as needed.
Home equity lines of credit. Instead of borrowing a lump
sum as with a home equity installment loan, the
consumer can borrow up to a prearranged limit, using
only as much of line of credit as the consumer “needs.”
Single-payment loans. These are short-term consumer
loans in which payment of the entire amount due is
made at the end of the loan period. Interest on single-
payment loans can be paid in two ways:
Interest Rates on Single-Payment Loans
Discount loan: interest is deducted from the principal
advanced; paying back the entire principal pays the interest as
well. The actual interest rate is higher than the quoted interest
rate because the consumer does not get use of the full
principal during the loan period.
Add-on method: the amount of interest due is paid at the end
of the loan period along with the principal.
Interest Rates on Installment Loans
Simple interest method. Interest is calculated on the
outstanding balance until the payment is made. Each payment
of part of the principal reduces the interest charge the next
Add-on method. The total amount of interest to be charged is
calculated as if the loan were a single-payment loan. The
monthly payment is simply a fixed fraction of the sum of the
principal and the interest charge. The actual interest rate is
about double the stated interest rate because the borrower
gets the use of only half the principal on average over the
length of the loan period.
The Various Types of Financial Institutions Involved
Commercial banks were originally created to make loans to
commerce. But consumer lending, especially through credit cards,
has become a big source or income for them. Banks are being
created to nothing more than offer credit cards. This is becoming
much easier with online banking. Banks can offer cards in all
states without ever seeing any of the customers. Bank ATMs
provide a convenient source of cash for customers.
Credit unions require a common bond among the people in the
association. Members of a credit union own the credit union.
Deposits are called share accounts, etc. Credit unions typically
cater to the small consumer borrower. Credit unions are
decreasing in number but increasing in size. The bigger the credit
union, the more likely it is to offer much the same services as a
Consumer finance companies usually cater to the smaller, higher-
risk consumer. The loans are usually quite small compared to bank
loans, have much greater default rates, and carry much higher
interest rates than bank loans.
Previous to the 1980s savings and loan associations did not make
many consumer loans (or commercial loans). They specialized in
home mortgages. (Still do.) But S&Ls were forced to pay high
market rates of interest on their deposits in 1980s and to stay
competitive, regulations allowed S&Ls to make more consumer
loans (and commercial loans), which carry higher interest rates
than do home mortgages.
Factors Affecting the Cost of Consumer Credit
• Banks, thrifts, and credit unions take in deposits, which are
less expensive than the bank loans finance companies use to
fund their loans.
• The smaller the loan, the more expensive it is (as a
percentage of the principal) to originate and service the loan.
• The less creditworthy the customer base, the greater the
default experience to the lending institution, and the more the
nondefaulters will have to pay to cover the cost of defaults.
• Finance companies face higher credit investigation costs than
do banks, thrifts, and credit unions because of the nature of
• The smaller the loan defaulted on, the more expensive it is to
collect on it (as a percentage of the principal).
• The more an institution emphasizes installment loans rather
than single-payment loans, the more costly the servicing of
• The more diversified the source of income for a financial
institution, the less risk in any one area of loan activity.
• The fixed costs of finance companies are higher as a
percentage of revenue than are the fixed costs of other
institutions. Finance companies often have many offices for
the convenience of customers.
The net result of all of the above is that finance companies have
higher costs associated with their loan activity and can
rationalize a higher interest rate on loans.