CHAPTER 7: USING CONSUMER LOANS

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CHAPTER 7 USING CONSUMER LOANS
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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

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Types of Consumer Loans

• Auto
• Durable goods
• Education loans
• Personal loans
• Consolidation loans

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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

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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

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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
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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.

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Calculating Finance Charges on Single-Payment
Loans

• 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.)

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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 methodAPR will be the
  same as the stated rate.

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Using the Simple Interest Method

• Annual Percentage Rate
• average annual finance charge
• average loan balance outstanding
• APR (240? 2)
• 1000
• 120
• 1000
• .12

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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.

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Using the Discount Method

• Annual Percentage Rate
• average annual finance charge
• average loan balance outstanding
• APR (240? 2)
• (1000 240)
• 120
• 760
• .158

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Comparing the Two Methods
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2. Installment Loans

• Repaid in a series of equal payments.
• Each payment is part principal and part interest.
• Maturities range from 6 months to 710 years or
  longer.
• Usually require collateral.

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Calculating Finance Charges on Installment Loans

• 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.)

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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.

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Calculating Finance Charges Using the Simple
Interest Method
88.85 x 12 1,066.20 Loan amount
1,000.00 Interest paid 66.20
Total amount paid over the 12-month period
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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

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Calculating Finance Charges Using the Add-On
Method
93.33 x 12 1,120.00 Loan amount
1,000.00 Interest paid 120.00
Total amount paid over the 12-month period
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Comparing the Two Methods
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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)

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THE END