# Address 6 - PowerPoint PPT Presentation

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1. Lecture 6 I. Using consumer loans

2. I. Basic Features of Consumer Loans • Formal, negotiated contracts • Specify- terms for borrowing- repayment schedule • One-time transaction • Normally used to pay for big-ticket items

3. Types of Consumer Loans • Auto • Durable goods • Student loans • Personal loans • Consolidation loans

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 • Friends and relatives

6. II. Shopping for Loans • Shop carefully before borrowing • Compare loan features • Finance charges and loan maturity • Total cost of transaction • Collateral requirements • Other features, such as prepayment penalties

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. Single Payment Loans: • Is repaid in full with a single payment on a given due date • Specified time period,usually less than 1 year. • Payment includes principal and interest. • May require collateral.

9. Calculating Finance Charges on Single-Payment Loans: • Simple Interest Method • calculated on the outstanding balance • Discount Method- not widely used anymore- interest calculated on the principal- then subtracted from loan amount; remainder goes to borrower- finance charges are paid in advance

10. 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.)

11. Using the Simple Interest Method: Interest = Principal x Rate x Time = \$1000 x .12 x 2 Finance Charges = \$240

12. Using the Simple Interest Method: Annual Percentage Rate = average annual finance charge average loan balance outstanding APR = (\$240  2)  \$1000 = \$120  \$1000 = .12 = 12%

13. 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.

14. Calculating Finance Charges on Installment Loans: • Simple Interest Method • calculated on the outstanding (declining) balance • Add-On Method • finance charges calculated on original loan balance and • then added to principal • costly form of consumer credit!

15. 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.)

16. Using the Simple Interest Method: • 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.

17. Simple Interest Method Continued: • This is the method used when computing with financial calculator. • With simple interest method Stated Rate = APR • In this example,APR = 12% and rate per period = 12% 12 = 1% per month.

18. Mo. Beg. Bal. PMT Int. Principal End. Bal. 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

19. Total amount paid over the 12-month period: \$88.85 x 12 = \$1,066.20 Loan amount = – 1,000.00 Interest paid = \$ 66.20

20. Using the Add-On Method: • Finance charges are calculated 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

21. Total amount paid over the 12-month period: \$93.33 x 12 = \$1,120.00 Loan amount = – 1,000.00 Interest paid = \$ 120.00

22. Comparing the Two Methods:

23. 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.

24. 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)