1 Chapter 7 – Consumer Loans Loan agreement – legal contract spelling out all terms and...

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Chapter 7 – Consumer Loans

• Loan agreement – legal contract spelling out all terms and conditions of a loan; other info in the loan disclosure statement

- See Figures 7.1 and 7.2

- Shows APR, number and amount of payments, late charges, fees, security agreement and other terms

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Types of Loans

Single Payment Other features:I = P * R * T

Installment or Fixed/variable rates

Amortizing Acceleration

Secured loans Recourse

Know types, sources, advantages and disadvantages

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Annual Loan Amortization$6,000 loan at 15% p. a. repayable annually over four years

Annual repayment is $2,101.59 per year

Payment Ending

Year Total To Interest To Principal Principal

1 $2,101.59 $900.00 $1,201.59 $4,798.41

2 2,101.59 719.76 1,381.83 3,416.58

3 2,101.59 512.49 1,589.10 1,827.48

4 2,101.59 274.11 1,827.48 -0-

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Home Equity Loans

• Second mortgage (if loan is foreclosed, paid after first mortgage paid off)

• Amortizing or revolving

• Equity in home pledged as security

• Interest is generally tax deductible

• House at risk, reduced financial flexibility

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Special Types of Loans

Student LoansFederally subsidized – on need and progressMade to student or parentPayment on parent loans begins immediately;

student loans deferred until after graduation

Car loans – available from many sourcesPayday loans – can be 250 to 1,000%!

Often use post dated checks

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Student Loans – Consolidation

• Combine with spouse’s– Lengthens repayment, lowers the “monthly”

• Complications:– Divorce: ½ end here; Fed law prevails;

divorce courts can’t separate; no pay, ex responsible

• Some advantages; disadvantages greater?

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Sources of Consumer Loans(Lowest to Highest Cost)

• Credit Unions

• Banks

• Sales Finance Companies– GMAC, Ford Credit

• Small Loan Companies– Household Finance, Beneficial, Associates

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Payment Calculation$6,000, Four years, 15% pa. Payable Monthly

Principal = PV = - 6,000

End value = FV = 0 Paid off

How many payments? N =(12*4)=48

Rate per month? I/Y=15/12 = 1.25

CPT PMT = $166.98 / month166.98 * 12 = $2003.81 per year

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Payments, Interest Rates & Terms

Changing the interest rate or lengthening the term of the loan can cause big changes in interest paid and/or payment amountAs interest rates increase, monthly payments

increase (Fig 7.4)

As maturity lengthened, monthly payments decrease but total financing charges increase

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Changing Loan Interest Rates

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Changing Loan’s Maturity

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Obtaining a Favorable Rate

• Strong credit rating

• Larger down payment

• Provide security

• Shorter maturity

• Variable rather than fixed rate

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Author's Advice

• Don't borrow if you can avoid it

• Control your use of debt – it's expensive

• How much can you comfortably carry?

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Guidelines

• Debt ratio: non-mortgage payments should not exceed 15% of take-home pay

• 28/36% rule:if total house payments are less than 28% of gross income and total debt payments are less than 36%, you are a good risk

• Excluding mortgages and student loans, other debts should be paid every four years

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Can't Pay Your Bills?

• Put budget in place• Self-control in use of debt• Credit counseling• Borrow from lowest cost source• Debt consolidation – lowers

payment, extends maturity• If all else fails, consider bankruptcy

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Bankruptcy

• Very serious matter - on record for 7 or 10 years• Chapter 13 – regular income and limited debts

– "Work out" program – reschedules payment and permits retention of assets

• Chapter 7 – straight bankruptcy; no hope of repayment– Eliminates debt, begin again, some assets sold

– Most common – 70% use

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