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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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