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7-1 CHAPTER 7: USING CONSUMER LOANS. 7-2 Consumer Loans  Formal, negotiated contracts  Specify the terms for borrowing  Specify the repayment schedule.

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Presentation on theme: "7-1 CHAPTER 7: USING CONSUMER LOANS. 7-2 Consumer Loans  Formal, negotiated contracts  Specify the terms for borrowing  Specify the repayment schedule."— Presentation transcript:

1 7-1 CHAPTER 7: USING CONSUMER LOANS

2 7-2 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

3 7-3 Types of Consumer Loans  Auto  Durable goods  Education loans  Personal loans  Consolidation loans

4 7-4 Student Loans Federally sponsored loans:  Stafford loans (Direct & Federal Family Education Loans—FEEL)  Perkins loans  Supplemental Loans for Students (SLS)  Parent Loans (PLUS)

5 7-5 Obtaining a Student Loan : –Demonstrate financial need –Make satisfactory progress in school –No defaults on other student loans! * It all starts with a FASFA!

6 7-6 Repaying Student Loans  Low interest rates  With Stafford & Perkins loans — interest doesn’t accrue until you’re out!  Consolidate your loans and repay: –Extended repayment plan –Graduated repayment schedule –Income-contingent repayment plan  Don’t default!

7 7-7 Repaying Consumer Loans  Single Payment or Installment  Fixed or Variable Interest Rate

8 7-8 Where Can You Get 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

9 7-9 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  Pawn shops

10 7-10 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 payment date, prepayment penalties and late fees

11 7-11 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

12 7-12 Repaying Your Loan 1. Single payment loans 2. Installment loans BANK

13 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.

14 7-14 Calculating Finance Charges on Single-Payment Loans:  Simple Interest Method –Calculated on the outstanding balance.  Discount Method –Interest calculated on the principal, –Then subtracted from loan amount; remainder goes to borrower. –Finance charges are paid in advance. –APR will be higher than stated interest rate.

15 7-15 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.)

16 7-16 Using the Simple Interest Method: Interest = Principal x Rate x Time = $1000 x.12 x 2 Finance Charges = $240  Borrower receives loan amount ($1000) now—  And pays back loan amount plus finance charges ($ $240) at end of time period.  Most consumer friendly method—APR will be the same as the stated rate.

17 7-17 Using the Simple Interest Method: Annual Percentage Rate = Average annual finance charge Average loan balance outstanding APR = ($240  2) $1000 = $120 $1000 =.12 = 12%

18 7-18 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.

19 7-19 Using the Discount Method: Annual Percentage Rate = Average annual finance charge Average loan balance outstanding APR = ($240  2) ($1000 – $240) = $120 $760 =.158 = 15.8%

20 7-20 Comparing the Two Methods:

21 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.

22 7-22 Calculating Finance Charges on Installment Loans:  Simple Interest Method –Calculated on the outstanding (declining) balance each period.  Add-On Method –Finance charges calculated on original loan balance — – And then added to principal. –Costly form of consumer credit!

23 7-23 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.)

24 7-24 Calculator (Set on 12 P/YR and END mode:) /-PV 12I/YR 12 N PMT$88.85 Use Exhibit 7.6 (Table calculated using $1000 loan) Find payment for 12 months at 12% interest: $88.85 [Note: Use the AMORT feature on your calculator to create following table.]

25 7-25 Mo.Beg. Bal.PMTInterest PrincipalEnd. Bal. 1$1,000.00$88.85$10.00 $78.85$ $ $88.85 $ 9.21 $79.64$ $ $88.85 $ 8.42 $80.43$ $ $88.85 $ 7.61 $81.24$ $ $88.85 $ 6.80 $82.05$ $ $88.85 $ 5.98 $82.87$ $ $88.85 $ 5.15 $83.70$ $ $88.85 $ 4.31 $84.54$ $ $88.85 $ 3.47 $85.38$ $ $88.85 $ 2.61 $86.24$ $ $88.85 $ 1.75 $87.10$ $ 87.96$88.85 $ 0.89 $87.96$ 0

26 7-26 Using the Simple Interest Method:  Simple interest is figured on the outstanding loan balance each period.  Each payment causes the outstanding loan balance to decrease.  Each subsequent payment, then, will incur a lower finance charge, so —  More of the next payment will go towards repaying the principal or outstanding loan balance!

27 7-27 Simple Interest Method Continued:  This is the method financial calculators use when solving for interest.  When simple interest method is used, whether for single payment or installment loans, Stated Rate = APR  In this example, APR = 12% and rate per period= 12%  12 = 1% per month.

28 7-28 $88.85 x 12= $1, Loan amount= – 1, Interest paid= $ Total amount paid over the 12- month period:

29 7-29 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

30 7-30 Add-On Method Continued:  Use financial calculator to figure APR for the Add-On Method using the payment just determined and solve for interest: Set on 12 P/YR and END mode: /-PV 93.33PMT 12 N I/YR21.45%

31 7-31 $93.33 x 12= $1, Loan amount= – 1, Interest paid= $ Total amount paid over the 12- month period:

32 7-32 Comparing the Two Methods:

33 7-33 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.

34 7-34 Other Loan Considerations:  Prepayment penalties Does the lender use Rule of 78s?  Credit life insurance and disability requirements Avoid if possible and get term insurance instead!  Buy on time or pay cash? May be better to pay cash — If you have it!

35 7-35 THE END!


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