1 Chapter 7 – Consumer Loans Loan agreement – legal contract spelling out all terms and conditions of a loan; other info in the loan disclosure statement.
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1 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
2 Types of Loans Single PaymentOther features: I = P * R * T Installment orFixed/variable rates AmortizingAcceleration Secured loans Recourse Know types, sources, advantages and disadvantages
3 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 YearTotalTo 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-
4 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
5 Special Types of Loans Student Loans Federally subsidized – on need and progress Made to student or parent Payment on parent loans begins immediately; student loans deferred until after graduation Car loans – available from many sources Payday loans – can be 250 to 1,000%! Often use post dated checks
6 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?
7 Sources of Consumer Loans (Lowest to Highest Cost) Credit Unions Banks Sales Finance Companies – GMAC, Ford Credit Small Loan Companies –Household Finance, Beneficial, Associates
8 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 / month 166.98 * 12 = $2003.81 per year
9 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 amount As interest rates increase, monthly payments increase (Fig 7.4) As maturity lengthened, monthly payments decrease but total financing charges increase
12 Obtaining a Favorable Rate Strong credit rating Larger down payment Provide security Shorter maturity Variable rather than fixed rate
13 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?
14 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
15 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
16 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