1. Chapter Fifteen
Consumer Loans, Credit Cards, Real Estate Lending and Managing Credit Risk

2. Key Topics Introduction Different Types of Loans
Types of Loans to Individuals & Families
Real Estate Loans
Risk and Problems in Real Estate lending
Home Equity Lending
Unique Characteristics of Consumer Loans
Credit Cards and Credit Scoring
Disclosure Rules and Discrimination
Consumer Loan Pricing and Refinancing

3. INTRODUCTION
The main reason many banks are issued charters of incorporation by state and national governments is to make loans
Lenders are expected to supply credit for all business and consumer financial needs and to price that credit fairly
Commercial banks are the largest lenders of household loans

4. INTRODUCTION
Loans support the growth of new businesses and jobs within the lender’s market area
Loans frequently give information to the marketplace about a borrower’s credit quality
The lending process requires careful monitoring at all times

5. INTRODUCTION p. 439
Consumer debt has become one of the fastest growing forms of borrowing money - $14 trillion in US
Banks lending to households depends on their need for a source of funds – checkable and savings deposits
Consumer credit is often among the most profitable services a lender can offer
However, services directed at consumers can also be among the most costly and risky financial products

6. DIFFERENT TYPES OF LOANS
Real Estate Loans – For personal homes
Consumer Loans – Loans to individuals and households
Commercial and Industrial Loans – business start-ups, growing a business
Agriculture Loans – for farmers
Miscellaneous Loans
Lease Financing – renting equipment
The largest category in dollar volume is real estate loans, followed by loans to individuals, and commercial and industrial (C&I) loans

7. Real Estate Loans p
Banks & finance & insurance companies make real estate loans to fund the buying of property
Homes, apartment complexes, shopping centers, office buildings, and land
One of the most rapidly growing areas of lending over the past decade. Almost 1/3 of all bank assets.

8. Secured by the property. Property is the collateral itself.
Real Estate Loans p
Real estate loans can be among the riskiest forms of credit extended to customers
Usually a long-term loan, typically bearing a term amortized over years
Secured by the property. Property is the collateral itself.
Has a fixed interest rate or a variable (floating) interest rate
Banks are the leading residential mortgage lenders today

9. Real Estate Mortgage Amortization Table - 20 year $200,000 loan with a 5% interest rate
Year Begin Balance Principal Interest Payment End Balance 1 $200,000 5,975 9,864 15, , ,025 6,280 9,559 15, , ,795 6,602 9,237 15, , ,143 6,939 8,900 15, , ,204 7,294 8,545 15, , ,910 7,668 8,171 15, , ,016 14,668 1,171 15,839 15, ,410 15, ,410 0

10. Real Estate Loans (continued)
Differences between Real Estate Loans and Other Loans
The average size of a real estate loan is usually much larger than the average size of other loans
Mortgage loans tend to have longer maturities versus other types of loans years to 30 years are typical for single- family homes

11. Risk and Problems in Real Estate Lending p. 456
The Most Risky of Home Mortgage Loans: Interest-Only and Adjustable Rate Mortgages and the Recent Mortgage Crisis (2008)
When housing prices were rising during the recent housing boom, how could lenders make high priced homes affordable?
More families were encouraged to sign up for adjustable-rate loans (ARMs) during a period when market interest rates were at historic lows

12. Risk and Problems in Real Estate Lending p. 456
Along with lenders giving Adjustable or floating rate loans two other types of lending led to the financial crisis of
Predatory lending
A bad practice among some lenders where lenders may require high fees
Subprime Loans
Granting loans to borrowers who have below-average credit scores

13. Real Estate Loans – Home Equity Loans p. 459-460
Home Equity Lending
Homeowners can borrow the equity in their homes
Equity is defined as the difference between a home’s estimated market value & the amount of the mortgage owed.
For example. Your mortgage is $100,000 but you owe $50, You would have $50,000 in equity.

14. Real Estate Loans – Home Equity Loans p. 459-460
Home Equity Lending
Two main types of home equity loans:
Traditional Home Equity Loan (HEL) a fixed rate with installments
2. Prime Equity Loan (PEL) – interest based on rate set by the bank but based on a rate set by the FED. – .

15. Types of Loans to Individuals and Families p. 440
Consumer loans are known by 1. Purpose – what the borrowed funds will be used for. For example to buy a car, or other large items 2. Type – Installment Loan the borrower must repay in installments (monthly or quarterly payments) or repay in one large payment. INTEREST RATES ARE HIGHER

16. Characteristics of Consumer Loans (continued)
Why are interest rates so high on most consumer loans?
Consumer loans are among the most costly and most risky to make per dollar of loanable funds. Made to individuals and households to purchase a car, or other large items for a house.

17. Credit Card Loans and Revolving Credit
Types of Loans Granted to Individuals and Families (continued) p
Credit Card Loans and Revolving Credit
Very popular form of credit today is credit cards.
Many credit cards have variable (changing) rates of interest
Card providers earn discount fees (1 to 7% of credit card sales) from merchants.

18. STEPS IN THE LENDING PROCESS
Finding New Loan Customers
Evaluating a Customer’s Character
Evaluating a Customer’s Credit Record
Evaluating a Customer’s Financial Condition
Does the borrower have Collateral & Signing the Loan Agreement
Monitoring the Loan Agreement

19. THE C’s OF CREDIT (Adverse Selection):
Evaluating a Consumer Loan Application – WHAT MAKES FOR A GOOD LOAN? p. 445
THE C’s OF CREDIT (Adverse Selection):
1. Character – Is the customer creditworthy. They have a good credit record of paying back loans.
2. Capacity – Able to sign documents
3. Cash – Ability to pay back loan. Has the income to make payments.
4. Collateral – Assets, like a car, house to secure the loan in case of default

20. Evaluating a Consumer Loan Application – WHAT MAKES FOR A GOOD LOAN. p
THE C’s OF CREDIT (Adverse Selection): 5. Conditions – What are the economic conditions like at the time of the loan. 6. Control – Does the loan meet all the policies and regulations?

21. Evaluating a Consumer Loan Application (cont)
Other Important Items For Lenders
Income Levels
Deposit Balances
Employment & Residential Stability
Debt and exposure
How to Qualify for a Consumer Loan
Home ownership or ownership of any form of real property
The most important thing to do – truthfully answer all of the loan officer’s questions

22. Credit Scoring Consumer Loan Application p. 450
The idea of credit scoring is that lenders are able to separate good loans from bad loans. Adverse selection.
The same factors that separated good loans from bad loans in the past will separate good loans from bad ones in the future.
Such an automated credit system removes personal judgment from the lending process

23. Credit Scoring Consumer Loan Application (continued) p. 452-453
The FICO System
Most famous of all credit-scoring systems currently in use
Scores range from 300 to 850 with higher values denoting less credit risk to lenders
FICO score are based on five different types of information (most important to least important):

24. Credit Scoring Consumer Loan Application (continued) p. 452-453
1. The borrower’s payment history 2. The amount of money owed 3. The length of a borrower’s credit history 4. The new credit being requested 5. The types of credit that the borrower has already used

25. FICO – A SAMPLE CREDIT SCORE

26. EXPLANATION OF CREDIT SCORE
1.  Proportion of balances to credit limits is too high on bank / revolving credit card accounts
2.  Proportion of loan balances to loan amounts is too high  
Consumers who use a high % of their available credit have a higher risk of delinquency (falling behind on payments) and charge-off (loan default) over time.

27. Laws and Regulations Applying to Consumer Loans (continued) p. 454
Customer Disclosure (Information) Requirements
Truth-in-Lending Act – The bank or lender must provide full information about the terms and all the costs and fees of a loan to a customer.
Fair Credit Reporting Act
Fair Credit Billing Act
Fair Debt Collection Practices Act

28. Laws and Regulations Applying to Consumer Loans (continued) p. 454
Making Credit Discrimination
Equal Credit Opportunity Act – everyone has the right to get a loan.
NO PERSON can be denied a loan based on age, sex, race, religion, rich or poor.
US law requires banks tell a customer, in writing, if they are denied a loan.

29. Laws and Regulations Applying to Consumer Loans (continued) p. 454
Community Reinvestment Act – Banks must have offices or branches in every community, rich and poor.