Presentation on theme: "Chapter Fifteen Consumer Loans, Credit Cards, Real Estate Lending and Managing Credit Risk."— Presentation transcript:
1 Chapter FifteenConsumer Loans, Credit Cards, Real Estate Lending and Managing Credit Risk
2 Key Topics Introduction Different Types of Loans Types of Loans to Individuals & FamiliesReal Estate LoansRisk and Problems in Real Estate lendingHome Equity LendingUnique Characteristics of Consumer LoansCredit Cards and Credit ScoringDisclosure Rules and DiscriminationConsumer Loan Pricing and Refinancing
3 INTRODUCTIONThe main reason many banks are issued charters of incorporation by state and national governments is to make loansLenders are expected to supply credit for all business and consumer financial needs and to price that credit fairlyCommercial banks are the largest lenders of household loans
4 INTRODUCTIONLoans support the growth of new businesses and jobs within the lender’s market areaLoans frequently give information to the marketplace about a borrower’s credit qualityThe lending process requires careful monitoring at all times
5 INTRODUCTION p. 439Consumer debt has become one of the fastest growing forms of borrowing money - $14 trillion in USBanks lending to households depends on their need for a source of funds – checkable and savings depositsConsumer credit is often among the most profitable services a lender can offerHowever, 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 homesConsumer Loans – Loans to individuals and householdsCommercial and Industrial Loans – business start-ups, growing a businessAgriculture Loans – for farmersMiscellaneous LoansLease Financing – renting equipmentThe 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 pBanks & finance & insurance companies make real estate loans to fund the buying of propertyHomes, apartment complexes, shopping centers, office buildings, and landOne 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 pReal estate loans can be among the riskiest forms of credit extended to customersUsually a long-term loan, typically bearing a term amortized over yearsSecured by the property. Property is the collateral itself.Has a fixed interest rate or a variable (floating) interest rateBanks 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 LoansThe average size of a real estate loan is usually much larger than the average size of other loansMortgage 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 ofPredatory lendingA bad practice among some lenders where lenders may require high feesSubprime LoansGranting loans to borrowers who have below-average credit scores
13 Real Estate Loans – Home Equity Loans p. 459-460 Home Equity LendingHomeowners can borrow the equity in their homesEquity 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 LendingTwo main types of home equity loans:Traditional Home Equity Loan (HEL) a fixed rate with installments2. 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) pCredit Card Loans and Revolving CreditVery popular form of credit today is credit cards.Many credit cards have variable (changing) rates of interestCard providers earn discount fees (1 to 7% of credit card sales) from merchants.
18 STEPS IN THE LENDING PROCESS Finding New Loan CustomersEvaluating a Customer’s CharacterEvaluating a Customer’s Credit RecordEvaluating a Customer’s Financial ConditionDoes the borrower have Collateral & Signing the Loan AgreementMonitoring the Loan Agreement
19 THE C’s OF CREDIT (Adverse Selection): Evaluating a Consumer Loan Application – WHAT MAKES FOR A GOOD LOAN? p. 445THE 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 documents3. 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 LendersIncome LevelsDeposit BalancesEmployment & Residential StabilityDebt and exposureHow to Qualify for a Consumer LoanHome ownership or ownership of any form of real propertyThe 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 SystemMost famous of all credit-scoring systems currently in useScores range from 300 to 850 with higher values denoting less credit risk to lendersFICO 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
26 EXPLANATION OF CREDIT SCORE 1. Proportion of balances to credit limits is too high on bank / revolving credit card accounts2. 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) RequirementsTruth-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 ActFair Credit Billing ActFair Debt Collection Practices Act
28 Laws and Regulations Applying to Consumer Loans (continued) p. 454 Making Credit DiscriminationEqual 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.