1. Prentice-Hall, Inc.1 Chapter 7 Using Consumer Loans: The Role of Planned Borrowing

2. Prentice-Hall, Inc.2 Characteristics of Consumer Loans  Single-payment versus installment loans  Secured versus unsecured loans  Variable-rate versus fixed-rate loans

3. Prentice-Hall, Inc.3 Single-Payment Loans Versus Installment Loans  Single-payment or balloon loans – sometimes called bridge or interim loans, because they are used until permanent financing can be arranged – loan is repaid in one lump-sum, including interest – normally for short-term lending of one year or less

4. Prentice-Hall, Inc.4 Single-Payment Loans Versus Installment Loans (cont’d)  Installment loans – loan is repaid at regular intervals – payment includes both principal and interest – normally used to finance cars, appliances, and other expensive items

5. Prentice-Hall, Inc.5 Installment Loan Amortization  The process of your payment going more toward principal and less toward interest each subsequent month.  Based on a simple- interest calculation.

6. Prentice-Hall, Inc.6 Secured Versus Unsecured Loans  Secured loans – are guaranteed by a specific asset – typically have lower rates

7. Prentice-Hall, Inc.7 Secured Versus Unsecured Loans (cont’d)  Unsecured loans – require no collateral – offered to borrowers with excellent credit histories – normally have high rates of interest – 12% to 21% annually

8. Prentice-Hall, Inc.8 Fixed-Rate Versus Variable- Rate Loans  Fixed-rate loans – have the same interest rate for the duration of the loan – normally have a higher initial interest rate because the lender could lose money if the rates increase – most consumer loans are fixed-rate loans

9. Prentice-Hall, Inc.9 Fixed-Rate Versus Variable- Rate Loans (cont’d)  Variable-rate loans – have an interest rate that is tied to an index (e.g., prime rate, 6-month Treasury bill rate) – can adjust on different intervals such as monthly, semi-annually, or annually – have a lifetime adjustment cap – normally have a lower initial interest rate because the lender won’t lose money if the rates increase

10. Prentice-Hall, Inc.10 Fixed-Rate Versus Variable- Rate Loans (cont’d)  Convertible loans begin as a variable rate loan and can be locked into the current rate a some predetermined time in the future.

11. Prentice-Hall, Inc.11 The Loan Contract  Insurance agreement clause  Acceleration clause  Deficiency payments clause  Recourse clause

12. Prentice-Hall, Inc.12 Insurance Agreement Clause  Requires you to purchase life insurance that will payoff your loan after your death  Normally benefits only the lender  Increases your total loan cost

13. Prentice-Hall, Inc.13 Acceleration Clause  Requires the entire loan to be paid-in- full if you miss just one payment  Are standard on most loans  Normally not invoked if you make a good faith effort to pay

14. Prentice-Hall, Inc.14 Deficiency Payments Clause  Requires any amount in excess to be paid if the collateral's value does not satisfy the loan.  Also requires payment of any outstanding charges incurred by the lender associated with the disposal of the collateral.

15. Prentice-Hall, Inc.15 Recourse Clause  Defines the lender’s ability to collect any outstanding balance – wage attachments and garnishments – liens on other property (secondary collateral)

16. Prentice-Hall, Inc.16 Special Types of Consumer Loans  Home equity loans  Student loans  Automobile loans

17. Prentice-Hall, Inc.17 Home Equity Loans  Are basically second mortgages  Use the equity in your home to secure your loan  Normally allow you to borrow up to 80% of your equity

18. Prentice-Hall, Inc.18 Home Equity Loans (cont’d)  Advantages – interest payments are tax-deductible – lower rates of interest than other types of consumer loans  Disadvantages – puts your home at risk if you default – sacrifices future financial flexibility because you can only have one outstanding home equity loan

19. Prentice-Hall, Inc.19 Student Loans  Loans with low, federally subsidized interest rates used for higher education.  Are tax-advantaged under the 1997 Taxpayer Relief Act.  Examples – Federal Direct/Stafford loans for students; PLUS Direct/PLUS Loans for parents.

20. Prentice-Hall, Inc.20 Student Loans (cont’d)  Federal Direct and PLUS Direct available through the school; Stafford and PLUS loans available through lenders.  Payment on Federal Direct and Stafford loans deferred for 6 months after graduation.  Borrowing limits apply.

21. Prentice-Hall, Inc.21 Automobile Loans  A consumer loan that is secured with an automobile.  Has a lower interest rate than an unsecured loan.  Normally has a maturity length of 2 to 6 years.

22. Prentice-Hall, Inc.22 Cost and Early Payment of Consumer Loans  Cost of single-payment loans.  Cost of installment loans.  Early repayment of installment loans.  Understanding the relationship between your payments, interest rates, and the term of the loan.

23. Prentice-Hall, Inc.23 Payday Loans  High fees charged.  Short-term loan of 1-2 weeks.  Those with jobs and checking accounts and students are typical users.  Check “held” by the payday lender.

24. Prentice-Hall, Inc.24 Cost of Single-Payment Loans  The simple interest method – both principal and interest are due at maturity – interest = principal x interest rate x time  The discount method – subtracts the entire interest charge from the loan principal before you receive the loan – inflates the rate of interest because the amount received is less than the amount borrowed

25. Prentice-Hall, Inc.25 Cost of Installment Loans  Repayment of both principal and interest occur at regular intervals  The simple interest method – this is the most common calculation method – remember, with each month the interest portion of the payment decreases and the principal portion increases – you pay interest only on the outstanding balance

26. Prentice-Hall, Inc.26 Cost of Installment Loans (cont’d)  The add-on method – adds the total interest payment to the principal of the loan – much more costly than the simple-interest method – can double the stated rate

27. Prentice-Hall, Inc.27 Early Repayment of Installment Loans  With the simple interest method, it is simply the outstanding balance.  With the add-on method, use the rule of 78s or sum of the year’s digits methods.

28. Prentice-Hall, Inc.28 Payment, Interest Rate and Loan Term  The total interest cost of your loan is directly related to the interest rate.  The total interest cost of your loan is inversely related to the maturity length.  Your periodic payment is directly related to both the duration and interest rate.

29. Prentice-Hall, Inc.29 Sources of Consumer Loans  Inexpensive sources of loans – home equity loans – other secured loans  More expensive sources of loans – credit unions – savings and loans – commercial banks

30. Prentice-Hall, Inc.30 Sources of Consumer Loans (cont’d)  Most expensive sources of loans – retail stores – finance companies Those who are in the worst financial shape have to pay the most for credit. You must have a solid credit rating to borrow from the cheaper lenders.

31. Prentice-Hall, Inc.31 Know How to Borrow  Maintain a strong credit rating  Reduce the lender’s risk – use a variable rate loan. – keep the loan term as short as possible. – provide collateral for the loan. – pay a large down payment on the item to be purchased with financing.

32. Prentice-Hall, Inc.32 Know When to Borrow  Do you really need to make this purchase?  Does it fit into your financial plan?  If cash is used, can you maintain sufficient liquidity?  What is the after-tax cost of borrowing versus the after-tax lost return from using savings to make the purchase?

33. Prentice-Hall, Inc.33 Control Your Use of Debt  Calculate the debt limit ratio  Apply the debt resolution rule  Control your consumer debt

34. Prentice-Hall, Inc.34 Take Steps When You Can’t Pay Your Bills  Implement a budget that brings in more money than you spend.  Use self-control to limit credit usage.  Talk to the creditor about restructuring the debt repayment.  Seek help from a credit counselor.

35. Prentice-Hall, Inc.35 Take Steps When You Can’t Pay Your Bills (cont’d)  Consider a cheaper loan to pay back more expensive debt.  Use savings to pay off current debt.  Consider a debt consolidation loan.

36. Prentice-Hall, Inc.36 Chapter 13: The Wage Earner’s Plan  Is a viable possibility if you – have a regular source of income – have less than $350,000 secured debt – have less than $100,000 unsecured debt  Sets-up a controlled repayment schedule  Allows you to maintain possession of your assets  Is reported on your credit report for 7 years

37. Prentice-Hall, Inc.37 Chapter 11: Debt Reorganization  Not very common because it is intended for businesses.  Is viable if you exceed the liability limits of Chapter 13.  Allows your creditors to vote on the repayment plan.

38. Prentice-Hall, Inc.38 Chapter 7: Straight Bankruptcy  Provides the opportunity to eliminate most of your debts and begin again.  Requires the liquidation of most of your assets by a court appointed trustee.  Allows you to keep some equity in your house, but the amount varies by state.  Should only be considered after you consult with a financial advisor and a lawyer.

39. Prentice-Hall, Inc.39 Summary  Secured and unsecured loans – secured loans are guaranteed by a specific asset and typically have lower rates – unsecured loans require no collateral but normally have higher rates of interest  Single-payment loans – both principal and interest are due at maturity

40. Prentice-Hall, Inc.40 Summary (cont’d)  Installment loans – Repayment of both principal and interest occur at regular intervals.  Fixed-rate interest versus variable-rate –Fixed-rate loans normally have a higher interest rate that remains constant throughout the loan. – Variable-rate loans have an interest rate based on an index, such as the prime rate or the 6-month treasury bill rate.

41. Prentice-Hall, Inc.41 Summary (cont’d)  Loan costs vary with the methods of computing finance charges  Sources of consumer loans—know the costs  Four ways to reduce your interest rate – use a variable-rate loan – keep loan term short – provide collateral – make a large down payment

42. Prentice-Hall, Inc.42 Summary (cont’d)  Determine how much debt you can afford – review your budget – analyze debt commitments – calculate your financial ratios – apply the debt resolution rule  Seek help if you get into trouble