Prepared by John Anderson, Queensland University of Technology

2 Chapter Five Consumer Lending

3 Learning Objectives Explain what consumer loans are Outline the major types of consumer loan Explain how different types of consumer loan are evaluated

4 Learning Objectives Explain, with the help of specimen consumer loan applications, how the principles of consumer lending are applied in practice Enumerate the precautions to be taken in assessing consumer loan applications

5 Learning Objectives Discuss how the credit scoring of consumer loan applications is done Briefly explain the laws and regulations affecting consumer loans Outline the trends in consumer credit Explain the pricing aspect of consumer loans

6 Introduction Consumer loans are generally regarded as loans for household and personal needs including: Furniture, electrical appliances, travel, boats, homes and so on. May be defined as: Types of loans made to finance consumption, rather than productive purposes.

7 Types of Consumer Loan Loans may be classified by: Purpose: Houses, holidays, motor vehicles higher study, etc. Term: Short-term ( 3 years) Terms of repayment: Instalment loans with regular P&I repayments, and non- instalment loans for emergency purposes repaid in one lump sum Security: Secured and unsecured loans

8 Types of Consumer Loan Personal Loans: Generally 2–5 years with monthly instalments (although can be non- instalment loan) Usually negotiated directly with the bank and requires a loan application form Also includes –Overdrafts/revolving line of credit –Margin lending for share investments with loan- to-value ratio (LVR) between 40% and 70%

9 Types of Consumer Loan Credit Cards: –Offered by banks and other companies under franchising agreement –Many consumer benefits including: Convenience Monthly summary Financial freedom No procedural hassles Low credit card fees

10 Types of Consumer Loan –Many card-provider benefits including: Relatively higher risk-adjusted returns Huge market Higher interest rates Expanding services Price-insensitive customers

11 Types of Consumer Loan –Merchant benefits including: Increased number of customers Prompt payment for credit sales Increase in number of prospects Customer profiling Advantage over other merchants –Important caveat — Card providers do face increased risk from credit card fraud and ensuing exposures

12 Types of Consumer Loan Six steps in credit card transaction 1 – Credit card swiped in terminal 2 – Cardholder and transaction details transferred to merchant’s institution 3 – If card issued by different institution, details routed to card-issuing firm 4 – Acceptance/Decline notification transferred to merchant’s institution 5 – Acceptance/Decline sent to merchant 6 – Merchant verifies credit card signature

13 Evaluating Consumer Loan Application Evaluation sees use of 3 Cs –Character: Track record of the individual Ability Purpose of loan Integrity of the borrower Spending habits

14 Evaluating Consumer Loan Application –Capacity to Repay: Net income Deposit balances with bank Stability of job Stability of residence Borrower’s margin –Collateral: Assets that may be recovered in default, although seizure must be a last resort

15 Evaluating Consumer Loan Application –Step-By-Step Assessment of Personal Loans Step 1 – Obtaining prescribed application form Step 2 – Conducting preliminary assessment Step 3 – Accepting and loading application Step 4 – Taking securities Step 5 – Determining interest, fees, charges Step 6 – Approving/rejecting application Step 7 – Supervising of loan and follow-up

16 Evaluating Consumer Loan Application –Step-By-Step Assessment of Credit Card Loans Step 1 – Obtain completed application form Step 2 – Conduct credit checks via Credit Advantage, other institutions, employer Step 3 – If checks satisfactory, load details into computer to assess whether sufficient points available Step 4 – Create and provide card to applicant with letter of conditions etc.

17 Example of a Consumer Loan Application Personal Loan –Application source Character: –Lender obtains authority to collect information from third parties –Personal details to be provided and evidenced –Applicant's employment history –Information about personal referees

18 Example of a Consumer Loan Application Capacity: –Current employment details –Capacity to service the proposed debt –Details about item(s) to be purchased –Amount to be borrowed and proposed repayment arrangements –Whether existing bank customer to verify general financial history Collateral: –What assets applicant has to indicate financial security or requirement for financial guarantees

19 Example of a Consumer Loan Application Credit Card Loans –Application source Largely similar to personal loan applications with additional information: –Type of card required –Interest-free periods (if any) –Membership of ‘rewards’ program(s) The applicant’s choices in card requirements will be reflected in the interest rate charged on the credit card.

20 Precautions to be Taken in Granting Consumer Loans A great many precautions must be taken in granting consumer credit, including: Inconsistent/withheld information Dangers of over-committed borrower Proper signing of all loan documentation Meticulously ensure bank’s lending policy is adhered to Proper searches for bankruptcy or other credit problems must be conducted

21 Credit Scoring Consumer Loan Applications –Credit scoring provides many advantages including: Large volume of credit applications can be handled quickly Lower cost than judgemental methods Lower staff training time and costs Speedier approvals for client and can be done via internet –Uses key variables in statistical model such as age, income, house ownership

22 Legal Aspects of Consumer Credit Consumer credit governed under numerous legislative acts –Uniform Consumer Credit Code Has governed all new credit transactions since November 1996 Aims to make standardised credit information fully disclosed and easily understandable, such as interest rates, fees and other charges

23 Legal Aspects of Consumer Credit in Malaysia Hire-Purchase Act, 1967; Moneylenders Act, 1951; Pawnbrokers Act, 1972; Banking And Financial Institutions Act, 1989; and Islamic Banking Act, 1983 Sales of Good Act, 1957

24 Trends in Consumer Credit Trends in Personal Lending Sustained growth Dominated by motor vehicles and other consumables Trends in Credit Card Lending Credit card figures not reported separately and so includes revolving lines of credit On consolidated figures, only around 50% of available credit is actually being used

25 Pricing and Structuring of Consumer Loans Loan Pricing: –Is a function of the cost of funds, risk, macroeconomic factors, inflation and competitor’s pricing –Either fixed or variable rate with or without early payment penalties –Fees add to profitability of the loan and are increasingly important loan pricing considerations

26 Pricing and Structuring of Consumer Loans Loan Structuring: –Refers to repayment structure and any other relevant conditions –Must be supported by appropriate documents at all stages –May contain guarantees or other collateral –Finalisation of the terms

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