© 2008 Thomson South-Western CHAPTER 7 USING CONSUMER LOANS

7-2 Consumer Loans  Formal, negotiated contracts  Specify the terms for borrowing  Specify the repayment schedule  One-time transaction  Normally used to pay for big- ticket items

7-3 Types of Consumer Loans  Auto loans  Durable goods loans  Education loans  Personal loans  Consolidation loans

7-4 Student Loans Federally sponsored loans:  Stafford loans (Direct & Federal Family Education Loans—FEEL)  Perkins loans  Parent Loans (PLUS)

7-5 Obtaining a Student Loan –Demonstrate financial need –Make satisfactory progress in school –No defaults on other student loans! It all starts with a FASFA!

7-6 Federal Student Loans

7-7 Repaying Consumer Loans  Single Payment or Installment  Fixed or Variable Interest Rate

7-8 Where Can You Get Consumer Loans?  Commercial banks  Credit Unions  Savings and Loan Associations  Consumer finance companies  Sales finance companies  Life Insurance companies  Friends and relatives

7-9 Managing Your Credit  Shop carefully before borrowing  Compare loan features –Finance charges and loan maturity –Total cost of transaction –Collateral requirements –Other features, such as payment date, prepayment penalties, late fees

7-10 Keep Track of Your Credit  Keep inventory sheet of debt  Know total monthly payments  Know total debt outstanding  Check your debt safety ratio: Total monthly consumer debt pmts Monthly take-home pay

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7-12 Repaying Your Loan 1. Single payment loans 2. Installment loans BANK

7-13 Single Payment Loans  Loan collateral: lien, chattel mortgage, collateral note  Specified time period, 1 year or less Payment due in full at maturity  Payment includes principal and interest  Loan repayment: –Prepayment penalty –Loan rollover may be possible if extension on loan is needed

7-14 Calculating Finance Charges on Single-Payment Loans  Simple Interest Method –Calculated on the outstanding balance.  Discount Method –Interest calculated on the principal, –Then subtracted from loan amount; remainder goes to borrower. –Finance charges are paid in advance. –APR will be higher than stated interest rate.

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7-16 F S = P x r x t Where F S = finance charge calculated using simple interest method P = principal amount of loan r = stated annual rate of interest t = term of loan, in years (or portions of year, eg.,.5, 1.5, etc.) Example: Calculate the finance charges and APR on a $1000 loan for 2 years at an annual interest rate of 12%. (Assume interest is the only finance charge.) Using the Simple Interest Method

7-17 Using the Simple Interest Method Interest = Principal x Rate x Time = $1000 x.12 x 2 Finance Charges = $240  Borrower receives loan amount ($1000) now—  And pays back loan amount plus finance charges ($ $240) at end of time period.  Most consumer friendly method—APR will be the same as the stated rate.

7-18 Using the Simple Interest Method Annual Percentage Rate = Average annual finance charge Average loan balance outstanding APR = ($240  2) $1000 = $120 $1000 =.12 = 12%

7-19 Using the Discount Method Interest = Principal x Rate x Time = $1000 x.12 x 2 Finance Charges = $240  Finance charges calculated the same way as in simple interest method—  But are then subtracted from loan amount ($1000 – $240).  Borrower receives the remainder ($760) now and pays back the loan amount ($1000) at end of time period.

7-20 Using the Discount Method Annual Percentage Rate = Average annual finance charge Average loan balance outstanding APR = ($240  2) ($1000 – $240) = $120 $760 =.158 = 15.8%

7-21 Comparing the Two Methods

7-22 Installment Loans  Repaid in a series of equal payments.  Each payment is part principal and part interest.  Maturities range from 6 months to 7–10 years or longer.  Usually require collateral.

7-23 Calculating Finance Charges on Installment Loans  Simple Interest Method –Calculated on the outstanding (declining) balance each period.  Add-On Method –Finance charges calculated on original loan balance — – And then added to principal. –Costly form of consumer credit!

7-24 Example: Calculate the finance charges and APR on a $1000 loan to be repaid in 12 monthly installments at an annual interest rate of 12%. (Assume interest is the only finance charge.) Calculating Finance Charges on Installment Loans

7-25 Calculator (Set on 12 P/YR and END mode:) /-PV 12I/YR 12 N PMT$88.85 Use Exhibit 7.5 (Table calculated using $1000 loan) Find payment for 12 months at 12% interest: $88.85 Calculating Finance Charges on Installment Loans

7-26 Monthly Payment Analysis for a Simple Interest Installment Loan

7-27 Using the Simple Interest Method  Simple interest is figured on the outstanding loan balance each period.  Each payment causes the outstanding loan balance to decrease.  Each subsequent payment will incur a lower finance charge.  Thus, more of the next payment will go towards repaying the principal.

7-28 Simple Interest Method  This is the method financial calculators use when solving for interest.  When simple interest method is used, whether for single payment or installment loans, Stated Rate = APR  In this example, APR = 12% and rate per period= 12%  12 = 1% per month.

7-29 $88.85 x 12= $1, Loan amount= – 1, Interest paid= $ Total amount paid over the 12- month period: Simple Interest Method

7-30 Using the Add-On Method  Calculate finance charges on the original loan amount: $1000 x.12 x 1 = $120  Add these charges to principal: $120 + $1000 = $1,120  Divide this amount by the number of periods to arrive at payment: $1,120  12 = $93.33

7-31 Using the Add-On Method  Use financial calculator to figure APR for the Add-On Method using the payment just determined and solve for interest: Set on 12 P/YR and END mode: /-PV 93.33PMT 12 N I/YR21.45%

7-32 $93.33 x 12= $1, Loan amount= – 1, Interest paid= $ Total amount paid over the 12- month period: Using the Add-On Method

7-33 Comparing the Two Methods

7-34 More on Loans  Carefully examine Installment Purchase Contract—it contains the terms of the loan.  Finance charges must include not only interest but also any other required charges.  Total charges, not just interest, must be used to calculate APR.

7-35 Other Loan Considerations  Prepayment penalties Does the lender use Rule of 78s (sum-of- the-digits method)?  Credit life insurance and credit disability insurance Avoid if possible, and get term insurance instead  Buy on time or pay cash? May be better to pay cash — If you have it

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