© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Using Consumer Loans #7

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Learning Goals Know when to use consumer loans and be able to differentiate between the major types. Identify the various sources of consumer loans. Choose the best loans by comparing finance charges, maturity, collateral, and other loan terms. Describe the features of, and calculate the finance charges on, single- payment loans. Evaluate the benefits of an installment loan. Determine the costs of installment loans and analyze whether it is better to pay cash or to takeout a loan.

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Using Consumer Loans Formal, negotiated contractsOne-time transaction - usually for big-ticket itemsNo more credit is available once repaid

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Different Types of Loans Auto loansOther durable goods loansEducation loansPersonal loansConsolidation loans

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Student Loans Federally sponsored loans: Stafford Loans (Direct & Federal Family Education Loans—FEEL) Perkins LoansParent Loans (PLUS)

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Exhibit 7.1 Federal Government Student Loans

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Consumer Loans Single Payment Specified period Lump sum payment due Installment Fixed, scheduled payments Fixed Interest rate and payments remain the same Variable-Rate Interest rate and payments change periodically

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Where Can You Get Consumer Loans? Commercial BanksConsumer Finance CompaniesCredit UnionsSavings and Loan Associations (S&Ls)Sales Finance CompaniesLife Insurance Companies

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Managing Your Credit Compare loan features Finance charges Loan maturity Total cost of the transaction Collateral Other loan considerations such as payment date, prepayment penalties, late fees Shop carefully before borrowing!

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 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 payments Monthly take-home pay Total monthly payments Monthly take-home pay

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Single-Payment Loans Loan collateralLienChattel mortgageCollateral noteLoan maturityLoan repaymentPrepayment penaltyLoan rollover

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Finance Charges and the APR Discount Method - Interest (calculated on principal) is subtracted from loan amount and remainder goes to borrower –Finance charges paid in advance –APR will be higher than stated interest rate Simple Interest Method – Calculated on outstanding balance

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. F S = P x r x t Where F S = finance charge using simple interest method P = principal loan amount r = stated annual interest rate t = term of loan Simple Interest Method Example- Calculate finance charges and APR on a $1,000 loan for 2 years at 8% interest rate (Assume interest is the only finance charge)

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Using the Simple Interest Method Interest = Principal x Rate x Time = $1,000 x.08 x 2 Finance Charge = $160 Receive full loan amount ($1,000) but pay back $1,160 (loan amount + finance charge) Most consumer friendly method

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Annual Percentage Rate = Average annual finance charge Average loan balance outstanding Simple Interest Method APR = ($160  2) $1000 = 8% APR is same as stated rate

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Discount Method Interest = Principal x Rate x Time = $1,000 x.08 x 2 Finance Charges = $160 Calculate same as simple interest method but subtract finance charges from loan amount ($1,000 – $160) Borrower receives $840 now, pays back $1,000

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Annual Percentage Rate = Average annual finance charge Average loan balance outstanding Discount Method APR = ($160  2) = $80 ($1000 – $160) = $840 = 9.52%

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Installment Loans Repay debt in a series of equal paymentsPayments includes principal and interestWide maturity range -- 6 months to 10 years or longer

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Calculating Finance Charges on Installment Loans Simple Interest Method Calculated on outstanding (declining) balance each period Add-On Method Finance charges calculated on original loan balance added to principal

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Example Calculate the finance charges and APR on a $1,000 loan to be repaid in 12 monthly installments at an annual interest rate of 8% (Assume interest is the only finance charge) Calculating Finance Charges on Installment Loans

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Calculator (Set on 12 P/YR and END mode) /- PV 8 I/YR 12 N PM = $86.99 Use Exhibit 7.5 (Table calculated using $1,000 loan) Find payment for 12 months at 8% interest: $86.99 Calculating Finance Charges on Installment Loans

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Simple Interest Method Simple interest calculated on outstanding loan balance each period Each payment decreases outstanding loan balance Subsequent payments incur a lower finance charge -- More of next payment goes towards repaying principal

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. $86.99 x 12= $1, Loan amount= – 1, Interest paid= $ Total amount paid over 12 months Simple Interest Method

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Add-On Method Calculate finance charges on the original loan amount $1,000 x.08 x 1 = $80 Add these charges to principal $80 + $1,000 = $1,080 Divide this amount by the number of periods to arrive at payment $1,080  12 = $90.00

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Add-On Method Use financial calculator to figure APR for the Add-On Method using payment just determined and solve for interest Set on 12 P/YR and END mode: /-PV 90.00PMT 12 N I/YR 14.45%

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Other Loan Considerations Prepayment penalties Rule of 78s = sum-of- the-digits method Credit Life InsuranceBuy on time or pay cash? May be better to pay cash — If you have it

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Comparative Finance Charges and APRs ($1000, 8%, 12 mo)