© 2013 Pearson Education, Inc. All rights reserved.7-1 Chapter 7 Using Consumer Loans: The Role of Planned Borrowing

© 2013 Pearson Education, Inc. All rights reserved.7-2 Introduction Consumer loans—formal contracts detailing how much you’re borrowing and when and how you’re going to pay it back. Used for bigger purchases. Debt and borrowing can get out of control.

© 2013 Pearson Education, Inc. All rights reserved.7-3 Consumer Loans—Your Choices Single-payment loans Variable-rate installment loans Unsecured fix-rate loans Secured loans

© 2013 Pearson Education, Inc. All rights reserved.7-4 First Decision: Single-Payment versus Installment Loans Single-Payment or Balloon Loan—paid back in a single lump-sum payment with interest at maturity. –Bridge or interim loan– short-term loan. Installment loan—repayment of both principal and interest at various intervals. –Loan amortization—with each payment, the interest portion covered decreases and principal portion covered increases.

© 2013 Pearson Education, Inc. All rights reserved.7-5 Second Decision: Secured versus Unsecured Loans Secured loan—guaranteed by an asset which typically lowers the rate of the loan. Unsecured loan—not guaranteed by an asset or collateral

© 2013 Pearson Education, Inc. All rights reserved.7-6 Third Decision: Variable-Rate versus Fixed-Rate Loans Fixed-rate interest rate loan—stays fixed for entire duration of the loan, not tied to market interest rates. Variable-rate or adjustable interest rate loan—interest rate varies based on the market interest rate. Prime rate—the interest rate that banks charge to their most creditworthy, or “prime” customers Convertible loan—variable-rate loan that can be converted to a fixed-rate loan.

© 2013 Pearson Education, Inc. All rights reserved.7-7 Fourth Decision: The Loan’s Maturity—Shorter versus Longer Term Loans Shorter term loan means lower interest rate and larger monthly payments Longer term loan means smaller monthly payments and higher interest rate

© 2013 Pearson Education, Inc. All rights reserved.7-8 Understand the Terms of the Loan: The Loan Contract Security agreement Note Default Acceleration clause Deficiency payments clause Recourse clause

© 2013 Pearson Education, Inc. All rights reserved.7-9 Special Types of Consumer Loans Home Equity Loan or Second Mortgage— secured loan using equity in home as collateral. Advantages: Interest is tax deductible Lower interest than other consumer loans. Disadvantages: Puts your home at risk. Limits future financing flexibility.

© 2013 Pearson Education, Inc. All rights reserved.7-10 Special Types of Consumer Loans Student Loan—low, federally subsidized interest, based on financial need Federal Direct/Stafford Loans: –Federal government makes direct loan to students through financial aid office. PLUS Direct/PLUS Loans: –Loans are made by private lenders such as banks and credit unions to parents.

© 2013 Pearson Education, Inc. All rights reserved.7-11 Figure 7.2 Percent of Students at a 4-Year College Who Borrow

© 2013 Pearson Education, Inc. All rights reserved.7-12 Special Types of Consumer Loans Automobile Loan—loan secured by auto. –Duration usually for 24, 36, or 48 months or even 5 to 6 years. –Low-cost auto loan rates used to push slow- selling vehicles or older models. –Repossession if default on loan.

© 2013 Pearson Education, Inc. All rights reserved.7-13 Cost and Early Payment of Consumer Loans APR—annual percentage rate—simple percentage cost of all finance charges over the life of the loan, on annual basis. Truth in Lending Act requires all consumer loan agreements disclose APR in bold print.

© 2013 Pearson Education, Inc. All rights reserved.7-14 Cost and Early Payment of Consumer Loans Cost of single-payment loans: Loan disclosure statement gives APR and finance charges of a loan Simple interest method: interest = principal x interest rate x time Discount method

© 2013 Pearson Education, Inc. All rights reserved.7-15 Payday Loans—A dangerous kind of single-payment loan $100 to $500 loan till next payday. Post-dated check with fee and principal left with payday lender. Due in 1 or 2 weeks. Annualized interest rates up to 400%

© 2013 Pearson Education, Inc. All rights reserved.7-16 TABLE 7.2 Payday Loan Facts

© 2013 Pearson Education, Inc. All rights reserved.7-17 Cost of Installment Loans Repayment of both interest and principal occurs at regular intervals. Payment levels are set so loan expires at a preset date. Use either simple interest or add-on method to determine what payment will be.

© 2013 Pearson Education, Inc. All rights reserved.7-18 Table 7.4 Illustration of a 12-Month Installment Loan for $5,000 at 14%

© 2013 Pearson Education, Inc. All rights reserved.7-19 Getting the Best Rate on Your Consumer Loans Inexpensive sources—family, home equity loans, cash value life insurance loans. More expensive sources—credit unions, S&Ls, and commercial banks. Most expensive sources—retail stores, finance companies or small loan companies

© 2013 Pearson Education, Inc. All rights reserved.7-20 Keys to Getting the Best Rate Strong credit rating Relatively risk-free to lender: –Use variable-rate loan –Short loan term –Collateral –Large down payment

© 2013 Pearson Education, Inc. All rights reserved.7-21 Should You Borrow or Pay Cash? Keep in mind that debt is expensive. Don’t borrow to spend. Use cash rather than credit. If benefits outweigh costs, borrowing makes sense.

© 2013 Pearson Education, Inc. All rights reserved.7-22 Controlling Your Use of Debt Debt Limit Ratio—percentage of take- home pay committed to non-mortgage debt. –Total debt can be divided into consumer debt and mortgage debt. –Ratio should be below 15%. –~20% should avoid additional debt.

© 2013 Pearson Education, Inc. All rights reserved.7-23 Debt Resolution Rule Control debt obligation, excluding borrowing for education and home financing, by forcing you to repay all outstanding debt obligations every 4 years. Logic is that consumer credit should be short-term.

© 2013 Pearson Education, Inc. All rights reserved.7-24 Controlling Consumer Debt Make sure it fits in with your goals and budget. Understand how costly consumer debt is. Borrowing limits future financial flexibility. Clues you might be in financial trouble.

© 2013 Pearson Education, Inc. All rights reserved.7-25 What To Do If You Can’t Pay Your Bills Budget so more money comes in. Use self-control in the use of credit. Go to your creditor. Go to a credit counselor.

© 2013 Pearson Education, Inc. All rights reserved.7-26 What To Do If You Can’t Pay Your Bills Borrow inexpensively. Use savings to pay off current debt. Use a debt consolidation loan. Bankruptcy—the last resort doesn’t wipe out all obligations.

© 2013 Pearson Education, Inc. All rights reserved.7-27 What To Do If You Can’t Pay Your Bills Most common types of personal bankruptcy: Chapter 13The wage earner’s plan Chapter 7 Straight bankruptcy

© 2013 Pearson Education, Inc. All rights reserved.7-28 Chapter 13: The Wage Earner’s Plan Must have: –Regular income –Secured debts under $1,010,650 (2007) –Unsecured debts under $336,900 (2007) For the individual—relief from harassment of bill collectors For creditors—controlled repayment with court supervision.

© 2013 Pearson Education, Inc. All rights reserved.7-29 Chapter 7: Straight Bankruptcy Can eliminate debts and begin again. “Means test” Most debts wiped out—not child support, alimony, student loans, and taxes. Trustee collects, sells all nonexempt property. Must complete credit counseling course.

© 2013 Pearson Education, Inc. All rights reserved.7-30 Figure 7.3 The Rise of Student Loan Debt