1. Loan to Own * Daniel Sweeney, CEPF * Based on the FDIC Money Smart unit with the same name

2. 2 Introduction By the end of this seminar, you will be able to:  Recognize different types of consumer installment loans  Learn the terminology of installment loans  Understand the difference between buying vs. leasing a car  Tell the difference between secured and unsecured loans  Understand home equity loans  Select which type of installment loan is best for you

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4. 4 Installment Loans - Terminology  Installment loans are loans that are repaid in equal monthly payments, or installments, for a specific period of time, usually several years.  Fixed rate loan: a loan that has an interest rate that stays the same throughout the term of the loan. Most installment loans have fixed rates.  Variable rate loan: a loan that has an interest rate that might change during any period of the loan, as written in the loan agreement, or contract.  Annual Percentage Rate (APR): the APR is the cost of your loan expressed as a yearly percentage rate. When shopping for the best loan rate, compare the APRs rather than the interest rates, since APRs reflect the cost of interest and other finance charges.

5. 5 Installment Loans - Terminology  Finance Charge: the dollar amount the loan will cost you. It includes items such as interest, service charges, and loan fees.  Collateral: the asset you promise to give to the lender if you do not pay back the loan.  Secured loan: a loan where the borrower offers collateral for the loan. The borrower gives up his or her right to the collateral if the loan is not paid back as agreed.  Unsecured loan: a loan where the lender does not require collateral.

6. 6 Examples What kind of loan/term is this?  Kevin took out a loan for a car and used his car as a collateral. What type of loan is this? Answer: secured loan  Amy took out a car loan and paid $100 in application fees and 10% interest on the loan. What do we call these fees and interest? Answer: finance charges  Mike took out a $100,000 mortgage on a house. His interest will be 5% for the first three years and then adjusted by a certain agreed upon margin afterwards. What type of loan is this? Answer: variable rate loan

7. 7 What Do Lenders Look For? (The Three C’s)  Capacity is your present and future ability to meet your payment obligations. This includes whether you have enough income to pay your bills and other debts.  Capital refers to your savings and other assets that can be used as collateral for a loan.  Character refers to how you have paid bills or debts in the past. Your credit report is one tool lenders use to consider your willingness to repay your debts.

8. 8 Annual Percentage Rate Annual Percentage Rate (APR): rate of interest you are charged plus fees, expressed as a yearly rate. The lower the APR, the better. The cost of a $5,000 loan over 5 years APRMonthly PaymentTotal Cost 10%$106.24$6,374.40 11%$108.71$6,522.60 12%$111.22$6,673.20 13%$113.77$6,826.20 14%$116.34$6,980.40 15%$118.95$7,137.00 16%$121.59$7,295.40

9. 9 Take a Loan or Rent to Own? Rent to Own a $500 TV  72 weekly payments  Weekly payment of $15  If you miss one payment, you loose the TV and all made payments  If you stick to the lease, your total cost is $15 x 72 = $1,080 Loan for $500 TV  1 year loan (12 payments)  APR = 10%  12 payment, $43.96 each  Total cost = $43.96 x 12 = $527.52  How much would you save if you borrow vs. rent?  Answer: $1,080 - $527.52 = $552.48  Question: How come the interest collected ($27.52) does not equal to 10% (or $50)?  Answer: (see amortization table next)  Why rent? (No credit is required)

10. 10 Amortization Table Amortization Table for $500 borrowed with 12 month term on October 7, 2009 (First month interest = (10% x 500) ÷ 12 = $4.166666  $4.17) Month Year 11 2009 12 2009 1 2010 2 2010 3 2010 4 2010 5 2010 6 2010 7 2010 8 2010 9 2010 10 2010 Payment ($) 43.96 Principal Paid ($) 39.7940.1240.4640.7941.1341.4841.8242.1742.5242.8843.2343.59 Interest Paid ($) 4.173.843.503.162.822.482.141.791.441.080.720.36 Total Interest ($) 4.178.0011.5014.6717.4919.9722.1123.8925.3326.4127.1327.50 Balance ($) 460.2420.0379.6338.8297.7256.2214.4172.2129.786.8343.59 0.00

11. 11 Buying and Leasing a Car: Differences  Ownership: when you lease a car, you don’t own the car. When the lease term is over you return the car to the dealership. When you buy a car, once the loan is paid off, you own the car.  Wear & Tear: most leases charge for exceeding “normal” wear and tear. If you buy, you would not have any additional costs for wear and tear.  Monthly Payments: Lease payments are lower than monthly loan payments because you are not purchasing the car.  Mileage: leases restrict the number of mileage you drive each year. If you exceed the agreed mileage you pay an additional price per mile.  Auto Insurance: usually costs more if you lease than if you purchase a car.

12. 12 Buy or Lease? QuestionLeaseLease/BuyBuy Can you make a down payment? NoYes, but smallYes Miles?< 12,00012,000-20,000> 20,000 Monthly Budget?Smallest possibleModestAs much as it takes How often you want a new car? 2-3 years3-6 years Keep as long as possible Maintain Car?Very WellSomewhatNo Customize Car?NoSomeAll the way Continual Car Payment? YesIf I have toNo Credit Rating?GoodAverageGood or Average

13. 13 Buying a Car  Getting a car loan is referred to as “financing your car.”  A car loan can be used to purchase a used or new car.  Your car becomes your collateral for the loan, which means the lender will hold the car title until the loan is paid off.  The title indicates who owns the car. If you do not pay the loan off, the lender can repossess, then sell the car, to get the remaining loan amount or proceeds back.  New car loans typically last 3-7 years (36-84 months), while used car loans last 2-4 years (24- 48 months).  The longer the loan term, the lower the payment, but the higher the loan rate.  Most lenders can pre-approve your car loan free of charge and with no obligation. This means the financial institution calculates how much money you can borrow to buy your car.

14. 14 Where Can You Get a Car Loan?  Bank – A financial institution run under federal and state laws and regulations. Banks make loans, pay checks, accept deposits, and provide other financial services.  Credit Unions – A nonprofit financial institution owned by people who have something in common. You have to become a member of the credit union to keep your money there.  Thrift – A savings bank or savings and loan association that is similar to a bank. Thrifts were created to promote homeownership and must have a majority of their assets is housing-related loans. Although many banks also make home loans, a thrift’s main business is to make home loans.  Finance Company – A financial institution whose sole business is giving loans. It does not accept deposits or provide other financial services.  Dealership – Auto dealership serve as financing agent for several financial institutions at a time. It can also provide you with special financing deals directly from the auto maker. But those usually have several restrictions.

15. 15 Auto Financing Tips  Shop around for auto financing before going to the dealer. Get pre-approved for the loan.  Compare APRs from local banks, credit unions, websites and newspapers.  Order a copy of your credit report and correct any errors a few months before shopping for a car.  Make the largest down payment you can. Beware of low down payment or long repayment plans. The more you borrow the longer you take to pay the loan, the more interest you pay and the more your car will cost you in the end. Additionally, if you have to sell the car in the first few years, you could owe the lender more than the car is worth.  Consider paying for tags, title search, and taxes separately rather than financing them. This can reduce the amount of interest you pay.

16. 16 Tips on Dealership Loans  Negotiate the best price on the car. Beware of dealers who insist on asking you how much you can afford every month. These dealers might be interested in making you stretch out the term of the loan to make the loan sound more affordable. However, by extending the length of the loan, your total cost will increase.  Be aware of penalties. Some lenders might charge you for paying off your loan early.  If you need to give the dealer a deposit, make sure you know whether you will get the money back if you change your mind. It is best to get this in writing.  Remember, service contracts, credit insurance, extended warranties, and other options are not required and can be costly over the term of the loan.  Be aware of ads that promise loans for people with bad credit. These deals often require a higher downpayment or have a very high APR.

17. 17 Title Loans (An Example)  Mike wanted to get a one-month $500 loan to pay for an unexpected medical expense. He saw a TV ad that mentioned, “If you have a car, you can get a loan.” Mike’s car is worth $2500, so he applied.  Finance company loaned him $500 with a 20% monthly interest rate. Note that the finance company did not advertise the APR. The finance company took his car title as collateral and Mike kept the car.  At the end of the month, Mike owed $600 ($500 principal + $100 interest). Mike could not repay the loan, so the lender extended the loan for another month and gave Mike the option of paying the $100 interest only.  At the end of the second month, Mike could not repay the loan again and he chose, instead, to extend the term one more month and paid another $100.  By the end of the year, Mike had paid $1,200 in interest for his $500 loan ($100 x 12)! This equates to a loan with a 240% APR. Finally, Mike received a bonus from work and was able to pay off the $500. This is a very expensive way to borrow money.  Question: How could have mike avoided this?  Answer: Prepare for emergencies. Save, budget, and put money aside for insurance and emergencies.

18. 18 Home Equity Loans  If you own a home, you have the option of borrowing against the value of your home. This is called a home equity loan.  Home equity loans can be used for almost any purpose. Many homeowners use home equity loans to consolidate higher interest rate loans or make home improvements.  In addition to installment loans, many lenders offer home equity loans in the form of lines of credit. This is called home equity line. Home equity lines of credit are open-end loans, like credit cards, that allow you to make multiple withdrawals up to a certain limit.  One of the major advantages of borrowing against your home is that the interest paid on the home equity loans or lines can be tax deductible.  One of the major disadvantages of borrowing against your home is that if you cannot make the monthly payments you risk losing your home.

19. 19 Tips on Home Equity Loans  Don’t agree to a home equity loan if you don’t have enough income to make the monthly payment.  Don’t let anyone pressure you into signing any documents; read and understand the closing papers carefully. Don’t be afraid to ask questions.  Remember to shop around for the best rates (APRs).  Remember, all home equity loans that are secured by your primary home have a three- day cancellation period. This means you have three days to change your mind.  If you sign a loan contract and you think you are a victim of a scam, contact an attorney.

20. 20 Unsecured Installment Loans  Sometimes called personal or signature loans, these loans can be used for a variety of personal expenses, such as bill consolidation, education expenses, or medical expenses.  There is no collateral requirement for an unsecured loan. The terms of the loan might range from 1-5 years.  Unsecured loans have some advantages: they have fast approval rate and might offer interest rate lower than credit card rates.  Some of unsecured loans disadvantages are: higher interest rate than secured loans and more strict credit requirements.  If you plan to use unsecured installment loan to consolidate your other loans, make sure the new APR is lower than your current APR.

21. 21 Takeaways By now, you should feel comfortable:  With the terminology of consumer installment loans  With the differences between renting to own and installment loans  Understanding the difference between buying and leasing a car  Knowing the details of taking an auto loan  With the difference between secured and unsecured loans  Understanding home equity loans and lines and some of your rights as a borrower of home equity loans

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