1. 1 (of 26) FIN 200: Personal Finance Topic 10-Personal Loans Lawrence Schrenk, Instructor

2. 2 (of 26) Learning Objectives 1. Explain the features of personal loans. ▪ 2. Explain and calculate interest rates and payments. 3. Describe home equity loans. 4. Describe car loans. 5. Decide between owning and leasing a car.▪

3. 3 (of 26) The Personal Loan

4. 4 (of 26) The Feature of a Personal Loan Amount Interest Rate Repayment Schedule  Amortized (Equal Payments) Maturity Collateral  Secured versus Unsecured

5. 5 (of 26) Some (Possibly) Misleading Rates ‘Note Rate’ or ‘Headline Rate’  Rate often quoted in advertisement  May not include all fees  May underestimate costs of borrowing Monthly Rate  Not in annual terms  ‘Annualizing’  Makes comparisons difficult

6. 6 (of 26) Common Interest Rates Annual Percentage Rate (APR) Simple Interest Add-On Interest

7. 7 (of 26) Annual Percentage Rate (APR) Standardized Loan Rate Inclusive of (Most) Fees Legally Defined–Truth in Lending Act (1969) Required Declaration Some Flaws  May not include all costs of borrowing  Simple interest  Different methods of calculation

8. 8 (of 26) The APR Calculation APR = Average Finance Expense divided by Principal  Example: $500 finance expense on a loan of $6,000 Calculator (Downloadable from OCC) Calculator

9. 9 (of 26) Simple Interest Interest as a percentage of the remaining balance No interest on interest, i.e., compounding Fee not included No time value of money

10. 10 (of 26) Simple Interest Calculation Simple Interest Payment Monthly payment with annual simple interest of 11% on a balance of $10,000.

11. 11 (of 26) Amortization Table

12. 12 (of 26) Graph of Amortization Table

13. 13 (of 26) Add-On Interest Total of interest and principle divided by payments Higher payments than simple interest  Interest payment constant (not reduced)

14. 14 (of 26) Add-On Interest Example: Loan of $10,000 for 10 years at 11% Add-On Interest Calculation

15. 15 (of 26) Type of Loans

16. 16 (of 26) The Home Equity Loan ‘Second Mortgage’ ‘Home Equity Line of Credit’ (HELOC) Revolving Line of Credit Financing charges only on balance (not total one of credit) Variable Interest Rate

17. 17 (of 26) Equity Value and Credit Limit Equity value is market value minus the remaining (first) mortgage balance No Liquidity Collateral for a home equity loan Credit limit: Keep both mortgages to less than 80% of house value

18. 18 (of 26) The Home Equity Loan: Pros and Cons Pros  Lower Interest Rate But higher than original mortgage Home Equity Loan Rates  Tax Advantages  Flexibility Payouts: Electronic, Checks, ATM, etc. Payments: Amortized, Interest Only, etc. Con  You risk losing your home!

19. 19 (of 26) The Home Equity Loan: Taxes A home equity loan (like an original mortgage) is not a ‘consumer loan’.  Consumer Loan: Student Loan, Credit Card Debt, Car Loan The interest can be deducted from federal and state income taxes, if... 1. Under maximum ($100,000) for ‘home equity indebtedness’ 2. ‘Home equity indebtedness’ is less than fair market value.

20. 20 (of 26) The Car Loan Consumer Loan Car as Collateral Installment Loan Web Resources  Consumer Reports Consumer Reports  Auto Safety/Crash Tests Auto Safety/Crash Tests

21. 21 (of 26) Car Selections: Financial Considerations New or Used Price:Blue BookYahooBlue BookYahoo Condition Insurance Maintenance (including gasoline) Resale Value Interest Rate Auto Interest RatesAuto Interest Rates Further Suggestions

22. Kelley Blue Book 22 (of 26)

23. 23 (of 26) Loan Features Down Payment  Trade In Interest Rate Maturity The Monthly Payment  Money financed minus down payment, etc.  Prior loan or lease balances transferred  Sales tax  Other items, e.g., service contracts.

24. 24 (of 26) Finding Financing Personal Savings/Investments Bank/Credit Union/Internet/AAA  Car Loan  Home Equity Loan Finance Company  Dealership Rebate versus Below-Market Interest Rate  Calculator (Bankrate.com) Calculator Pre-Approved Loan

25. 25 (of 26) Lease versus Own Own  Equity Value (Part of Net Worth) Lease  No Resale Issues, but  No ‘Terminal Value’  Extra Fees  Lower Monthly Payment

26. Project Notes 26 (of 26)

27. 27 (of 26) Ethical Dilemma As a result, Fritz and Helga are having difficulty paying their bills. Several months ago they began using a local payday loan company to pay their bills on time. And now they are no longer able to borrow because the repayment plus interest would have exceeded their paychecks. Fritz and Helga have had their cars repossessed, their home foreclosed on, and they are preparing to file for bankruptcy. a. Is the payday loan company being ethical in continuing to loan more and more to Fritz and Helga each week? b. What could Fritz and Helga have done to avoid ultimate financial ruin?