Download Loan Intrest

What Is Consumer Borrowing?
• Obtaining funds from a lender under
specific loan provisions.
• Called “Consumer Loans.”
– Made for a specified purpose.
– Must be repaid according to a specified
schedule.
• Consumer loans are necessary
because few people can pay cash for
big-ticket items.
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Advantages of Consumer Loans
• Permits buying expensive items.
• Permits you to use the item while
paying for it.
• Provides financial flexibility--spread
payments over long period of time.
• To cover unexpected expenses and
emergencies.
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Disadvantages of Consumer Loans
• You must pay interest on the loan.
• Must provide collateral or security for
the loan.
• If overused, may be unable to repay
your debts.
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Background on Personal Loans
• Usually obtained to finance a large
purchase
• Has a specific repayment schedule
• Sources of loans
– Commercial banks, savings institutions,
finance companies, credit unions, some
automobile manufacturers, friends, or
family members
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Background on Personal Loans
• The personal loan process
– Application process
• Personal balance sheet
• Personal cash flow statement
– Loan contract: a contract that specifies the
terms of a loan, as agreed to by the
borrower and the lender
• Amount of the loan
• Interest rate
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Background on Personal Loans
– Loan repayment schedule
• Amortize: to repay the principal of a loan
through a series of equal payments
• Each payment includes part of the principal and
part of the interest
– Maturity: the life or duration of the loan
• Longer maturity equals lower payments, but
more interest is paid over the life of the loan
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Background on Personal Loans
– Collateral: assets of a borrower that back a
secured loan in the event that the borrower
defaults
• Secured loan: a loan that is backed or secured
by collateral which could be repossessed if the
lender defaulted on the loan
• Unsecured loan: a loan that is not backed
by collateral
– Cosigning is sometimes required if credit
history is weak
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Five Cs of Consumer Borrowing
• Character - refers to the integrity of
the prospective borrower.
– Have you met your previous obligations?
• Capital - refers to the net worth
position of the applicant.
– Have you sufficient financial assets?
• Capacity - refers to the ability of the
borrower to repay borrowed amounts.
– Can you meet your future obligations?
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Five Cs of Consumer Borrowing
• Collateral - consists of items of value
that may be pledged to secure the loan.
• Conditions - refers to general economic
conditions.
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Managing Debt
To determine how much you can borrow,
debt payments should be compared to
disposable income, and the amount
borrowed should be compared to net
worth.
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Amount of Debt
• Ratio of debt payment to disposable
income (should not exceed 20%)
– measures you ability to make your non-mortgage debt
payments from current disposable income.
– Is a “flow” measure--matches cash inflow with cash
outflows.
– A low ratio (<10%) indicates you can borrow more.
– Ratios over 20% indicates too much has been
borrowed.
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Amount of debt (continued)
• Ratio of debt to net worth.
– Excludes mortgage debt and the value of
your home.
– “stock” measure - relates debt to
accumulated net worth.
– A ratio of more than 100% indicates no
additional debt should be undertaken.
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Background on Personal Loans
• Focus on Ethics: Predatory Lending
– Beware of illegal lending practices
• Lender charging high loan fees
• Lender provides home equity loan with the
expectation of default so he can take ownership
• Lender ties other products to loan approval
• Lender includes balloon payment at end of loan
• Loan agreement includes confusing information
– Shop around for best loan terms
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Methods of Computing Interest
• Simple interest method
– single payment loan
– installment loan
• Discount method
• Add-on method
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Interest Rates on Personal Loans
• Annual percentage rate (APR): a rate
that measures the finance expenses
(including interest and other expenses)
on a loan on an annualized basis
• Add-on interest method: a method of
determining the monthly payment on a
loan
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Interest Rates on Personal Loans
• Simple interest: interest on a loan
computed as a percentage of the
existing loan amount (or principal)
– Size of payment depends on size of loan,
interest rate and maturity
– The higher the interest rate, the higher the
payment
– The longer the maturity, the lower the
payment
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Home Equity Loan
• Home equity loan: a loan where the equity in
a home serves as collateral for the loan
• Equity of a home: the market value of a home
minus the debt owed on the home
• Credit limit on a home equity loan
– Limit based on equity invested
– Financial institutions usually loan up to 80% of the
equity in a home
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Home Equity Loan
• Interest rate is typically variable
– Rate is usually tied to an interest rate index
and adjusted periodically
– Interest on most home equity loans is tax
deductible
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Car Loans
• Selecting the car — things to consider
– Personal preferences
– Price
– Insurance
– Resale value
– Repair expenses
– Financing rate
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Car Loans
• Negotiating the price
– Negotiating by phone may be beneficial
– Trade-in tactics can be misleading
– No-haggle dealers can save time and
stress
– Information is valuable – shop around
– Purchasing a car online is possible, but not
yet a streamlined process
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Car Loans
– Financing decisions
• Estimate dollar amount of monthly payment you
can afford before shopping
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Student Loans
• Student loan: a loan provided to finance
part of the expenses a student incurs
while pursuing a degree
• Loan may be provided to either the
student or the student’s parents
• Repayment typically deferred until
student is out of school
• Interest may be tax deductible
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