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Using Consumer Loans
#7
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Learning GoalsKnow 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
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Using Consumer Loans
Formal, negotiated contracts
One-time transaction - usually for big-ticket items
No more credit is available once repaid
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Different Types of Loans
Auto loans
Other durable goods loans
Education loans
Personal loans
Consolidation loans
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Student Loans
Federally sponsored loans:
Stafford Loans (Direct & Federal Family Education Loans—FEEL)
Perkins Loans
Parent Loans (PLUS)
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Exhibit 7.1 Federal Government Student Loans
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Consumer Loans
Single Payment • Specified period• Lump sum
payment due
Installment• Fixed, scheduled
payments
Fixed• Interest rate and
payments remain the same
Variable Interest Rate
• Interest rate and payments change periodically
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Where Can You Get Consumer Loans?
Commercial Banks
Consumer Finance Companies
Credit Unions
Savings and Loan Associations
Sales Finance Companies
Life Insurance Companies
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Managing Your Credit
Compare loan features• Finance charges • Loan maturity • Total cost of transaction• Collateral • Other considerations such as
payment date, prepayment penalties, late fees
Shop carefully before borrowing!
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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 consumer debt pmts Monthly take-home pay
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Single-Payment Loans
Loan collateralLienChattel mortgageCollateral note
Loan maturity Loan repayment
Prepayment penaltyLoan rollover
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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
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FS = P x r x tWhere
FS = finance charge using simple interest methodP = principal loan amountr = stated annual interest ratet = term of loan
Simple Interest Method
Example- Calculate finance charges and APR on a $1000 loan for 2 years at 8% interest rate (Assume interest is the only finance charge)
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Using the Simple Interest Method
Interest = Principal x Rate x Time = $1000 x .08 x 2Finance Charge = $160
• Receive full loan amount ($1000) but pay back $1600 (loan amount + finance charge)
• Most consumer friendly method
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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
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Discount Method
Interest = Principal x Rate x Time= $1000 x .08 x 2
Finance Charges = $160
Calculate same as simple interest method but subtract finance charges from loan amount ($1000 – $160)
Borrower receives $840 now, pays back $1000
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Annual Percentage Rate =
Average annual finance chargeAverage loan balance outstanding
Discount Method
APR = ($160 2) = $80 ($1000 – $160) = $840
= 9.52%
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Installment Loans
Repay debt in a series of equal payments
Payments includes principal and interest
Wide maturity range -- 6 months to 10 years or longer
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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
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ExampleCalculate the finance charges and APR on a $1000 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
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Calculator(Set on 12 P/YR and
END mode) 1000 +/- PV
8 I/YR
12 N PM = $86.99
Use Exhibit 7.4 (Table calculated using $1000 loan)
Find payment for 12 months at 8% interest:
$86.99
Calculating Finance Charges on Installment Loans
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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
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$86.99 x 12 = $1,043.88Loan amount = – 1,000.00
Interest paid = $ 43.88
Total amount paid over 12 months
Simple Interest Method
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Add-On Method
• Calculate finance charges on the original loan amount
$1000 x .08 x 1 = $80• Add these charges to principal
$80 + $1000 = $1,080• Divide this amount by the number of periods
to arrive at payment$1,080 12 = $90.00
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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:
1000 +/- PV90.00 PMT12 N
I/YR 14.45%
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Other Loan Considerations
Prepayment penalties
Rule of 78s = sum-of- the-digits method
Buy on time or pay cash?
May be better to pay cash — If you have it
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Comparative Finance Charges and APRs ($1000, 8%, 12 mo)