#7
Using Consumer
Loans
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Consumer Loans
• Formal, negotiated contracts
• One-time transaction
– Usually for big-ticket items
• No more credit is available once repaid
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Types of Consumer Loans
• Auto loans
• 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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Federal Student Loans
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Consumer Loans
• Single
Payment
• Installment
• Fixed
• Variable
Interest Rate
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Where Can You Get
Consumer Loans?
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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
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Finance charges
Loan maturity
Total cost of transaction
Collateral requirements
Other considerations such as
payment date, prepayment penalties, late fees
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Keep Track of Your Credit
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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 collateral
– Lien
– chattel mortgage
– collateral note
• Loan maturity
• Loan repayment
– Prepayment penalty
– Loan rollover
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Finance Charges and the APR
Simple Interest Method - Calculated on
outstanding balance
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
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Simple Interest Method
FS = P x r x t
Where
FS = finance charge using
simple interest method
P = principal loan amount
r = stated annual interest
rate
t = term of loan
ExampleCalculate 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 2
Finance Charge = $160
• Receive full loan amount ($1000) but pay
back $1600 (loan amount + finance charge)
• Most consumer friendly method
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Simple Interest Method
Annual Percentage Rate =
Average annual finance charge
Average loan balance outstanding
APR = ($160 2)
= 8%
$1000
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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 $760 now, pays back $1000
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Discount Method
Annual Percentage Rate =
Average annual finance charge
Average loan balance outstanding
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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Calculating Finance Charges
on Installment Loans
Example
Calculate 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)
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Calculating Finance Charges
on Installment Loans
Use Exhibit 7.5
(Table calculated
using $1000 loan)
Find payment for
12 months at 8%
interest:
$88.99
Calculator
(Set on 12 P/YR and
END mode)
1000 +/- PV
8
I/YR
12
N
PM = $86.99
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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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Simple Interest Method
Total amount paid over 12 months
$86.99 x 12
= $1,043.88
Loan amount = – 1,000.00
Interest paid = $ 43.88
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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 +/- PV
90.00
PMT
12
N
I/YR
14.45%
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Other Loan Considerations
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Prepayment penalties
Rule of 78s = sum-of- the-digits method
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Credit life insurance and credit disability
insurance
– Avoid if possible - get term insurance instead
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Buy on time or pay cash?
– May be better to pay cash — If you have it
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