#7
Using Consumer
Loans
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Learning Goals
Know 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, singlepayment 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
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Using Consumer Loans
Formal, negotiated contracts
One-time transaction - usually for big-ticket items
No more credit is available once repaid
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Different Types of Loans
Auto loans
Other durable goods loans
Education loans
Personal loans
Consolidation loans
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Student Loans
Federally
sponsored
loans:
Stafford Loans (Direct & Federal
Family Education Loans—FEEL)
Perkins Loans
Parent Loans (PLUS)
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Exhibit 7.1 Federal Government
Student Loans
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Consumer Loans
Single Payment
• Specified period
• Lump sum
payment due
Fixed
• Interest rate and
payments remain the
same
Installment
• Fixed, scheduled
payments
Variable Interest Rate
• Interest rate and
payments change
periodically
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Where Can You Get
Consumer Loans?
Commercial Banks
Consumer Finance Companies
Credit Unions
Savings and Loan Associations
Sales Finance Companies
Life Insurance Companies
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Managing Your Credit
Compare loan features
•
•
•
•
•
Finance charges
Loan maturity
Total cost of transaction
Shop carefully
Collateral
before borrowing!
Other considerations such as
payment date, prepayment penalties, late fees
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Single-Payment Loans
Loan collateral
Lien
Chattel mortgage
Collateral note
Loan maturity
Loan repayment
Prepayment penalty
Loan rollover
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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)
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Simple Interest Method
Annual Percentage Rate =
Average annual finance charge
Average loan balance outstanding
APR = ($160 2)
= 8%
$1000
APR is same
as stated rate
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Discount Method
Annual Percentage Rate =
Average annual finance charge
Average loan balance outstanding
APR =
($160  2) =
$80
($1000 – $160) = $840
= 9.52%
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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)
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Calculating Finance Charges
on Installment Loans
Use Exhibit 7.4
(Table calculated
using $1000 loan)
Find payment for
12 months at 8%
interest:
$86.99
Calculator
(Set on 12 P/YR and
END mode)
1000 +/- PV
8
I/YR
12
N
PM = $86.99
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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%
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Other Loan Considerations
Prepayment penalties
Rule of 78s = sum-ofthe-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)
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.