Chapter Fifteen
Consumer Loans, Credit Cards, Real Estate
Lending and Managing Credit Risk
Key Topics
• Introduction
• Different Types of Loans
• Types of Loans to Individuals & Families
• Real Estate Loans
• Risk and Problems in Real Estate lending
• Home Equity Lending
• Unique Characteristics of Consumer Loans
• Credit Cards and Credit Scoring
• Disclosure Rules and Discrimination
• Consumer Loan Pricing and Refinancing
INTRODUCTION
• The main reason many banks are
issued charters of incorporation by
state and national governments is to
make loans
• Lenders are expected to supply credit
for all business and consumer
financial needs and to price that credit
fairly
• Commercial banks are the largest
lenders of household loans
INTRODUCTION
• Loans support the growth of new
businesses and jobs within the lender’s
market area
• Loans frequently give information to the
marketplace about a borrower’s credit
quality
• The lending process requires careful
monitoring at all times
INTRODUCTION
p. 439
• Consumer debt has become one of the
fastest growing forms of borrowing money
- $14 trillion in US
• Banks lending to households depends on
their need for a source of funds –
checkable and savings deposits
• Consumer credit is often among the most
profitable services a lender can offer
▫ However, services directed at consumers
can also be among the most costly and
risky financial products
DIFFERENT TYPES OF LOANS
• Real Estate Loans – For personal homes
• Consumer Loans – Loans to individuals and
households
• Commercial and Industrial Loans – business
start-ups, growing a business
• Agriculture Loans – for farmers
• Miscellaneous Loans
• Lease Financing – renting equipment
• The largest category in dollar volume is real
estate loans, followed by loans to individuals,
and commercial and industrial (C&I) loans
Real Estate Loans
p. 457-458
• Banks & finance & insurance
companies make real estate loans to
fund the buying of property
▫ Homes, apartment complexes,
shopping centers, office buildings,
and land
• One of the most rapidly growing
areas of lending over the past decade.
Almost 1/3 of all bank assets.
Real Estate Loans
p. 457-458
• Real estate loans can be among the
riskiest forms of credit extended to
customers
▫ Usually a long-term loan, typically
bearing a term amortized over 15-30
years
▫ Secured by the property. Property is the
collateral itself.
▫ Has a fixed interest rate or a variable
(floating) interest rate
▫ Banks are the leading residential
mortgage lenders today
Real Estate Mortgage Amortization Table - 20 year
$200,000 loan with a 5% interest rate
Year
1
2
3
4
5
6
Begin Balance
$200,000
194,025
187,795
181,143
174,204
166,910
Principal
5,975
6,280
6,602
6,939
7,294
7,668
Interest
9,864
9,559
9,237
8,900
8,545
8,171
Payment End Balance
15,839
194,025
15,839
187,795
15,839
181,143
15,839
174,204
15,839
166,910
15,839
159,292
9
10
30,016
15,410
14,668
15,418
1,171
421
15,839
15,410
15,418
0
Real Estate Loans (continued)
• Differences between Real Estate
Loans and Other Loans
▫ The average size of a real estate
loan is usually much larger than
the average size of other loans
▫ Mortgage loans tend to have
longer maturities versus other
types of loans - 15 years to 30
years are typical for singlefamily homes
Risk and Problems in Real Estate Lending
• The Most Risky of Home Mortgage
Loans: Interest-Only and Adjustable
Rate Mortgages and the Recent
Mortgage Crisis (2008)
▫ When housing prices were rising
during the recent housing boom, how
could lenders make high priced homes
affordable?
▫ More families were encouraged to sign
up for adjustable-rate loans (ARMs)
during a period when market interest
rates were at historic lows
p. 456
Risk and Problems in Real Estate Lending
• Along with lenders giving Adjustable
or floating rate loans two other types
of lending led to the financial crisis of
2008.
• Predatory lending
▫ A bad practice among some lenders
where lenders may require high fees
• Subprime Loans
▫ Granting loans to borrowers who
have below-average credit scores
p. 456
Real Estate Loans – Home Equity Loans p. 459-460
• Home Equity Lending
▫ Homeowners can borrow the
equity in their homes
▫ Equity is defined as the
difference between a home’s
estimated market value & the
amount of the mortgage owed.
▫ For example. Your mortgage is
$100,000 but you owe $50,000.
You would have $50,000 in
equity.
Real Estate Loans – Home Equity Loans p. 459-460
• Home Equity Lending
▫ Two main types of home
equity loans:
1. Traditional Home Equity
Loan (HEL) a fixed rate
with installments
2. Prime Equity Loan (PEL) –
interest based on rate set by
the bank but based on a rate
set by the FED. –
.
Types of Loans to Individuals and Families
Consumer loans are known by
1. Purpose – what the borrowed
funds will be used for. For example
to buy a car, or other large items
2. Type – Installment Loan the
borrower must repay in installments
(monthly or quarterly payments) or
repay in one large payment.
INTEREST RATES ARE
HIGHER
p. 440
Characteristics of Consumer Loans (continued)
• Why are interest rates so high on
most consumer loans?
▫ Consumer loans are among the
most costly and most risky to
make per dollar of loanable
funds. Made to individuals and
households to purchase a car, or
other large items for a house.
Types of Loans Granted to Individuals and
Families (continued)
p. 441-442
• Credit Card Loans and Revolving
Credit
▫ Very popular form of credit today is
credit cards.
▫ Many credit cards have variable
(changing) rates of interest
▫ Card providers earn discount fees (1 to
7% of credit card sales) from
merchants.
STEPS IN THE LENDING PROCESS
1. Finding New Loan Customers
2. Evaluating a Customer’s Character
3. Evaluating a Customer’s Credit Record
4. Evaluating a Customer’s Financial
Condition
5. Does the borrower have Collateral &
Signing the Loan Agreement
6. Monitoring the Loan Agreement
Evaluating a Consumer Loan Application – WHAT
MAKES FOR A GOOD LOAN?
p. 445
THE C’s OF CREDIT (Adverse
Selection):
1. Character – Is the customer
creditworthy. They have a good credit
record of paying back loans.
2. Capacity – Able to sign documents
3. Cash – Ability to pay back loan. Has the
income to make payments.
4. Collateral – Assets, like a car, house to
secure the loan in case of default
Evaluating a Consumer Loan Application – WHAT
MAKES FOR A GOOD LOAN?
p. 445
THE C’s OF CREDIT (Adverse
Selection):
5. Conditions – What are the economic
conditions like at the time of the loan.
6. Control – Does the loan meet all the
policies and regulations?
Evaluating a Consumer Loan Application (cont)
• Other Important Items For Lenders
• Income Levels
• Deposit Balances
• Employment & Residential Stability
• Debt and exposure
• How to Qualify for a Consumer Loan
• Home ownership or ownership of any
form of real property
• The most important thing to do –
truthfully answer all of the loan officer’s
questions
Credit Scoring Consumer Loan Application p. 450
• The idea of credit scoring is that
lenders are able to separate good
loans from bad loans. Adverse
selection.
• The same factors that separated good
loans from bad loans in the past will
separate good loans from bad ones in
the future.
• Such an automated credit system
removes personal judgment from the
lending process
Credit Scoring Consumer Loan Application
(continued)
p. 452-453
• The FICO System
▫ Most famous of all credit-scoring
systems currently in use
▫ Scores range from 300 to 850 with
higher values denoting less credit
risk to lenders
▫ FICO score are based on five
different types of information (most
important to least important):
Credit Scoring Consumer Loan Application
(continued)
p. 452-453
1. The borrower’s payment
history
2. The amount of money owed
3. The length of a borrower’s
credit history
4. The new credit being
requested
5. The types of credit that the
borrower has already used
FICO – A SAMPLE CREDIT SCORE
EXPLANATION OF CREDIT SCORE
Proportion of balances to credit limits is too high on
bank / revolving credit card accounts
2. Proportion of loan balances to loan amounts is too
high
• Consumers who use a high % of their available credit
have a higher risk of delinquency (falling behind on
payments) and charge-off (loan default) over time.
1.
Laws and Regulations Applying to Consumer
Loans (continued)
p. 454
• Customer Disclosure (Information)
Requirements
• Truth-in-Lending Act – The bank
or lender must provide full
information about the terms and all
the costs and fees of a loan to a
customer.
• Fair Credit Reporting Act
• Fair Credit Billing Act
• Fair Debt Collection Practices Act
Laws and Regulations Applying to Consumer
Loans (continued)
p. 454
Making Credit Discrimination
• Equal Credit Opportunity Act –
everyone has the right to get a loan.
NO PERSON can be denied a loan
based on age, sex, race, religion, rich
or poor.
US law requires banks tell a
customer, in writing, if they are
denied a loan.
Laws and Regulations Applying to Consumer
Loans (continued)
p. 454
• Community Reinvestment Act – Banks
must have offices or branches in every
community, rich and poor.