Student and Consumer Loans The Role of Planned Borrowing Professor Payne Finance 4100 Learning Objectives Understand the various consumer loans Calculate the cost of a consumer loan Pick an appropriate source for your loan ID: 624245
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Chapter 7
Student and Consumer Loans: The Role of Planned Borrowing
Professor Payne, Finance 4100Slide2
Learning Objectives
Understand the various consumer loans.
Calculate the cost of a consumer loan.
Pick an appropriate source for your loan.Control your debt.Understand the alternatives for financing your college education.
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Introduction
Consumer loans—formal contracts detailing how much you’re borrowing and when and how you’re going to pay it back.
Used for bigger purchases.
Debt and borrowing can get out of control.3Slide4
Consumer Loans—Your Choices
Single-payment versus installment
Secured versus unsecured
Variable-rate versus fixed rateShorter- versus longer-term 4Slide5
First Decision: Single-Payment versus Installment Loans
Single-payment or balloon loan
—paid back in a single lump-sum payment with interest at maturity.
Bridge or interim loan– short-term loanInstallment loan—repayment of both principal and interest at various intervals.Loan amortization—with each payment, the interest portion covered decreases and principal portion covered increases5Slide6
Second Decision: Secured versus Unsecured Loans
Secured loan
—guaranteed by an asset which typically lowers the rate of the loan
Unsecured loan—not guaranteed by an asset or collateral6Slide7
Third Decision: Variable-Rate versus Fixed-Rate Loans
Fixed-rate interest rate loan
—stays fixed for entire duration of the loan, not tied to market interest rates
Variable-rate or adjustable interest rate loan—interest rate varies based on the market interest ratePrime rate—the interest rate that banks charge to their most creditworthy, or “prime” customersConvertible loan—variable-rate loan that can be converted to a fixed-rate loan7Slide8
Fourth Decision: The Loan’s Maturity—Shorter versus Longer Term Loans
Shorter term loan means lower interest rate and larger monthly payments
Longer term loan means smaller monthly payments and higher interest rate
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Understand the Terms of the Loan: The Loan Contract
Insurance agreement clause
Acceleration clause
Deficiency payments clauseRecourse clause9Slide10
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Special Types of Consumer Loans
Home equity loan or second mortgage
—secured loan using equity in home as collateral
Advantages:Interest is tax deductibleLower interest than other consumer loansDisadvantages:Puts your home at riskLimits future financing flexibility 11Slide12
Special Types of Consumer Loans
Automobile loans
—secured loan specifically for purchasing an automobile
Usually 24, 36, or 48 monthsCan extend to 5 or 6 yearsLow risk to lender because of collateral 12Slide13
Cost and Early Payment of
Consumer Loans
APR
—annual percentage rate—simple percentage cost of all finance charges over the life of the loan, on annual basis.Truth in Lending Act requires all consumer loan agreements disclose APR in bold print.
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Cost of Single-Payment Loans
Loan disclosure statement gives APR and finance charges of a loan
States interest calculation
Simple interest method: Discount method:Interest is subtracted from loan amount received
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Payday Loans—A dangerous kind of single-payment loan
$100 to $500 loan till next payday
Post-dated check with fee and principal left with payday lender
Due in 1 or 2 weeksAnnualized interest rates up to 400%16Slide17
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Cost of Installment Loans
Repayment of both interest and principal occurs at regular intervals.
Payment levels are set so loan expires at a preset date.
Use either simple interest or add-on method to determine what payment will be.18Slide19
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Early Payment of an Add-on Loan
If installment loan is repaid early, determine amount of principal still owed.
Most common method for add-on loan is Rule of 78 or sum of the year’s digits.
Rule of 78 determines what proportion of each payment goes towards principal.Prepayment penalty22Slide23
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Getting the Best Rate on Your Consumer Loans
Inexpensive sources—family, home equity loans, cash value life insurance loans
More expensive sources—credit unions, savings and loans, and commercial banks
Most expensive sources—retail stores, finance companies or small loan companies24Slide25
Keys to Getting the Best Rate
Strong credit rating
Reduces risk to lender:
Use variable-rate loanShort loan termCollateralLarge down payment25Slide26
Should You Borrow or Pay Cash?
Keep in mind that debt is expensive.
Don’t borrow to spend.
Use cash rather than credit.If benefits outweigh costs, borrowing makes sense.26Slide27
Controlling Your Use of Debt
Determine how much debt you can comfortably handle.
Debt level comfort and need changes at different stages of the financial life cycle.
With age, debt proportion of income tends to decline.Use several measures to control debt commitments.27Slide28
Controlling Your Use of Debt
Debt Limit Ratio
—percentage of take-home pay committed to non-mortgage debt.
Total debt can be divided into consumer debt and mortgage debt.Ratio should be below 15%.~20% should avoid additional debt.
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Debt Resolution Rule
Control debt obligations, excluding borrowing for education and home financing, by forcing you to repay all outstanding debt obligations every 4 years.
Logic is that consumer credit should be short-term.
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Controlling Consumer Debt
Make sure it fits in with your goals and budget.
Understand how costly consumer debt is.
Borrowing limits future financial flexibility.Look for clues that you might be in financial trouble.30Slide31
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What To Do If You Can’t Pay Your Bills
Budget so more money comes in.
Use self-control in the use of credit.
Go to your creditor.Go to a credit counselor.32Slide33
What To Do If You Can’t Pay Your Bills
Borrow inexpensively
Use savings to pay off current debt
Use a debt consolidation loanBankruptcy—the last resortdoesn’t wipe out all obligations.33Slide34
What To Do If You Can’t Pay Your Bills
Most common types of personal bankruptcy:
Chapter 13 The wage earner’s plan
Chapter 7 Straight bankruptcy34Slide35
Chapter 13: The Wage Earner Plan
Must have:
Regular income
Secured debts under $1,149,525 (2014)Unsecured debts under $383,175 (2014)For the individual—relief from harassment of bill collectors; retain possession of assetsFor creditors—controlled repayment with court supervision35Slide36
Chapter 7: Straight Bankruptcy
Can eliminate debts and begin again.
“Means test”
Most debts wiped out—not child support, alimony, student loans, and taxes. Trustee collects, sells all nonexempt property.Must complete credit counseling course.36Slide37
Student Loans and Paying for College
Understand the consequences of your choice of school and major
Understand the full costs of school and what you can do to borrow less and borrow smarter
Manage your money well while on campusRepay your loans without sacrificing your financial goals37Slide38
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So Many Choices—Schools and Majors
Research what your expected salary will be so you do not take on too much debt
Understand the positive and negative aspects of your school and major choices
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Borrowing Less and Borrowing Smarter
Compare financial aid packages and college costs
Apply for federal financial aid first
Look for state and local grants and scholarshipsUse tax credits and deductions to your advantage40Slide41
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Paying for Your College Education
529 plan
Prepaid tuition plans
College savings plansCoverdell Education Savings Account (ESA)42Slide43
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Federal Student Loans
Department of Education is your lender
Interest is fixed over the life of the loan
Federal Perkins Loan ProgramDirect Subsidized LoansDirect Unsubsidized LoansDirect PLUS Loans Direct Consolidation Loans 44Slide45
Private Loans
Provides you with funds after you have exhausted all federal financial aid
Offered by commercial banks and credit unions
Interest rate variesRates are usually higher than federal student loan ratesGenerally do not offer deferment or forbearance options45Slide46
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Manage Your Money Responsibly
Choose a bank that charges low fees
Use direct deposit
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Repaying Your Loans
Repayment Plans
Standard
ExtendedIncome-BasedGraduatedDefermentEnrolled at least half-time, unemployed, or meet hardship standards you can postpone payments for up to 3 yearsNo interest is accrued on subsidized loansForbearanceDelay payments due to illness, financial hardship, or residency requirementInterest accrues48Slide49
Summary
Consumer loans can be single-payment loans, installment loans, secured loans, or unsecured loans.
Loan costs are finance charges which include interest payments, processing fees, credit check fees, and insurance fees.
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Summary
There are numerous sources of loans, but the key to getting a favorable rate is a strong credit rating and reducing lender’s risk.
Control debt by borrowing when debt fits within your financial plan and budget, and know your debt limits using the debt limit ratio and debt resolution rule.
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Summary
Understand the role your school and major play in student loan debt.
Use tax-advantaged accounts like 529 plans and Coverdell Educational Savings Accounts to save for college.
Use federal student loans as your first borrowing alternative. 51Slide52
End of Chapter 7 Slides
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