Consumer Loans

1. Consumer Loans

2. Consumer loans have some differences compared to credit cards and other open credit plans like credit cards: Consumer loans Open credit One shot transaction used over and over again no more credit when loan continual line of credit is paid off no checks or cards cards and checks issued borrow for big ticket items borrow for relatively low cost stuff

3. Types of loans The typical loans here are for an auto, durable goods, education, personal reasons, and for consolidation. As with all loans, you want to pay attention to the maturity date on the loan (when the loan is totally paid off), the interest rate and any compounding that may occur, and if any collateral must be offered in case of default on the loan. Auto loans are the most frequent of the types. Loans here typically have interest compounded monthly with maturity anywhere from 36 to 72 months. The car itself is the collateral. Durable goods are things such as washers and dryers, TV’s and the like. The maturity is less than on cars and the items also are the collateral.

4. Education Loans Banks give loans for education on their own, but the federal government has programs that allow banks to offer education loans at lower rates than they would offer on their own. Stafford Loans and Perkins Loans are two examples of government backed loans. Let’s explore the general details of these types of loans. To get one of these loans the student would visit the financial aid office. The loans are based on need, where need is defined as the cost of attending school minus the amount you can pay or your family can pay. The interest rate on the loans is typically lower than the bank’s normal rate because the government guarantees repayment. The bank does not have to worry about default and therefore does not have to charge a default premium.

5. The financial aid office will have relationships established with banks and other financial institution, so all you have to do is fill out the paper work on campus and submit to the financial aid office. You never have to visit the financial institution. You do have to be making satisfactory progress toward a degree to get/keep the loan. The authors say that due to resent legislation, if you file for bankruptcy you can not get out of paying back your student loan. (So I guess the government backing only helps the banks if you become incapacitated or deceased.)

6. Some consumer loans can be repaid in one single payment or there may be a series of payments (installments). The rate of interest may be variable or fixed. Where can you get these types of loans? Banks, credit unions, S&L’S offer these loans. Other entities that provide these loans are specialized consumer loan companies, sales arms of the companies selling the goods (GMAC for example), life insurance companies (when you have cash value built up), and you can even borrow from friends and relatives.

7. Loan Features to be aware of: Collateral - An asset of the borrower that the lender would get if the borrower can not repay. We mentioned before on cars that the car is the collateral on the car loan. The car would be repossessed it default occurs. A lien is a legal claim the lender puts on record at the county courthouse and permits the lender to liquidate the collateral to satisfy the loan if trouble occurs. A chattel mortgage is an instrument the lender has when the borrower maintains possession of the movable property (tv’s, jewelry and the like). The lender gets title if there is trouble. A collateral note gives the lender the right to sell items when trouble occurs.

8. Note that on some loans if you try to pay the loan off earlier than originally agreed to you may have a prepayment penalty. If you remember back to the house loan, you owe money each period and you pay back some principal and some interest each period. You would think that if you paid off the loan early that you wouldn’t have to pay interest charges for periods of time you don’t owe money. But sometimes you will have to. In the lenders defense , when you entered the agreement they expected those earnings and may want you to make the payments. Beware the type of prepayment system you have so you are not surprised.

9. The authors mention that there still exists a type of loan that calculates simple interest. I thought simple interest had all but disappeared. The simple interest method of simple interest example: Borrow $1000 and pay back in a single payment at the end of 2 years with interest at 12% per year. The payment is 1000 + [1000 times 2 (years) times .12] = 1000 + 240 = 1240. Now, if interest was compounded yearly, borrowing 1000 and paying back 1240 would mean a yearly rate found in the following way (from F = P(1 + i)n: 1240 = 1000(1 + i)2 or 1.24 = (1 + i)2, or i = sqrt(1.24) - 1 = .1136 or 11.36%.

10. The discount method of simple interest example: Note that with the discount method, interest is calculated like with the simple interest method. But the interest is paid at the time of the loan, essentially making the loan a lower amount. Say you borrow $1000 over 2 years at 12% a year. The interest over the two years would be 240 and so you would only get 760 at the time of the loan. You would then pay back $1000. If you borrowed 760 and paid back 1000 two years later the yearly compound interest would be found in the following 1000 = 760(1 + i)2. So, i = sqrt(1000/760) - 1 = .1471 or 14.71%