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Chapter 21

Chapter 21. Consumer Lending and Borrowing. To see the vital role played by consumers in supplying loanable funds through savings to the money and capital markets. To learn about the important role consumers play as major borrowers of funds and the laws that protect their rights.

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Chapter 21

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  1. Chapter 21 Consumer Lending and Borrowing

  2. To see the vital role played by consumers in supplying loanable funds through savings to the money and capital markets. To learn about the important role consumers play as major borrowers of funds and the laws that protect their rights. To explore the characteristics of consumer lending institutions.  Learning Objectives 

  3. Many financial analysts have referred to the period since World War II as the age of consumer finance. Individuals and families have become the principal source of loanable funds flowing into the financial markets today. They also are one of the largest borrowing groups in the entire financial system. Introduction

  4. Consumers as a group are among the most important lenders of funds in the economy. Loanable funds are supplied by consumers – individuals and families (households) – when they purchase financial assets from other units in the economy. Consumers as Lenders of Funds

  5. Financial Assets Purchased by Consumers 21 - 5

  6. Financial Assets Purchased by Consumers 21 - 6

  7. One of the most important trends affecting consumer savings and lending today is the explosion of new financial instruments. Many of these new instruments offer the consumer greater financial flexibility, as well as the potential for higher rates of return. Recent Innovations inConsumer Savings Instruments

  8. Examples: NOW accounts / share drafts automatic transfer services (ATS) share accounts at money market mutual funds consumer cash management services universal life insurance individual and Keogh Plan retirement accounts Roth and Education IRAs money market and market-index CDs variable-rate annuities and insurance plans Recent Innovations inConsumer Savings Instruments

  9. Consumers as Borrowers of Funds

  10. Consumers as Borrowers of Funds

  11. Is Consumer Borrowing Excessive?

  12. The concept of a household portfolio effect argues that consumers may alter their level of spending until they once again feel comfortable with the balance between their income, financial assets, and liabilities. On the other hand, the wealth effect causes many individuals and families to feel comfortable with heavier debt loads, believing they could sell off their higher-valued assets if trouble appeared on the horizon. Is Consumer Borrowing Excessive?

  13. Financial analysts frequently divide the credit extended to consumers into three broad categories. Residential mortgage credit – used to support the purchase of homes Installment credit – used primarily for long-term nonresidential purposes Noninstallment credit – used for short-term cash needs Categories of Consumer Borrowing

  14. Like traditional home mortgages, a home equity loan is secured by a borrower’s home. Unlike traditional home mortgages however, many home equity loans consist of a revolving credit line that the borrower can draw on for purchases of any goods or services. Home Equity Loans

  15. A credit card permits the consumer to buy now and pay later, while a debit card provides a convenient way of paying now. Convenience users substitute credit cards for cash, while installment users maintain large outstanding credit card balances. A smart card is closely related to the debit card. Credit and Debit Cards

  16. The consumer’s decision about when and how much to borrow is influenced by: the size of the individual or family income and accumulated household wealth the stage in life the business cycle price expectations interest rates The Determinants of Consumer Borrowing

  17. Financial intermediaries – banks, savings and loan associations, credit unions, and finance companies – account for most of the loans made to consumers in the U.S. economy. However, a growing share of consumer loans are being sold off the balance sheets and placed in loan pools (securitization). In recent years, institutions also tend to diversify their lending operations. Consumer Lending Institutions

  18. Consumer Lending Institutions Leading Consumer Lending Institutions in the United States Source: Board of Governors of the Federal Reserve System. *2004 figures are as of first quarter.

  19. Commercial banks approach the consumer by direct lending, through purchases of installment paper from merchants, and by making loans to other consumer lending institutions. Finance companies have a long history of active lending in the consumer installment field, both directly and indirectly. Consumer Lending Institutions

  20. Savings and loans and savings banks have long been dominant in residential mortgage lending, though they are also aggressively expanding their portfolios. The so-called “fringe banks” (such as “check-cashing” companies, “title loan” companies, “payday lenders,” “pawn shops,” and “rent to own” shops) lend primarily to distressed borrowers. Consumer Lending Institutions

  21. Consumer loans usually carry greater risk than most other kinds of loans, although they also tend to be more profitable. Hence, most loan officers carefully consider the ratio of household debt to gross income the duration of employment of the borrower the past payment record (credit integrity) ownership of valuable properties the number of breadwinners in the family Factors Considered in Making Consumer Loans

  22. Today, credit scoring techniques are used for a wide variety of loans and other financial services. Advanced statistical techniques are employed to assemble information about applicants for consumer loans, analyze the information gathered, and develop a numerical score. Using that score, lenders can make a decision as to whether a borrower has scored high enough to qualify for a loan. Credit Scoring Techniques

  23. Important new laws have been designed in recent years to protect consumers in their dealings with lending institutions, especially with respect to financial disclosure. Consumer Credit Protection Act (1968) (Truth in Lending) Fair Credit Reporting Act (1970) Fair Credit Billing Act (1974) Consumer Leasing Act (1976) Financial Disclosure and Consumer Credit

  24. Competitive Banking Equality Act (1987) Fair Credit and Charge Card Disclosure Act (1988) Truth in Savings Act (1991) Financial Services Modernization (Gramm-Leach-Bliley) Act (1999) The Financial Services Modernization Act was passed, in part, to create tougher laws to deal with identity theft. Financial Disclosure and Consumer Credit

  25. The civil rights movement has had an impact on the granting of consumer loans. Equal Credit Opportunity Act (1974, amended 1976) Fair Housing Act (1968) Home Mortgage Disclosure Act (1975) Community Reinvestment Act (1977) Financial Institutions Reform, Recovery, and Enforcement Act (1989) Credit Discrimination Laws

  26. The right to declare bankruptcy is designed to give individuals and businesses a fresh start, helping them to work themselves out from under a crippling burden of debt. Consumer Bankruptcy Laws

  27. Consumers filing for bankruptcy primarily use one of two methods. Filing for bankruptcy under Chapter 7 normally completely discharges all of a household’s unsecured debts. A Chapter 13 bankruptcy filing usually sets in motion a new debt repayment plan to work gradually out of the debts owed. Consumer Bankruptcy Laws

  28. In view of the soaring number of bankruptcy filings and in an effort to lower the cost of consumer credit for most borrowers, proposals have been made to make bankruptcy a more costly process and to encourage the development of more financial education courses for consumers. Consumer Bankruptcy Laws

  29. Consumer Information Center at www.consumer.gov Equifax Credit Bureau at www.equifax.com Experian Credit Bureau at www.experian.com Federal Deposit Insurance Corporation at www.fdic.gov Federal Reserve Board at www.federalreserve.gov Markets on the Net

  30. Federal Trade Commission at www.ftc.gov FICO Scores and Reports at www.myfico.com Identity Theft Clearinghouse at rn.ftc.gov/dod/widtpubl$.startup?Z-ORG-CODE=PU03 National Endowment for Financial Education at www.nefe.org Transunion Credit Bureau at www.transunion.com Markets on the Net

  31. Introduction to Consumer Lending and Borrowing Consumers as Lenders of Funds Financial Assets Purchased by Consumers Recent Innovations in Consumer Savings Instruments Consumers as Borrowers of Funds Is Consumer Borrowing Excessive? Categories of Consumer Borrowing Chapter Review

  32. Home Equity Loans Credit and Debit Cards The Determinants of Consumer Borrowing Consumer Lending Institutions Commercial Banks Finance Companies Other Consumer Lending Institutions Chapter Review

  33. Factors Considered in Making Consumer Loans Credit Scoring Techniques Financial Disclosure and Consumer Credit Credit Discrimination Laws Consumer Bankruptcy Laws Chapter Review

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