Chapter 7

Personal Loans

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Chapter Objectives• Provide a background on personal loans

• Calculate the payment and the real cost of borrowing on personal loans

• Describe home equity loans

• Discuss car loans

• Explain how to decide between financing the purchase of a car and leasing a car

• Describe the key features of student loans

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Background on Personal Loans• Usually obtained to finance a large purchase

• Specific repayment schedule

• Sources of Loans

• Chartered banks, finance companies, credit unions, some automobile manufacturers, friends or family members

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Background on Personal Loans (cont’d)

• The Personal Loan Process• Involves filling out the application, negotiating

the interest rate, and negotiating the loan contract

• Application Process

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Background on Personal Loans (cont’d)

• Loan Contract: a contract that specifies the terms of a loan as agreed to by the borrower and the lender

• Amount of the Loan

• Interest Rate

• Loan Repayment Schedule

• Maturity or Term: the life or duration of the loan

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Background on Personal Loans (cont’d)

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Background on Personal Loans (cont’d)

Issue of Security

• Collateral: assets of a borrower that back a loan in the event that the borrower defaults

• Secured loan

• Unsecured loan

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Background on Personal Loans (cont’d)

• Co-signing is sometimes required if credit history is weak

• Payday loan: a short-term loan provided to you if you need funds in advance of receiving your paycheque

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Background on Personal Loans (cont’d)

• Predatory Lending• Beware of illegal lending practices

• Lender charging high loan fees

• Lender provides home equity loan with the expectation of default so he can take ownership

• Lender ties other products to loan approval

• Lender includes balloon payment at end of loan

• Loan agreement includes confusing information

• Shop around for best loan terms

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The Real Cost of Borrowing on Personal Loans

• APR must be converted to an effective interest rate, also known as the effective yield, EY

• Real cost of borrowing must also take into account the payment of additional fees

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The Real Cost of Borrowing on Personal Loans (cont’d)

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Home Equity Loan

• Home equity loan: a loan in which the equity in a home serves as collateral

• Equity of a home: the market value of a home minus the debt owed on the home– Credit Limit on a Home Equity Loan

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Home Equity Loan (cont’d)

• Second mortgage: a secured mortgage loan that is subordinate (or secondary) to another loan

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Home Equity Loan (cont’d)

• Interest Rate

• Typically variable

• Usually tied to a specified interest rate index that changes periodically

• Prime rate: the interest rate a bank charges its best customers

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Home Equity Loan (cont’d)

• Interest-only payments and variable interest rates may create two problems for the borrower

1. Borrower may never get around to paying down the principal of the loan

2. Interest rates may rise to a point where the borrower is no longer able to afford the minimum interest-only payments

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Car Loans• Selecting the Car• Personal Preferences

• Price

• Condition

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Car Loans (cont’d)

• Insurance

• Resale Value

• Repair Expenses

• Financing Rate

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Car Loans (cont’d)

• Negotiating the Price• Some dealers negotiate and some do not

• Sticker price is manufacturer’s suggested retail price (MSRP)

• Negotiating by Phone or Fax• May be beneficial

• Call several dealers

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Car Loans (cont’d)

• Trade-in Tactics• Attempt to negotiate price on new car before

mentioning that you have a trade-in

• The Value of Information• Information is valuable–shop around

• Use consumer magazines or Web sites

• Purchasing a Car Online• Not as efficient as buying an airline ticket or a book

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Financing Decisions (cont’d)

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Purchase versus Lease Decision

• Leasing is a popular alternative to buying a car

• Advantages of leasing

• Disadvantages of leasing

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Purchase versus Lease Decision (cont’d)

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Purchase versus Lease Decision (cont’d)

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Student Loans

• Student loan: a loan provided to finance a portion of a student’s expenses while pursuing post-secondary education

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