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FIN 200: Personal Finance
Topic 10-Personal LoansLawrence Schrenk, Instructor
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Learning Objectives
1. Explain the features of personal loans. ▪
2. Explain and calculate interest rates and payments.
3. Describe home equity loans.
4. Describe car loans.
5. Decide between owning and leasing a car.▪
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The Feature of a Personal Loan
Amount Interest Rate Repayment Schedule
Amortized (Equal Payments) Maturity Collateral
Secured versus Unsecured
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Some (Possibly) Misleading Rates
‘Note Rate’ or ‘Headline Rate’ Rate often quoted in advertisement May not include all fees May underestimate costs of borrowing
Monthly Rate Not in annual terms ‘Annualizing’ Makes comparisons difficult
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Common Interest Rates
Annual Percentage Rate (APR) Simple Interest Add-On Interest
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Annual Percentage Rate (APR)
Standardized Loan Rate Inclusive of (Most) Fees Legally Defined–Truth in Lending Act (1969) Required Declaration Some Flaws
May not include all costs of borrowing Simple interest Different methods of calculation
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The APR Calculation
APR = Average Finance Expense divided by Principal
Example: $500 finance expense on a loan of $6,000
Calculator (Downloadable from OCC)
$500APR = = 0.08 or 8%
$6,000
Average Annual Finance ExpenseAPR =
Average Balance
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Simple Interest
Interest as a percentage of the remaining balance
No interest on interest, i.e., compounding Fee not included No time value of money
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Simple Interest Calculation
Simple Interest Payment
Monthly payment with annual simple interest of 11% on a balance of $10,000.
11%Simple Interest Payment = × $10,000 = $91.67
12
Annual Simple InterestSimple Interest Payment = × Balance
Periods in Year
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Amortization Table
YearTotal
PaymentInterest Payment
Principal Payment Balance
1 $1,806.02 $1,100.00 $706.02 $10,000.002 $1,806.02 $1,022.34 $783.68 $9,293.983 $1,806.02 $936.13 $869.88 $8,510.304 $1,806.02 $840.45 $965.57 $7,640.425 $1,806.02 $734.23 $1,071.78 $6,674.856 $1,806.02 $616.34 $1,189.68 $5,603.077 $1,806.02 $485.47 $1,320.54 $4,413.398 $1,806.02 $340.21 $1,465.80 $3,092.859 $1,806.02 $178.97 $1,627.04 $1,627.0410 $1,806.02 $0.00 $1,806.02 $0.00
Loan of $10,000 for 10 years at 11%
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Graph of Amortization Table
Amoritization Graph
$0.00
$500.00
$1,000.00
$1,500.00
$2,000.00
1 2 3 4 5 6 7 8 9 10
Years
Val
ue Principal Payment
Interest Payment
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Add-On Interest
Total of interest and principle divided by payments
Higher payments than simple interest Interest payment constant (not reduced)
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Add-On Interest
Example: Loan of $10,000 for 10 years at 11%
Add-On Interest Calculation
Total Interest + PrincipalAnnual Payment =
Total Payments
$10,000 11% + $10,000Annual Payment = $1,110.00
10
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The Home Equity Loan
‘Second Mortgage’ ‘Home Equity Line of Credit’ (HELOC) Revolving Line of Credit Financing charges only on balance (not total
one of credit) Variable Interest Rate
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Equity Value and Credit Limit
Equity value is market value minus the remaining (first) mortgage balance
No Liquidity Collateral for a home equity loan Credit limit: Keep both mortgages to less
than 80% of house value
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The Home Equity Loan:Pros and Cons Pros
Lower Interest Rate But higher than original mortgage Home Equity Loan Rates
Tax Advantages Flexibility
Payouts: Electronic, Checks, ATM, etc. Payments: Amortized, Interest Only, etc.
Con You risk losing your home!
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The Home Equity Loan: Taxes
A home equity loan (like an original mortgage) is not a ‘consumer loan’.
Consumer Loan: Student Loan, Credit Card Debt, Car Loan
The interest can be deducted from federal and state income taxes, if...
1. Under maximum ($100,000) for ‘home equity indebtedness’
2. ‘Home equity indebtedness’ is less than fair market value.
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The Car Loan
Consumer Loan Car as Collateral Installment Loan Web Resources
Consumer Reports Auto Safety/Crash Tests
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Car Selections: Financial Considerations New or Used Price: Blue Book Yahoo Condition Insurance Maintenance (including gasoline) Resale Value Interest Rate Auto Interest Rates Further Suggestions
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Loan Features
Down Payment Trade In
Interest Rate Maturity The Monthly Payment
Money financed minus down payment, etc. Prior loan or lease balances transferred Sales tax Other items, e.g., service contracts.
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Finding Financing
Personal Savings/Investments Bank/Credit Union/Internet/AAA
Car Loan Home Equity Loan
Finance Company Dealership
Rebate versus Below-Market Interest Rate Calculator (Bankrate.com)
Pre-Approved Loan
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Lease versus Own
Own Equity Value (Part of Net Worth)
Lease No Resale Issues, but No ‘Terminal Value’ Extra Fees Lower Monthly Payment
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Ethical Dilemma
As a result, Fritz and Helga are having difficulty paying their bills. Several months ago they began using a local payday loan company to pay their bills on time. And now they are no longer able to borrow because the repayment plus interest would have exceeded their paychecks. Fritz and Helga have had their cars repossessed, their home foreclosed on, and they are preparing to file for bankruptcy. a. Is the payday loan company being ethical in continuing to
loan more and more to Fritz and Helga each week? b. What could Fritz and Helga have done to avoid ultimate
financial ruin?
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