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Chapter 7

Chapter 7. Learning Objectives (part 1 of 3). Describe the different types of installment loans Compute the monthly payment for an installment loan Explain why a monthly payment is not one-twelfth of an annual payment

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Chapter 7

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  1. Chapter 7

  2. Learning Objectives (part 1 of 3) • Describe the different types of installment loans • Compute the monthly payment for an installment loan • Explain why a monthly payment is not one-twelfth of an annual payment • Construct a loan amortization table and explain the two reasons why it is important

  3. Learning Objectives (part 2 of 3) • Show the impact on the amortization table of adding extra principal to a payment • Explain how an add-on rate loan works • Construct an amortization table for an add-on rate loan • Identify the lenders who most commonly provide installment loans

  4. Learning Objectives (part 3 of 3) • Evaluate whether it is better to take out an auto loan or a home equity loan to buy an auto • Discuss what happens when you default on a loan with collateral • List the protections a consumer has from a debt collector • Discuss the two primary chapters for declaring bankruptcy: 7 and 13 • Describe how bankruptcy works under each chapter

  5. Types of Installment Loans • Auto Loan • New or Used • Home Improvement Loan • Marine loan • Signature • Secured Personal Loan • Household goods • Certificate of Deposit

  6. Computation of Monthly Payment • Payment x PVIFA = Loan Amount • Payment = the payment made each period • PVIFA = the present value interest factor for the annuity based on the number of payments and the interest rate of the loan • Loan Amount = Amount initially borrowed • Payment = Loan Amount / PVIFA

  7. Example #1 (annual payments) Andy wants to take out a $10,000 home improvement loan. His local bank indicates he can have a five-year loan at an 8 percent interest rate with annual payments. What would his annual payment be? Answer: $10,000 / 3.9927 = $2,504.56

  8. Example #2 (annual payments) Andy wants to take out a $10,000 home improvement loan. His local bank indicates he can have a five-year loan at an 8 percent interest rate with monthly payments. What would his monthly payment be? Answer: $10,000 / 49.3169 = $202.77

  9. Relationship of monthly payment to annual payment Monthly payment is less than one-twelth the annual payment because the monthly payment allows a faster pay down of principal, which allows lower interest charges over time.

  10. Loan Amortization Table • Two reasons why it is important • Indicates how much would be owed if loan were paid off at any point in time (lenders occasionally miscalculate this number) • Indicates how much of each payment is interest, in case the interest on the loan is tax deductible.

  11. Example of a Loan Amortization Table Loan = $1,000, Term = 12 months Interest Rate = 12 percent Mo. Beginning PMT Interest Repay. End # of Month of Prin. Of Month 1 $1,000.00 $88.85 $10.00 $78.85 $921.15 2 $921.15 $88.85 $9.21 $79.64 $841.5 3 $841.51 $88.85 $8.42 $80.43 $761.08

  12. Impact of Adding Money to a Payment Loan terms same as previous example Add $100 to first payment Mo. Beginning PMT Interest Repay. End # of Month of Prin. Of Month 1 $1,000.00 $188.85 $10.00 $178.85 $821.15 2 $821.15 $88.85 $8.21 $80.64 $741.51 3 $741.51 $88.85 $7.41 $81.44 $659.07

  13. How an add-on rate loan works • Total Interest Due = Amount Borrowed x add-on rate x Maturity in Years • Monthly Payment = (Amount Borrowed + Interest) / Maturity in months • Amortization of interest based on Rule of 78

  14. Example $1,000 at 6% add-on rate for one year • Interest = $1,000 x .06 x 1 year = $60 • Monthly payment = ($1,000 + $60) / 12 months = $88.33

  15. Amortization Table Mo. Beginning PMT Interest Repay. End # of Month of Prin. Of Month 1 $1,000.00 $88.33 $9.23 $79.10 $920.90 2 $920.90 $88.33 $8.46 $79.87 $841.03 3 $841.03 $88.33 $7.69 $80.64 $760.39

  16. Lenders of Installment Loans • Commercial banks • Mutual Savings banks • Savings & Loans • Credit Unions • Consumer Finance Company

  17. Auto Loan vs. Home Equity Loan to buy an auto • Higher fees for a home equity loan • Interest deductible on home equity loan • With auto loan, loan is due if auto sold • If pay off loan early enough, auto loan may be cheaper despite non-deductibility of interest • With home loan, lose home if default

  18. Loan defaults • Always better to try to work out an adjustment directly with lender • After default, lender may seize property pledged as collateral • If collateral sold, borrower still owes if sale net proceeds are insufficient to cover the principal due

  19. Protections from a debt collector Defined by the Fair Debt Collection Practices Act • Contact only between 8 am and 9 pm • No contact at work if know employer disapproves • May not harass, oppress, or abuse, and may not lie

  20. Declaring Bankruptcy • Chapter 7 • Liquidation chapter • Chapter 13 • Reorganization chapter

  21. Chapter 7 Bankruptcy • Exempt & Nonexempt property • Nonexempt is sold & proceeds turned over to creditors • All debt that can be discharged is so done, • Stays on record for 10 years

  22. Chapter 13 bankruptcy • Can use only if owe less than • $250,000 in unsecured debt • $750,000 in secured debt • Works like a court imposed debt consolidation loan • Stays on record for 7 years • No mercy shown if fail to make promised payments

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