6 BANK LOANS
6.1 Consumer Loans
6.2 Granting and Analyzing Credit
6.3 Cost of Credit
6.4 Credit and the Law
6.5 Bank Loans and Policy
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Lesson 6.1
CONSUMER LOANS
GOALS
Define major terms associated with
consumer lending
Explain the difference between installment
loans and open-end loans
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INSTALLMENT LOANS
Fixed amount
Fixed interest
Fixed period of payback
Fixed number of payments
Legal contract of both parties
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INSTALLMENT LOANS
Personal loans
No Specific purpose needed
Automobile loans
Most common type of installment loan
Home equity loans
Difference between value of home and what is owed
on first mortgage; It is a second mortgage
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INSTALLMENT LOANS
Education loans
Stafford loans for students and PLUS loans for
parents MAY be backed by government
Low interest
Usually do not have to be paid back until after
graduation
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SECURED AND UNSECURED LOANS
A secured loan is one in which some item of
value backs the loan in case the borrower
defaults on the loan.
The item that secures the loan is called collateral.
A lien is a legal claim to property to secure a debt.
An unsecured loan is a loan backed only by the
reputation and creditworthiness of the borrower.
Unsecured loans are sometimes called signature
loans.
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LENDING TERMINOLOGY
Principal is the amount borrowed.
Interest is the amount you pay to use the principal.
Most installment loans have FIXED rates
Variable rates: change over time
Indexed rates: linked to some other rate, FED’s prime
rate + some other figure
Very important to know HOW interest is calculated
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LENDING TERMINOLOGY
Fees are other charges for the loan.
Application fee, document preparation fee, etc
The finance charge is the total dollar amount to
be paid for the loan.
Includes all interest calculation, fees and other costs
Total payments is the total amount a consumer
must repay.
Includes principal and total finance charges
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LENDING TERMINOLOGY
Payment is the amount the borrower repays
each specified period.
Acceleration clause may bring entire loan due
because of missed or late payments
Missed payments may also be cause for variable
interest to increase
Balloon payment—WATCH OUT!
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OPEN-END LOANS
Amount owed is flexible with no set pay-off date
Credit cards
Principal goes up and down as does the interest paid
Grace period
Some have annual fees
Lines of credit
Home equity reserve
May draw on them as needed
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Lesson 6.2
GRANTING AND
ANALYZING CREDIT
GOALS
List steps in the credit-approval process
Identify major criteria in a person’s credit
rating
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RISK MANAGEMENT
Risk management for bankers is the practice of
minimizing financial loss through effective policies.
Banks face risks in operations, credit, liquidity,
legal and regulatory compliance, and even
marketing matters.
Risk management policies include consideration of
the bank’s overall financial position, reserve
requirements, cash flow, and ratio analyses of
liabilities and assets.
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CREDIT-APPROVAL PROCESS
Application
Documentation-proof of employment, etc
Processing: file is created on you; verification
Underwriting: review…approve or decline
Collateral
Capacity
Credit reputation
Closing
Funding
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ANALYZING CREDIT
Consumer reporting agencies
Credit-scoring systems
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CONSUMER REPORTING AGENCIES
A consumer reporting agency (CRA) is a company that
compiles and keeps records on consumer payment
habits and sells these reports to banks and other
companies to use for evaluation creditworthiness.
Consumer reporting agencies are sometimes called
credit bureaus.
The three largest CRAs
Equifax
Experian (formerly TRW)
TransUnion
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CREDIT REPORTS INCLUDE
Personal data
Accounts history
Delinquent accounts
Public records
Inquiries
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CREDIT-SCORING SYSTEMS
A credit-scoring system can provide an efficient
and unbiased method of evaluating credit.
These scores place a numerical value on the
performance or status of an applicant in various
categories.
Slide 17 Copyright South-Western, a division of Thomson, Inc.
FICO
The FICO credit-scoring system developed by
Fair, Isaac and Company, Inc. has become the
dominant credit-scoring system.
The FICO score is a three-digit number that
credit granters can use in making a loan
approval decision.
Slide 18 Copyright South-Western, a division of Thomson, Inc.
FICO CRITERIA
Payment history (approximately 35 percent)
Amounts owed (approximately 30 percent)
Length of credit history (approximately 15 percent)
New credit (approximately 10 percent)
Types of credit (approximately 10 percent)
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Lesson 6.3
COST OF CREDIT
GOALS
Identify key factors in the cost of credit
Explain the impact of negative credit
ratings on consumers
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WHAT CREDIT COSTS
Annual percentage rate
Amount of interest charged on loan—yearly figure
Figured many different ways
Minimum payments
Term
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REVIEWING APR AND FINANCE CHARGE
The APR is a key aspect of comparing credit costs.
Sum-of-digits method
Takes total finance charge, divides it by number of
payments in the term then applies higher ratio of
interest to early payments
Typical with mortgages
example: 12 month loan. Adding digits 1 -12 will
total 78. First month 12/78 of interest is figured into
payment, second month, 11/78 of interest figured
Slide 22 Copyright South-Western, a division of Thomson, Inc.
REVIEWING APR AND FINANCE CHARGE
Previous balance method
Lenders take the amount owed at the beginning of
the billing cycle and calculate interest on that figure
Regardless of payments or charges
Adjusted balance method
When payments made during billing cycle are
subtracted, and new purchases do not count
Slide 23 Copyright South-Western, a division of Thomson, Inc.
REVIEWING APR AND FINANCE CHARGE
Average daily balance method
Most common method
Balances for each day of the billing cycle are added
together then divided by the number of days in the
cycle
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MINIMUM PAYMENTS
Most credit cards require a minimum payment
every month.
Minimum payments are usually 2 to 5 percent of
the unpaid balance.
Paying the minimum payment keeps the account
in good standing, but it does not reduce the
principal much.
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TREND TOWARD LOWER MINIMUM PAYMENTS
Increases bank profits
Contributes to greater consumer debt
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TERM
For installment loans, length of term also affects
the total finance charge.
Repaying the loan over a longer period
reduces the monthly payment
Increases interest rate
increases the total payment for the loan
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COMPARING LOANS
Loan amount: $6,000
Creditor A Creditor B Creditor C
APR 14% 14% 15%
Length of Loan 3 years 4 years 4 years
Monthly Payment $205.07 $163.96 $166.98
Total Finance Charge $1,382.52 $1,870.08 $2,015.04
Total Payments $7,382.52 $7,870.08 $8,015.04
Slide 28 Copyright South-Western, a division of Thomson, Inc.
THE IMPACT OF CREDIT
Overextension
Consumers take on more debt than they can
manage
Consequence: Poor or ruined credit rating
Documentation stays on file for at least 7 years
The role of banks
Credit counseling
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Lesson 6.4
CREDIT AND THE LAW
GOALS
Explain the purpose of consumer
protection laws in lending
Identify important laws associated with
consumer loans
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TRUTH IN LENDING
The Truth in Lending Act (TILA), Title I of the
Consumer Credit Protection Act of 1968
guarantees that all information about costs of a
loan is provided in writing to consumers.
Items that must be disclosed include the following:
Total sales price Schedule of payments
Amount financed Prepayment policies
Annual percentage rate Late payment policies
Variable rate information Security interest
Total payments
Slide 31 Copyright South-Western, a division of Thomson, Inc.
EQUAL CREDIT OPPORTUNITY ACT
The Equal Credit Opportunity Act (ECOA) prohibits
the use of race, color, religion, national origin,
marital status, age, receipt of public assistance, or
exercise of any consumer right against a lender as
a factor in determining creditworthiness.
Reason for denial must be supplied upon request.
Slide 32 Copyright South-Western, a division of Thomson, Inc.
FAIR CREDIT REPORTING ACT
The Fair Credit Reporting Act (FCRA) aims to
protect the information that credit bureaus, medical
information companies, and tenant screening
services may collect.
Slide 33 Copyright South-Western, a division of Thomson, Inc.
FAIR CREDIT REPORTING ACT
Consumers must be told what is in their file
If information has been used against them
Consumers can dispute inaccuracies—agency
MUST investigate disputes within 30 days
CRAs cannot report information older than 7
years (10 in the case of bankruptcy)
Limits access to consumer files
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FAIR CREDIT REPORTING ACT
Consumers must authorize release of credit
report to employers or any report that includes
medical information
Consumers can exclude themselves from credit-
bureau lists that are sold for unsolicited offers
Consumers can seek damages for violations of
the law
Slide 35 Copyright South-Western, a division of Thomson, Inc.
FAIR DEBT COLLECTION PRACTICES ACT
The Fair Debt Collection Practices Act (FDCPA)
protects consumers from unfair collection
techniques.
Collectors cannot:
Use deceptive or abusive techniques
Cannot call at odd hours
Harass, threaten you with legal action (unless it is
actually going to happen)
Reveal debt or collection actions to others such as
employers
Slide 36 Copyright South-Western, a division of Thomson, Inc.
FAIR CREDIT BILLING ACT
Is an amendment of TILA
Specifies fair procedures for resolving billing
disputes
Prevents creditors from taking adverse action
until the dispute is resolved
Slide 37 Copyright South-Western, a division of Thomson, Inc.
FAIR CREDIT AND CHARGE CARD DISCLOSURE ACT
Is an amendment of TILA
Requires credit and charge card issuers to
provide information about open-end credit in
direct mail or telephone solicitations
Slide 38 Copyright South-Western, a division of Thomson, Inc.
HOME EQUITY LOAN CONSUMER PROTECTION ACT
Is an amendment of TILA
Requires lenders to make appropriate
disclosures about open-end loans that are
secured by homes
Places limitations on such plans
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CREDIT REPAIR ORGANIZATION ACT
Prohibits credit repair companies from misleading
consumers about their services and costs
Requires agreements to be in writing
Slide 40 Copyright South-Western, a division of Thomson, Inc.
GRAMM-LEACH-BLILEY ACT
Compels banks and other financial institutions to
protect the privacy of consumers
Institutions MUST have written policies and allow
consumers to ―opt out‖ if they choose
Slide 41 Copyright South-Western, a division of Thomson, Inc.
COMPLIANCE
Authority for enforcing consumer protection acts
varies with the individual law and the
government agency associated with it.
Federal statutes are enforced by
Federal Reserve
Federal Deposit Insurance Corporation (FDIC)
Federal Trade Commission (FTC)
Courts
Examiners conduct audits to test compliance.
Slide 42 Copyright South-Western, a division of Thomson, Inc.
Assignment
Page 165: Checkpoint (be able to explain each)
Page 166: Checkpoint (be able to explain each)
Page 167: Think Critically 1 – 4
Slide 43 Copyright South-Western, a division of Thomson, Inc.
Lesson 6.5
BANK LOANS
AND POLICY
GOALS
Explain how loans affect a bank’s income
Describe the purpose of a bank’s loan
policy committee
Slide 44 Copyright South-Western, a division of Thomson, Inc.
LOANS AND INCOME
Loans have a direct impact on a bank’s income,
because the interest charged is its major income
source.
Approving questionable loans could lead to
default, or failure to repay a loan, and, in turn, to
lower income.
A bank’s income depends on how well it
manages its loans.
Slide 45 Copyright South-Western, a division of Thomson, Inc.
LOANS AND LIQUIDITY
Liquidity means having the funds to meet a
bank’s obligations when required.
Loan term
Interest rate
Loan type
Collateral
Liquidity risk refers to the risk that a bank will
have to sell its assets at a loss to meet its cash
demands.
Slide 46 Copyright South-Western, a division of Thomson, Inc.
CREDIT AND MARKET RISK
Credit Risk—the bank’s estimate of the
probability that the borrower can and will repay a
loan with interest as scheduled.
Market Risk—the risk that an investment will
decrease in price as market conditions change.
Slide 47 Copyright South-Western, a division of Thomson, Inc.
LOAN DECISIONS AND TRADE-OFFS
Knowing how to analyze the loan term, interest
rate, as well as other factors, helps determine
the profit a bank can make from its loans.
Slide 48 Copyright South-Western, a division of Thomson, Inc.
LOAN POLICY COMMITTEE
All banks must have a lending policy, a written
statement of the guidelines and standards to
follow in making credit decisions.
A bank’s board of directors through membership
on its loan policy committee sets its lending
policy.
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EXAMPLES OF LENDING POLICY
Minimum credit standards for new loans
Process used to check applicants’ credit history
Documents required as part of the application
Interest rate for various loan types and risk
Bank’s loan mix
Treatment of past-due and delinquent loans
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COMMUNITY REINVESTMENT ACT (CRA)
The Community Reinvestment Act (CRA) is the
federal law requiring banks to meet the credit
needs of the entire communities they serve.
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