Chapter 8

Personal Loans

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Chapter Objectives
Provide a background on personal loans
Outline the types of interest rates that are charged on personal loans Describe home equity loans

Discuss car loans

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Chapter Objectives
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
Has a specific repayment schedule Sources of loans
Commercial banks, savings institutions, finance companies, credit unions, some automobile manufacturers, friends, or family members
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Background on Personal Loans

The personal loan process
Application process
Personal balance sheet

Personal cash flow statement

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
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Background on Personal Loans

Loan repayment schedule
Amortize: to repay the principal of a loan through a series of equal payments Each payment includes part of the principal and part of the interest

Maturity: the life or duration of the loan

Longer maturity equals lower payments, but more interest is paid over the life of the loan

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Background on Personal Loans

Collateral: assets of a borrower that back a secured loan in the event that the borrower defaults
Secured loan: a loan that is backed or secured by collateral which could be repossessed if the lender defaulted on the loan Unsecured loan: a loan that is not backed by collateral

Cosigning is sometimes required if credit history is weak

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Background on Personal Loans

Exhibit 8.1: An Example of a Loan Application

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Financial Planning Online: Loan Request Online

Go to: http://www.lendingtree.com
This Web site provides a set of questions that you can answer to specify the type of loan that you desire. You will then receive up to four loan offers from various financial institutions within the next business day.
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Background on Personal Loans

Focus on Ethics: 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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Interest Rates on Personal Loans

Annual percentage rate (APR): a rate that measures the finance expenses (including interest and other expenses) on a loan on an annualized basis
Add-on interest method: a method of determining the monthly payment on a loan
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Interest on Personal Loans

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Interest Rates on Personal Loans

Simple interest: interest on a loan computed as a percentage of the existing loan amount (or principal)
Size of payment depends on size of loan, interest rate and maturity
The higher the interest rate, the higher the payment The longer the maturity, the lower the payment
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Interest Rates on Personal Loans

Exhibit 8.3: Example of a Loan Repayment Schedule

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Home Equity Loan

Home equity loan: a loan where the equity in a home serves as collateral for the loan
Equity of a home: the market value of a home minus the debt owed on the home Credit limit on a home equity loan
Limit based on equity invested

Financial institutions usually loan up to 80% of the equity in a home

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Home Equity Loan

Interest rate is typically variable
Rate is usually tied to an interest rate index and adjusted periodically

Interest on most home equity loans is tax deductible

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Financial Planning Online: Applying for a Home Equity Loan

Go to: http://www.bloomberg.com
Click on: Mortgage Calculator, then Online Home Equity This Web site provides access to home equity loan applications.

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Car Loans
Selecting the car things to consider
Personal preferences Price Insurance Resale value Repair expenses Financing rate
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Car Loans
Negotiating the price
Negotiating by phone may be beneficial Trade-in tactics can be misleading No-haggle dealers can save time and stress Information is valuable shop around Purchasing a car online is possible, but not yet a streamlined process
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Car Loans
Financing decisions
Estimate dollar amount of monthly payment you can afford before shopping

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Financial Planning Online: Prices of New Cars

Go to: http://autos.yahoo.com/
Click on: New Car Guide under New Cars heading This Web site provides estimates of what you should pay for any new car, based on the cars features and options that you specify.
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Car Loans

Exhibit 8.4: Stephanie Spratts Car Analysis

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Car Loans

Exhibit 8.5: Stephanies Possible Monthly Loan Payments

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Financial Planning Online: Trade-In and Retail Value of Used Cars

Go to: http://www.kbb.com
This Web site provides trade-in and retail values for a used car, based on the condition of the car, its age, and other characteristics that you specify.

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Financial Planning Online: Car Loan Interest Rate Quotation

Go to: http://autos.yahoo.com/buy.html
Click on: Car Financing, then Get An Auto Loan This Web site provides a car loan interest rate quotation based on your desired car, the amount you need to borrow, and the term of the loan.
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Financial Planning Online: Prevailing Car Loan Interest Rates

Go to: http://biz.yahoo.com/b/r/a.html
This Web site provides average car loan interest rates across the United States and in various states, which provide a useful benchmark for you to consider before obtaining a car loan.

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Financial Planning Online: What Is the Optimal Loan Maturity?

Go to: http://www.financenter.com/products/ sellingtools/calculators Click on: Auto, then What term of loan should I choose?
This Web site provides a comparison of what your car loan payments will be based on loan maturity.
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Purchase versus Lease Decision

Leasing is a popular alternative to buying a car
Advantages of leasing
Lower down payment Just return the car at the end of the lease period

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Purchase versus Lease Decision

Disadvantages of leasing
You build no equity in the car You are still responsible for maintenance and damages Additional charges may be imposed
Too many miles Ending the lease before the specified period

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Financial Planning Online: Should You Lease or Buy?

Go to: http://www.bloomberg.com
Click on: Tools, then Lease/Buy calculator This Web site provides a comparison of the cost of leasing versus purchasing a car.

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Purchase versus Lease Decision

Exhibit 8.6: Stephanies Comparison of the Cost of Purchasing versus Leasing

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Purchase versus Lease Decision

Exhibit 8.6: Stephanies Comparison of the Cost of Purchasing versus Leasing

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Student Loans
Student loan: a loan provided to finance part of the expenses a student incurs while pursuing a degree Loan may be provided to either the student or the students parents
Repayment typically deferred until student is out of school Interest may be tax deductible
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How Personal Loans Fit within Your Financial Plan

Key personal loan decisions for your financial plan are:
How much money can you afford to borrow on a personal loan? If you obtain a personal loan, should you pay it off early?

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Integrating the Key Concepts

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Integrating the Key Concepts

Part 1: Financial Planning Tools
Part 2: Liquidity Management Part 3: Financing
In Chapter 8 we learned about personal loans Chapter 9 teaches about purchasing and financing a home

Part 4: Protecting Your Wealth

Part 5: Investing
Part 6: Retirement and Estate Planning
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