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Consumer Finance

Prepared by
Prof. Rahul Mailcontractor
Assistant Professor,
KLSs Institute of Management Education and Research,
Belgaum

Definition
The term consumer finance refers to the activities
involved in granting credit to consumers to enable
them to possess goods meant for everyday use.
Business procedure through which the consumers
purchase semi durable and durable goods other than
real estate in order to obtain a series of payments
extending over a period of 3 months to 5 yrs.

Types of Consumer Credit


Revolving credit: it is a ongoing credit
arrangement where by the financier on a
revolving basis grants credit. The consumer is
entitled to avail credit to the extent sanctioned as
credit limit ex: Credit Card
Fixed credit: it is like a term loan where by the
financier provides loans for a fixed period of time.
The credit has to be repaid within a stipulated
period ex: monthly installment loan, hire
purchase.

Cash Loan: Under this type of credit banks and


financial institutions provide money with which the
consumers buy goods for personal consumption here
the lender and seller are different and lender does
not have the responsibility of seller.
Secured Finance: when the credit granted by
financial institutions is secured by collateral it takes
the form of secured finance. The collateral is taken
by the creditor in order to satisfy the debt in the even
of default by the borrower. The collateral may be in
the form of personal property, real property or liquid
assets.
Unsecured Finance: When there is no security
offered by the consumer against which money is
granted by financial institutions, it is called
unsecured finance.

Sources of Consumer Finance


Traders : The predominant agencies that are
involved in consumer finance are traders. They
include sales finance companies, hire purchase
and other such financial institutions.
Commercial Banks: Commercial Banks provide
finance for consumer durables. Banks lend large
sum of money at wholesale rate to commercial or
sales finance companies, hire purchase concerns
and other such finance companies. Banks also
provide consumers personal loans meant for
purchasing consumer durable goods.

Credit Card Institutions: These institutions arrange for


credit purchase of consumer goods through respective
banks which issue the credit cards. The credit card
system enables a person to buy credit card services on
credit. On presentation of credit card by the buyer, the
seller prepares 3 copies of the sales voucher, one for
seller, bank/credit card company and 3rd for the buyer.
The seller forwards a copy to the bank for collection.
The sellers bank forwards all such bills to the card
issuing bank or company. The bank debits the amount
to the customers account. The buyer receives monthly
statement from the card issuing bank or company and
the amount is to be paid within a period of 20 to 45
days without any additional charges.

(NBFCs):Non banking Financial companies


constitute an important source of consumer
finance. Consumer finance companies also known
as small loan companies or personal finance
companies are non saving institutions whose
prime assets constitute sale finance receivables,
personal cash loans, short and medium term
receivables. These companies charge substantially
higher rate of interest than the market rates.
Credit Unions: A credit union is an association of
people who agree to save their money together and
in turn provide loans to each other at a relatively
lower rate of interest. These are caller co-operative
credit societies. They are non profit deposit taking
and low cost credit institutions.

Mode of Consumer Finance


Open Account: any number of purchases per
month up to a certain value
Credit card: most popular mode of finance
Revolving account: purchases during a month
and payment on installment basis
Option plan: option of paying in full or part
Installment account: Equal periodic
installments
Cash loan : purchases are made through cash
and payment is made periodically.

Demand for consumer finance(Factors)

Increase in consumer disposable income


Enhancement in real income of consumer
Convenient size of installment payment
Growth in nuclear families leading to number
of house holds
Lower charges
Down payment and credit contract

Products covered
Consumers financing covers a wide range of
products such as cars, Televisions, washing
machines, refrigerators, Air conditioners,
computers etc. The products covered possess
some distinct feature such as durability,
sustainability, salability and serviceability etc.

Terms of Finance

Eligibility : The basic eligibility for consumer finance is the income of the
individual customer and the nature of employment. The EMIs are worked
out on the basis of number of installments and tenure of employment of the
customer.
Guarantee: Financiers insist on guarantee for the credit availed by the
customer. Guarantee is obtained in order to ensure prompt payment of the
installment.
Tenure : Consumer finance is granted for short period ranging from 3
months to 5 yrs. The tenure also depends on the value of the asset
purchased. Assets of smaller value are given short term credit and assets of
higher value are given comparatively longer term credit.
Rate of interest : the effective rate of consumer finance is much higher than
the rates applicable to business finance. This is because the loans are
granted based on the personal integrity of the customer. The effective
interest varies between 20% and 30%. Finance companies use different
methods of disclosing interest rates.

Other charges : in addition to rate of interest finance


companies also charge documentation fees, processing fees,
management fees, service charges, collection costs etc. A
deposit is also taken as a precautionary measure to guard
against default in payment of installments.
Mode of payment: in case of individual loans payments are
usually collected in advance in the form of post dated
checks.
In the case of institutional financing there is an arrangement
for deduction of installments from the salary of the
employee which is remitted to the finance company.
Credit evaluation: A verification of details furnished by the
customer is carried out in order to ascertain the validity of
the statement and the credit standing of customer. The
evaluation may be carried out by the financier or an
independent agency details collected include age, monthly
income, status of employment, previous record, assets own,
borrowers equity, type of collateral offered etc.

Pricing of Consumer Finance


The pricing of consumer credit depends on the
extent of facility offered by the financier. The
components of price are risk free rate of
interest assuming no probability of default,
default risk premium, administrative expenses.

Advantages of Consumer
Credit(Finance)
Enjoying position : An important benefit of consumer credit is
that it allows people to enjoy possession of goods without
having to pay for them immediately.
Saving : consumer credit allows for a mechanism of
compulsory saving this induces people to use their income
wisely and promotes thrift among people.
Convenient mode : Consumer credit offers a convenient mode
of acquiring consumer durables.
Meeting emergency : Consumer credit is useful in meeting
emergencies such as illness, accident and death which involve
unexpected expenses.

Maximization of revenues: Consumer credit facilitates


speedy disposal of goods which would have remained
unsold in the absence of credit facility to consumers.
This helps in increased sales and profits through credit
sales.
Accelerates industrial investment: Consumer credit
accelerates investment in consumer durable industry
giving rise to growing level of income and
employment.
Enhanced living standard : consumer credit enables
people of limited means to acquire goods to enhance
their general standard of living.

Promoting Economic development : Consumer credit


promotes higher levels of investment, employment and
income thus raising the effective demand and
promoting higher standard of growth and
development.

Disadvantages of Consumer
Finance
Thoughtless buying : consumer credit being attractive
tempts people to buy goods indiscriminately even if
they are not needed.
Insolvency : Credit forces people to mortgage a
substantial portion of their fixed future income which
may lead to insolvency and bad debts.
Costly Credit : Consumer credit with its benefit of
convenient buying brings with it severe consequence
of costliness of credit because the effective rate of
interest is much higher than on paper.

Risk to traders : Consumer Credit posses considerable


risk to traders because if the buyer defaults on payment
the lender can acquire the good but cannot sell it at the
original price.
Artificial Boom: Consumer credit creates artificial boom
in consumer durable industry.
Bad Debt : Consumer credit generates a substantial
amount of revenue for traders but there is a high risk of
bad debt.
Economic instability: Indiscriminate consumer credit
leads to economic instability because of recurrence of
booms and slumps. In boom there is credit extension
and in recession there is credit tightening.