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Chapter Eighteen

Consumer Loans, Credit Cards, and Real


Estate Lending
McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
18-2

Consumer
Lending
• Has been among the most popular financial
services offered in recent years
• One of the most important sources of
revenues and deposits for banks and their
competitors (credit unions, savings
associations, and finance and insurance
companies); a source of supplemental
income
• On the other hand, presents a special
challenge due to higher-than-average
default rates.
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Types of Consumer Loans


• Classify Consumer Loans by Purpose – What
the Borrowed Funds are Used For, or by
Type – Whether the Borrower Must Repay in
Installments or in One Lump Sum

• Residential Mortgage Loans


• Nonresidential Loans
▫ Installment Loans
▫ Noninstallment Loans
• Credit Card Loans and Revolving Credit
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Residential Mortgage
Loans

Credit to Finance the Purchase of


Residential Property in the Form of
Houses and Multifamily Dwellings.
This is Usually a Long-Term Loan (15-
30 years) Which is Secured By the
Property Itself. Fixed or Variable Rate
of Interest
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Nonresidential Loans:
Installment
Loans
Short-Term to Medium-Term Loans
Repayable in Two or More Consecutive
Payments, Usually Monthly or
Quarterly. These Are Often Used to
Finance Big Ticket Purchases or
Consolidate Existing Debt
(automobile, furniture, appliances).
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Noninstallment
Loans
Short-Term Loans By Individuals for
Immediate Cash Needs and Repayable
in One Lump Sum When the
Borrower’s Note Matures (charge
accounts, medical care, auto and
home repairs)
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Credit Card Loans


• Credit Cards Offer Holders Access to Either
Installment or Noninstallment Credit.
• Banks Find That the Installment Users of
Credit Cards are the Most Profitable – Provide
Higher Risk-Adjusted Returns Than Other
Types of Loans.
• Card issuers earn income from:
 Cardholders’ annual fees
 Interest on outstanding loan balances
 Discounting the charges that merchants accept on
purchases.
18-8

Debit Cards

Debit Cards Can Be Used To Pay For Goods


And Services, But Not To Extend Credit.
They Are A Convenient Vehicle For Making
Deposits Into And Withdrawals From ATMs
And They Facilitate Check Cashing.
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Characteristics of Consumer
Loans

• Most Costly and Most Risky to Make


Per Dollar
• Cyclically Sensitive
• Interest Inelastic
Evaluating a Consumer
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Application Loan

• Character and Purpose


• Income Levels
• Deposit Balances
• Employment and Residential Stability
• Pyramiding of Debt
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Credit
Bureaus
• Credit Reporting Agencies or Credit Bureaus
Assemble and Distribute to Lenders the
Credit History of Millions of Borrowers
• Information
▫ Personal Identifying Data
▫ Personal Credit Histories
▫ Public Information That May Have Bearing on
Loan
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Credit Scoring

• Credit Scoring Systems are Based on


Sophisticated Statistical Models in Which
Several Variables are Joined to Establish a
Numerical Score to Separate Good Loans From
Bad Loans. The Most Famous of These
is the FICO Scoring System Developed by Fair
Isaac.
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Predatory Lending and


Subprime
Loans

An Abusive Practice Among Some


Lenders That Consists of Granting Loans
to Subprime Borrowers and Charging
Them Excessive Interest Rates and Fees,
Increasing the Risk of Default. Subprime
Lending Played Important Role in the
2007 Credit Crisis.
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Real Estate
Loans
• Among the Riskiest Loans Banks Can Make

• Average Size is Larger Than the Average


Size of Other Loans

• Tend to Have Longer Maturities Than Other


Loans
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Factors Used in Evaluating Real


Loans Estate
• Size of Down Payment Relative to Purchase
Price of Property
• Should Be Evaluated in Terms of Total
Relationship
• Need to Pay Attention to Particular Aspects
of Credit Application:
▫ Amount and Stability of Income (Gross Debt
Service)
▫ Available Savings and Source of Down Payment
▫ Track Record in Maintaining Property
▫ Outlook for Real Estate Market in Local Area
▫ Outlook for Interest Rates If Variable Rate Loan
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Cost-Plus Model of Pricing


Loans

Risk Risk
Lender's
Loan Rate Nonfunding Premium Premium Desired
Cost of
Paid by = + Operating + for + for Time + Profit
Raising
Consumer Costs Customer to Margin
Funds
Default Maturity
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Annual Percentage Rate


(APR)
The APR is the Internal Rate of Return
that Equates Total Payments With the
Amount of the Loan. The Truth in
Lending Act Requires That This Rate
Be Disclosed to Consumers On All
Loans
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Simple
Interest
In Simple Interest the Customer Only Pays
Interest On the Amount of the Principal Left.
First the Declining Loan Balance is Calculated
and That Reduced Balance is Used to Calculate
the Amount of Interest Owed

$3,000 loan at 12% simple interest per year produces $360 in


interest, or a 12 percent effective rate interest (is): =
$3,000(0.12)(1)= $360

$3,360
$3,000 =
(1+is )
is  12%