CHAPTER SEVENTEENConsumer Loans, Credit Cards, And Real Estate

Lending

To learn about the many types of loans lenders make to consumers(individuals and families) and to real estate borrowers and to understand the factors that influence the profitability and risk of consumer and real estate loans. In addition, the chapter examines how consumer and real estate loan rates may be determined and the options a loan officer has today in pricing loans extended to individuals and families.

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Types of Consumer Loans

Residential Mortgage Loans

Nonresidential LoansInstallment Loans

Noninstallment Loans

Credit Card Loans

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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 Which is Secured By the Property Itself

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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.

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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

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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. Banks Also Earn Discount Fees From Merchants on Credit Cards.

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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

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Evaluating a Consumer Loan Application

Character and Purpose

Income Levels

Deposit Balances

Employment and Residential Stability

Pyramiding of Debt

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Credit Scoring

Credit Scoring Systems are Based on Discriminant or Logit Models (Statistical Techniques) in Which Several Variables are Joined to Establish a Numerical Score to Separate Good Loans From Bad Loans

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Laws and Regulations Applying to Consumer Loans

Truth in Lending Act

Fair Credit Reporting Act

Fair Credit Billing Act

Fair Debt Collection Practices Act

Equal Credit Opportunity Act

Community Reinvestment Act

Home Ownership and Equity Protection Act

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Predatory Lending

An Abusive Practice Among Some Lenders That Consists of Granting Loans to Weak Borrowers and Charging Them Excessive Interest Rates and Fees, Increasing the Risk of Default

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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 Estate Loans

Size of Down Payment Relative to Purchase Price of PropertyShould Be Evaluated in Terms of Total RelationshipDeposit Stability is a Key FactorAmount and Stability of IncomeAvailable Savings and Where Down Payment Comes FromTrack Record in Maintaining PropertyOutlook for Real Estate Market in Local AreaOutlook for Interest Rates If Variable Rate Loan

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Home Equity Lending

Home Owners Can Use the Difference in Home’s Estimated Value and Remaining Mortgages as a Borrowing BaseTwo Types of Credit

Closed End CreditLines of Credit

Can Be Used for Any Legitimate PurposeThe 1986 Tax Reform Act Has Helped This Type of Loan Grow in Popularity

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Cost-Plus Model of Pricing Loans

Loan Rate Paid by

Consumer=

Bank's Cost of Raising

Loanable Funds

+Nonfunding Operating

Costs+

Risk Premium

for Customer

Default

+

Risk Premium for Time

to Maturity

+Desired Profit

Margin

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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 Told to Consumer 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

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Discount Rate Method

The Discount Rate Method Requires the Customer to Pay the Interest in Advance. Interest is Deducted First and the Customer Receives the Loan Amount Less Any Interest Owed

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Add-On Loan Rate Method

Interest Owed is Added to the Principal Amount, Then the Loan Payments are Calculated By Dividing This Sum By the Number of Loan Payments

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Rule of 78s

A Rule of Thumb to Determine Exactly How Much Interest Income a Bank is Entitled to Accrue at Any Point in Time From an Installment Loan Being Paid in Monthly Installments.

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Compensating Balance Requirements

Some Banks Require Customers to Keep a Certain Percentage of the Loan Amount in a Deposit Account in the Bank. This Raises the Effective Cost of a Consumer Loan.

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Variable Rate Consumer Loan

Floating Prime Based

Consumer Loan Rate

=Prime or

Base Rate

+Risk

Premium

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Interest Rates on Home Mortgages

Fixed Rate Mortgage (FRM) – 1930s to 1970s Most Mortgages Were Fixed-Rate Mortgages. They Had a Fixed Interest Rate That Did Not Change Over the Life of the Loan

Adjustable Rate Mortgage (ARM) – in the Early 1970s Adjustable Rate Mortgages Were Allowed. These Mortgages Have an Interest Rate That Changes Over the Life of the Mortgage. Roughly One Quarter of All Mortgages are Adjustable Today

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Mortgage Points

This is an Additional Up Front Charge Often Required on Home Mortgages. It is a Percentage of the Loan Amount and Reduces the Amount of the Loan Available