personal loans and credit cards © dr. b. c. paul 2002 revisions 2008 note – the subject covered...
TRANSCRIPT
Personal Loans and Personal Loans and Credit CardsCredit Cards© Dr. B. C. Paul 2002 revisions 2008© Dr. B. C. Paul 2002 revisions 2008
Note – The subject covered in these slides is considered to be “common Note – The subject covered in these slides is considered to be “common knowledge” to those familiar with the subject and books or articles knowledge” to those familiar with the subject and books or articles covering the concepts are widespread. covering the concepts are widespread.
Herby’s Personal Loan Herby’s Personal Loan ChoiceChoice
$5,000 in initial repairs$5,000 in initial repairs The Old Rational Bank Loan OptionThe Old Rational Bank Loan Option
$200 loan application fee$200 loan application fee 10% compounded monthly10% compounded monthly 5 year amortization5 year amortization
Convert a present loan amount into an Convert a present loan amount into an annuity of payments in the futureannuity of payments in the future A/P * Present Loan Amount A/P * Present Loan Amount checkcheck
A Bank Loan for HerbyA Bank Loan for Herby
A/PA/P n = 60 = 5 years * 12 months per yearn = 60 = 5 years * 12 months per year i = 10% per year/ 12 months per year = i = 10% per year/ 12 months per year =
0.008330.00833 A/PA/P0,00833, 60 0,00833, 60 = 0.021247= 0.021247
Monthly cost for initial repairsMonthly cost for initial repairs 0.021247 * $5000 = $106.240.021247 * $5000 = $106.24
Also an initial fee of $200Also an initial fee of $200
If Herby Picks the Bank If Herby Picks the Bank LoanLoan
Herby’s $5,000 repair money
Herby’s$200 loanInitiationfee
Herby’s $106.24 per month for the next 5 years
Herby Also had a Simple Herby Also had a Simple Interest Loan Option with Interest Loan Option with Sleezy MoneySleezy Money
The Sleezy Money loan has no up front The Sleezy Money loan has no up front $200 loan initiation fee$200 loan initiation fee
The Sleezy Money loan has an interest The Sleezy Money loan has an interest rate of 9% instead of 10%rate of 9% instead of 10%
What a Deal! Who needs the Banker?!!What a Deal! Who needs the Banker?!! Just One QuestionJust One Question What the Heck is a Simple Interest Loan?What the Heck is a Simple Interest Loan?
Simple Interest or Simply Simple Interest or Simply
_ _ _ _ _ _ __ _ _ _ _ _ _ Is a special type of Loan known as a Is a special type of Loan known as a
Simple Interest or Add Interest LoanSimple Interest or Add Interest Loan Main Places FoundMain Places Found
Sleezy Finance Houses (such as Herby’s Sleezy Finance Houses (such as Herby’s Sleezy Money Finance Company)Sleezy Money Finance Company)
Auto LoansAuto Loans Most that come from Car DealersMost that come from Car Dealers A lot of Car Loans from BanksA lot of Car Loans from Banks
Calculating Simple Calculating Simple InterestInterest
Interest Rate is Reported on an annual Interest Rate is Reported on an annual basisbasis
There is no compounding or interest There is no compounding or interest charged on interestcharged on interest You still need to get the period interest rate You still need to get the period interest rate
by dividing by number of payments per yearby dividing by number of payments per year If Sleezy money charges 9% with monthly If Sleezy money charges 9% with monthly
payments for 5 yearspayments for 5 years Period Interest Rate is 9/12 = 0.75%Period Interest Rate is 9/12 = 0.75% Still need to convert to decimal for calculation 0.0075Still need to convert to decimal for calculation 0.0075
The TrickThe Trick
Interest is charged as one lump sumInterest is charged as one lump sum Loan Amount * Period Interest Rate * Loan Amount * Period Interest Rate *
Number of payments = InterestNumber of payments = Interest For Herby 5000 * 0.0075 * 60 = $2,250For Herby 5000 * 0.0075 * 60 = $2,250
The Interest is then added to loan The Interest is then added to loan immediatelyimmediately Ie Herby’s loan is for $5,000 + $2,250 = Ie Herby’s loan is for $5,000 + $2,250 =
$7,250$7,250 (Can see why they are called Add Interest (Can see why they are called Add Interest
Loans)Loans)
Calculating PaymentsCalculating Payments
Loan amount with interest added is just Loan amount with interest added is just divided by number of paymentsdivided by number of payments For Herby $7,250 / 60 = $120.83For Herby $7,250 / 60 = $120.83
Whats Wrong with That?Whats Wrong with That?
Notice that you paid full interest rate on Notice that you paid full interest rate on all the money that you borrowed even all the money that you borrowed even after you have paid the money offafter you have paid the money off
If Herby tries to pay a simple interest loan If Herby tries to pay a simple interest loan off the next month he’ll still pay $7,250 or off the next month he’ll still pay $7,250 or full interest for 5 yearsfull interest for 5 years
The ImpactThe ImpactHerby's Interest Rate
0
100
200
300
400
500
600
1 7 13 19 25 31 37 43 49 55
Month
% A
nn
ual
In
tere
st
Series1
Herby’s interest rateStarts at 9% butClimbs over time toOver 450%
Herby’s regularBank loan costs$1,458 in interest
Herby’s SimpleInterest Loan willCost $2,250(half again asMuch)
The DeceptionThe Deception
Auto Dealers and Some Finance Houses Auto Dealers and Some Finance Houses quote attractive interest ratesquote attractive interest rates Only in the fine print is simple interest Only in the fine print is simple interest
discloseddisclosed Herby’s 9% Simple interest loan is Herby’s 9% Simple interest loan is
equivalent of 13.5% of a regular equivalent of 13.5% of a regular compound interest loancompound interest loan Allows organizations to quote far lower rates Allows organizations to quote far lower rates
than competition than competition
Herby’s Credit CardHerby’s Credit Card
Credit cards usually do not charge a fixed Credit cards usually do not charge a fixed monthly payment monthly payment (except for some minimum (except for some minimum usually around $15 to $25)usually around $15 to $25) Instead they charge a fixed percentage of Instead they charge a fixed percentage of
the outstanding balancethe outstanding balance will produce a declining monthly payment like a will produce a declining monthly payment like a
reverse geometric gradient going downreverse geometric gradient going down We have no super hero for thatWe have no super hero for that We do have a spreadsheetWe do have a spreadsheet
We Will Use the Interest We Will Use the Interest Rate Comparison Rate Comparison SpreadsheetSpreadsheet
Begins with calculatingPeriod interest rate(ie annual rate divided byThe # of compoundingPeriods per year).
Credit Card(with single cycle average daily balance)(minimum a % of principal + interest)
13 Interest Rate365 Number of Compounding Periods/Year
0.000356 Period Interest Rate12 Number of Payments/Year
0.01089 Payment Interest Rate19.41667 Years for Loan Payoff
5000 Loan Amount
0 Percent Transaction Fee Rolled Into Loan 0 Transaction Fee0 Minimum Fee
none Maximum Fee (enter none if no maximum)
1 % of balance required20 Monthly Minimum Payment
104.4514 Maximum Payment Amount 9.697733 Final Payment Amount4805.44 Interest Paid
0 Fees Paid
Calculates A Payment Calculates A Payment Interest RateInterest Rate
This is really an approximation.Average Daily balanceCharges each transaction fromThe time it occurs.This spreadsheet wasDesigned to compare differentWays to borrow a lump sum.
(1+daily int)^(365/12)Same way you found actualAnnual interest on a Credit Cd.
Credit Card(with single cycle average daily balance)(minimum a % of principal + interest)
13 Interest Rate365 Number of Compounding Periods/Year
0.000356 Period Interest Rate12 Number of Payments/Year
0.01089 Payment Interest Rate19.41667 Years for Loan Payoff
5000 Loan Amount
0 Percent Transaction Fee Rolled Into Loan 0 Transaction Fee0 Minimum Fee
none Maximum Fee (enter none if no maximum)
1 % of balance required20 Monthly Minimum Payment
104.4514 Maximum Payment Amount 9.697733 Final Payment Amount4805.44 Interest Paid
0 Fees Paid
Enter Loan Amount
And Payment Calculation Terms
Shows the Transaction Shows the Transaction FeesFeesCredit Card(with single cycle average daily balance)(minimum a % of principal + interest)
13 Interest Rate365 Number of Compounding Periods/Year
0.000356 Period Interest Rate12 Number of Payments/Year
0.01089 Payment Interest Rate19.41667 Years for Loan Payoff
5000 Loan Amount
0 Percent Transaction Fee Rolled Into Loan 0 Transaction Fee0 Minimum Fee
none Maximum Fee (enter none if no maximum)
1 % of balance required20 Monthly Minimum Payment
104.4514 Maximum Payment Amount 9.697733 Final Payment Amount4805.44 Interest Paid
0 Fees Paid
We assume we have noneAnd that they just charge theSupplies with a credit cardAt Home Peephole.
Working Up CostsWorking Up Costs
Period Debt Interest Payment Principal1 5000 62.87926 112.8793 50 02 4950 62.25046 111.7505 49.5 03 4900.5 61.62796 110.633 49.005 04 4851.495 61.01168 109.5266 48.51495 05 4802.98 60.40156 108.4314 48.0298 06 4754.95 59.79755 107.3471 47.5495 07 4707.401 59.19957 106.2736 47.07401 08 4660.327 58.60758 105.2108 46.60327 09 4613.723 58.0215 104.1587 46.13723 0
10 4567.586 57.44129 103.1171 45.67586 011 4521.91 56.86687 102.086 45.2191 012 4476.691 56.2982 101.0651 44.76691 0
Principal is 1% ofdebtInterest is the debt X monthly yield
Payment is the sum ofPrinciple + interest
(Note I assume there is never a late or over-limit fee)
Spreadsheet Calculates Spreadsheet Calculates Some Interesting StatisticsSome Interesting Statistics
Note that the credit card will take nearly 19.5 years to pay off (provided no bodyCharges anything new for 19.5 years)
There will be $4,800 in interest charges and they will pay almost $2 forEvery dollar they spend. (Bankers will almost get more money than theStore and all the materials suppliers combined).
19.41667 Years for Loan Payoff5000 Loan Amount
0 Percent Transaction Fee Rolled Into Loan0 Minimum Fee
none Maximum Fee (enter none if no maximum)
1 % of balance required20 Monthly Minimum Payment
104.4514 Maximum Payment Amount 9.697733 Final Payment Amount4805.44 Interest Paid
The Game AfootThe Game Afoot
Why are credit cards so hard to pay-offWhy are credit cards so hard to pay-off The minimum payments are generally set to The minimum payments are generally set to
be competitive with signature loans at banksbe competitive with signature loans at banks But the modest payment hides a high interest But the modest payment hides a high interest
rate and results in slow payment of the debtrate and results in slow payment of the debt
The Declining Payment - Why?The Declining Payment - Why? Official Answer - to better service the Official Answer - to better service the
customer by minimizing demands made upon customer by minimizing demands made upon himhim
Its A TRAPIts A TRAP
By directing a high percentage of your By directing a high percentage of your payments to interest and then slowly payments to interest and then slowly declining those payments - credit card debt declining those payments - credit card debt takes a long time to pay-offtakes a long time to pay-off
The Credit Card Company’s bet you a life The Credit Card Company’s bet you a life time of debt that if you ever get a good credit time of debt that if you ever get a good credit card debt - you won’t be able to avoid using card debt - you won’t be able to avoid using your card again for 20 years - You'll your card again for 20 years - You'll recharge the debt.recharge the debt.
Other Credit Card GamesOther Credit Card Games
Credit Cards have “Cash Advance Fees”Credit Cards have “Cash Advance Fees” Credit Card Checks or getting cash from an ATM is Credit Card Checks or getting cash from an ATM is
considered a “Cash Advance”considered a “Cash Advance” Cash advances are usually 3% to 5% of the amount Cash advances are usually 3% to 5% of the amount
advanced (or a minimum fee of $10 or $25)advanced (or a minimum fee of $10 or $25) some cards do have a maximum fee alsosome cards do have a maximum fee also
If Herby gets a cash advance on his credit card If Herby gets a cash advance on his credit card he will payhe will pay $5,000 * 0.03 = $150$5,000 * 0.03 = $150
so much for getting out of that loan initiation feeso much for getting out of that loan initiation fee
More GamesMore Games
If Herby Charges supplies at Smowe’s or If Herby Charges supplies at Smowe’s or Home Peephole he does not pay a cash Home Peephole he does not pay a cash advance fee.advance fee. But the credit card company charges a But the credit card company charges a
fraction of a percent to the merchant (hidden fraction of a percent to the merchant (hidden in higher prices)in higher prices) Reason some gas stations have a higher price Reason some gas stations have a higher price
for credit cards than cashfor credit cards than cash Reason that not every store takes credit cardsReason that not every store takes credit cards
Cash Advance vs. Cash Advance vs. PurchasePurchase
In addition to cash advance fee credit cards charge a In addition to cash advance fee credit cards charge a higher interest rate for cash advances than higher interest rate for cash advances than purchasespurchases purchases are often 7.9% to 23%purchases are often 7.9% to 23% cash advances are typically 12.9 to 32%cash advances are typically 12.9 to 32%
If you get a cash advance on your credit card - all If you get a cash advance on your credit card - all your payments will go to cover purchases your payments will go to cover purchases (lower rate)(lower rate) until the low rate stuff is paid off until the low rate stuff is paid off (never if you fall in the (never if you fall in the declining payment trap)declining payment trap) About the only way to get a cash advance off your back is About the only way to get a cash advance off your back is
to pay-off the entire card.to pay-off the entire card.
The Promotional OfferThe Promotional Offer
Many credit cards offer promotional Many credit cards offer promotional interest ratesinterest rates They last around 3 to 12 months depending They last around 3 to 12 months depending
on the card - on the card - And then they jump to a higher And then they jump to a higher interest rateinterest rate The idea is to get you to run up a balance that The idea is to get you to run up a balance that
you won’t be able to dig out ofyou won’t be able to dig out of
Often they will charge a cash advance Often they will charge a cash advance fee with a promotional interest rate checkfee with a promotional interest rate check
The Grace PeriodThe Grace Period
Most cards offer a grace periodMost cards offer a grace period If you pay-off your balance in full each month there is no If you pay-off your balance in full each month there is no
interest BUTinterest BUT
Many credit cards are shortening grace period from Many credit cards are shortening grace period from 25 days to 2025 days to 20 They wait about a week to 10 days after your “statement date” to send They wait about a week to 10 days after your “statement date” to send
the billthe bill Takes about 3 or 4 days in the mailTakes about 3 or 4 days in the mail They warn you in fine print that it may take 3 to 5 days to credit your They warn you in fine print that it may take 3 to 5 days to credit your
paymentpayment Takes you about 3 or 4 days to get payment to their officeTakes you about 3 or 4 days to get payment to their office Result - Result - you may have only a day or two to have the money in your you may have only a day or two to have the money in your
checking account ready to pay them.checking account ready to pay them.
Bankers GraceBankers Grace
If your payment doesn’t make it on timeIf your payment doesn’t make it on time ( (I I wonder how much hustle they put into processing your payment if wonder how much hustle they put into processing your payment if its close - I wonder how you’d prove it)its close - I wonder how you’d prove it)
Credit Cards Charge a late fee (usually $35 Credit Cards Charge a late fee (usually $35 or now a graduated scale) in addition to or now a graduated scale) in addition to interestinterest
If they can catch you several times, most will If they can catch you several times, most will raise the interest rate that they charge on raise the interest rate that they charge on your account (after all you’re a bad credit your account (after all you’re a bad credit risk because you don’t pay on time)risk because you don’t pay on time) They will revoke any special rates you haveThey will revoke any special rates you have
Dynamic Interest RatesDynamic Interest Rates
Universal DefaultUniversal Default If they find you are ever late on payments to anyone If they find you are ever late on payments to anyone
they can raise your interest ratethey can raise your interest rate The Stealth AlternativeThe Stealth Alternative
If you are ever late to them or an affiliate or if they If you are ever late to them or an affiliate or if they periodically re-evaluate your credit worthiness periodically re-evaluate your credit worthiness based on secret factors they can raise your ratebased on secret factors they can raise your rate
Most cards have floating interest rates – it is an Most cards have floating interest rates – it is an index value plus a spreadindex value plus a spread You take all the market risk.You take all the market risk.
Billing Cycle TricksBilling Cycle Tricks
Some credit cards change the way they calculate Some credit cards change the way they calculate the “average daily balance”the “average daily balance” They do the average daily balance as a two cycle They do the average daily balance as a two cycle
average (ie the average over two months instead of average (ie the average over two months instead of each billing cycle)each billing cycle)
ResultsResults If you try to take a promotional offer and then pay off the balance If you try to take a promotional offer and then pay off the balance
before the rate goes up - they get to zap you even after the balance before the rate goes up - they get to zap you even after the balance is paid.is paid.
They can continue to charge you interest on purchases after they They can continue to charge you interest on purchases after they are paid offare paid off
You have to keep your credit card paid off for many months straight You have to keep your credit card paid off for many months straight to stop monthly interest charges.to stop monthly interest charges.
Now We Have Looked at Now We Have Looked at Bank Loans, Simple Interest Bank Loans, Simple Interest Loans, and Credit CardsLoans, and Credit Cards
Now you get the opportunity to make a comparison of your own
Assignment #8
Help Fred and Fanny Furniture Decide whether to buy $4,000 worthOf furniture using a Personal Loan from a Bank, a Simple InterestLoan, or a Credit Card.