Lesson 8 Borrowing Money

Transcription

1 AOBF Financial Planning Lesson 8 Borrowing Money Student Resources Resource Description Student Resource 8.1 Reading: Why Borrow? Student Resource 8.2 Worksheet: Borrowing and Lending Terms Student Resource 8.3 Reading: Borrowing and Lending Terms Student Resource 8.4 Worksheet: Borrowing Sources Student Resource 8.5 Examples: Loan Recommendation Letters Student Resource 8.6 Guide: Loan Recommendation Letter

2 Student Resource 8.1 Reading: Why Borrow?

3

4

5

6

7

8

9

10

11 Bankruptcies are on the rise in the United States, as many Americans have overborrowed.

12 Job loss and unexpected health problems can also lead to bankruptcy.

13 Student Resource 8.2 Worksheet: Borrowing and Lending Terms Student Name: Date: Directions: Jot down what you know about each term. Add information after viewing the presentation and write a definition of each term year loan 2. Adjustable rate loan 3. Annual percentage rate (APR) 4. Collateral 5. Co-sign 6. Credit score/fico score 7. Down payment 8. Fixed rate loan

14 9. Interest 10. Minimum payment 11. Mortgage broker 12. Prime rate 13. Refinance 14. Repayment schedule

15 Student Resource 8.3 Reading: Borrowing and Lending Terms This presentation provides an overview of some of the most important concepts and terms in borrowing. Through the stories of two sets of borrowers, you ll learn about what kind of things people borrow money for and what lenders look for when approving loans.

16 The majority of people who buy cars, especially new ones, borrow money in order to buy the vehicle. Cars are often an important purchase that can allow people to drive to work, especially to areas that are not easily accessible by public transportation. A down payment is money that the buyer has to pay at the time of purchase. Most lenders require a certain percentage of the total price to be paid up front. A credit score (sometimes known as FICO score) is meant to measure a borrower s ability to repay a loan. The higher the credit score, the more likely a borrower is to be approved for a loan. Making late payments or declaring bankruptcy lowers a credit score. Borrowing money and paying it back on time improves a credit score.

17 There are many different variables to consider when getting a car loan. The type of loan you choose can have a big impact on the total amount of money you will pay for the car. Interest is an amount of money, expressed as percentage of the balance remaining on the loan, that a borrower must pay on a regular basis in addition to paying off the principal of the loan. In a sense, interest is a fee you are paying to the lender for letting you use their money. Sometimes, if a person has no credit history or a poor credit history, lenders will approve the loan if someone with a better credit history assumes joint responsibility for the loan by co-signing. The co-signer must repay the loan if the other signer defaults. The annual percentage rate, or APR, is a more accurate way of figuring out the interest rate for a loan, as it includes any up-front fees.

18 Because there are so many different types of loans, it really pays to shop around for the best terms of credit! A repayment schedule determines how often the borrower must make payments to the lender and for how long.

19 Another important reason people borrow money is to buy a house or condominium. These are usually the largest loans people ever take out, and many people spend 30 years or more paying off their home loans.

20 A mortgage broker helps home buyers borrow money to buy a home. Mortgage brokers can help buyers understand how much they can afford to pay in house-related payments each month (including property taxes and insurance) and help them get a loan amount on which they can reasonably make the monthly payments. The minimum payment is the lowest amount a borrower can afford to pay back each month, given his other monthly expenses.

21 By putting a down payment on a home, the buyer is able to take out a smaller loan amount. Often, banks will give better terms when a significant down payment is made. In the past, many lenders required at least a 10% down payment. More recently, lenders have allowed a 5% or even no down payment, but they offered less advantageous terms. Collateral is an asset that the buyer promises to give to the lender if the buyer cannot pay back the loan.

22 An adjustable rate loan has an interest rate that goes up or down, depending on the base rate to which it is tied. Adjustable rate loans can be risky since rates go up as well as down, so they are usually about one point below the rate of fixed rate loans. A fixed rate loan always has the same interest rate, even if the prime interest rate goes up or down.

23 Because it often takes 20, 30, or more years to pay off a home loan, it is very important that buyers carefully choose both the amount of loan they can take out and the terms of the loan. A 30-year loan has a repayment schedule that spreads out over 30 years. The longer the repayment schedule, the lower the monthly payments but the greater the total interest that will have to be repaid. Borrowers can refinance, which involves replacing a mortgage with a different, usually better, interest rate.

24 Student Resource 8.4 Worksheet: Borrowing Sources Student Name: Date: Directions: Read the characteristics carefully and fill in the column Possible Uses? by writing down what purchases are likely with that borrowing source. Borrowing Source Characteristics Possible Uses? Banks and credit unions Check-cashing stores Credit cards Banks and credit unions offer a wide variety of loans, including personal loans, small business loans, home equity loans, home mortgages, and credit cards. They are good place to start if you are searching for a loan because of their many options. If you build a relationship with a banker, he can help guide you to the loan that makes most sense for your needs. For some people it is difficult to open up a bank account or get loans, either because they have no permanent address, they don t have the money to make the minimum deposits that some banks require, or they have very poor credit histories. Check-cashing stores provide some of the services that banks do, such as cashing checks and making small loans. They can be useful for those who are not able to open a bank account. However, they usually charge much higher fees for their services than banks do. Banks, credit unions, and other financial institutions offer credit cards. With a credit card, you are able to borrow up to the credit limit of the card, and if necessary you are able to make small monthly payments on the balance of the card. However, credit cards charge interest on the amount borrowed, and in many cases, if the terms of the card are not met (such as a late payment), the interest rates can go up dramatically. The interest rates on credit cards are usually higher than for other loans, such as personal loans, car loans, and home loans.

25 Borrowing Source Characteristics Possible Uses? Mortgage lenders Businesses Loans against cash value in life insurance policies While many banks offer home loans, there are some financial institutions that specialize in these loans. Because of their specialization, they are sometimes able to provide better rates or other benefits to home buyers. Mortgage brokers often serve as intermediaries between the buyer and mortgage lender, helping the buyer to find a loan that meets her needs and preparing the necessary paperwork. Mortgage brokers often work with many different lenders, including banks and private lenders, to find their clients the most favorable loans. Many different types of businesses offer credit to buyers. Some retailers offer credit cards that can only be used to make purchases at their stores. Others, like auto, furniture, and electronics dealers, offer loans to help customers buy their products. Unlike most banks, these companies often approve loans even to customers with no credit history or with poor credit history, thus giving them the ability to begin improving their credit scores. The terms on these loans vary widely, so it is important to check if one can find better terms at a bank or credit union. Because of the easy credit, one possible danger of this type of loan is that it can lead to impulse shopping buying nonwealth-building assets that one can t afford! Whole life insurance policies accrue cash value that may be used in form of loans or withdrawals by the policy owner. Once the funds are borrowed, the policyholder may or may not elect to repay the loan. Interest rates vary for these loans, but they are usually lower than from other sources. However, unexpected fees may sometimes be incurred during the borrowing process that will add to the baseline rate.

26 Student Resource 8.5 Examples: Loan Recommendation Letters RECOMMEND LOAN April 27, 2012 Dear Mr. Sandoval, I m writing in response to your questions about obtaining a loan for solar panels to place on your roof. After reviewing your situation carefully, I feel that this investment is a good one for you. In order to obtain financing, I recommend that you visit the branch of your bank and apply for a home equity loan. I have based this recommendation on the fact that you have an excellent score and enough equity in your home to borrow against it. The pros of a home equity loan are that you can work with your own banker and obtain a relatively low interest rate, under 6%. The cons are that the amount of the house you do own will be reduced due to the loan and you will be paying more per month in your expenses. If you are approved for the loan, expect to repay the loan monthly for at least five years. Congratulations on pursuing your goal of a creating a greener environment, and please let me know if you have any questions about my recommendations. Sincerely, Alberta Kelly, Certified Financial Planner DON T RECOMMEND LOAN April 27, 2012 Dear Ms. Singleton, I m writing in response to your questions about obtaining a loan for a third puppet theater. After reviewing your situation carefully, I feel that this is not a good time for you to take on more debt. Since you already have maxed out two credit cards to pay for your first two puppet theaters, and neither has yet made a profit, I feel you would be better served by growing the first two theaters and waiting until they are profitable before pursuing a loan for a third. I would recommend that you work to pay down the debt on your credit cards and work to improve your credit score in order to become a more attractive loan candidate. When you do, I would be happy to assess your financial situation again. Please let me know if you have any questions about my recommendations. Sincerely, Stefan Prusakov, Certified Financial Planner

27 Student Resource 8.6 Guide: Loan Recommendation Letter Directions: Assume the role of a certified financial planner. Read each scenario carefully and answer the questions about each. Then choose one client and write a letter outlining your recommendation based on his or her need for the loan and his or her ability to repay it. Use Student Resource 8.5, Example: Loan Recommendation Letters, as a model. Client 1: Lucy Diamond is a single mom in her forties who is bringing up four children on her own. She owns a dry cleaning business in a small town. Two of her children work after school. Lucy wants your advice she is considering taking out a loan for $15,000 to buy new machines for her dry-cleaning business. Though these machines are expensive to buy, they use less energy and do a better job than her current machines. She thinks that in the long run they will help her improve her profits. Lucy rents her apartment and has very little credit card debt. Need for loan: Ability to repay: Client 2: Max Hammer is a semiretired plumber, now in his late sixties. Max has found retirement challenging, as he did not save enough to live comfortably. He continues to work part time as a greeter at a large discount store, but he is not earning much. He heard that all television broadcasts will be converted to high definition in a few years, so he wants to purchase a new high-definition large-screen TV. He figures that since he is retired, and spends a lot of time at home, a TV would be a good investment. He found a top-end model at his local electronics store for $5,000. He wouldn t even have to pay a penny until next year, when his interest rate would be about 10%, about the same as his credit card. There is no way Max could pay cash for the TV, as he already has maxed out the $10,000 limit on his credit card. Need for loan: Ability to repay: Client 3: Jude Rigby is a graduate student at Ohio State University. He is in his mid twenties. Jude wants to borrow money to help pay for graduate school. Although he has some income through teaching part time, as well as a few scholarships, he does not earn enough to make ends meet. Until he graduates in about two years, he needs some extra money, about $5,000 each year, just to be able to buy food and pay rent, with a little left over for a movie or a dinner out once a month. He s thought of getting a second job, but feels that if he works more, it will just take him longer to graduate. Need for loan: Ability to repay:

28 Before handing in your loan recommendation letter, check to make sure it meets or exceeds the following assessment criteria: The letter includes a clear explanation of whether or not you recommend borrowing and why. If your recommendation is to borrow: o o o The letter explains the best place to borrow from and why. The letter provides pros and cons of borrowing from this place. The letter explains how and when the borrower will be expected to repay the loan. If your recommendation is not to borrow: o o The letter gives clear reasoning explaining why not. The letter explains a financial strategy to help the borrower repair what is necessary in order to be able to borrow at a later date. You accurately evaluate the borrower s ability to pay. You accurately evaluate the borrower s level of need. The letter is neat and legible and uses proper grammar, spelling, and punctuation.