Personal Finance Questions: Student and Consumer Loans

Question: Explain the purpose of a convertible loan.
A convertible loan has the potential of overcoming the disadvantages (to the borrower) of variable-rate and fixed-rate loans
- The borrower can enjoy the lower cost of a variable-rate loan while still being able to lock in the savings of a fixed-rate loan when a low interest rate comes along.

Question: Name the advantages and disadvantages of an unsecured loan
Unsecured loans require no collateral, only a signature
- Larger unsecured loans are generally given only to borrowers with excellent credit histories
- The major fault with these type of loans is that they require higher interest rates.

Question: Describe the four major parts of a typical loan contract
The loan contract will contain an insurance agreement clause which requires you (the borrower) to purchase credit life insurance to pay off the loan in the event of your death.
An acceleration clause states that if you miss one payment, the entire loan comes due immediately
- Usually, however, the lender will give you some time to catch up on the payments
- The deficiency payments clause requires that if you default on a secured loan, not only can the lender repossess whatever is secured, but if when that asset is sold it does not cover what you owe, you can be billed for the difference
- A recourse clause defines what actions a lender can take to claim money from you in case you default on the loan.

Question: What is the distinguishing feature of an automobile loan?
The automobile is used as collateral and will be repossessed if the borrower defaults on the loan
- The duration of these loans is usually very short, often for only 24 to 60 months.
Although they can be as long as 72 months
- Some lenders offer a very low 3% or less interest rate for this purpose.

Question: What are the advantages of a home equity loan, and what, if any, are the disadvantages?
It is usually easier and less expensive to obtain a home equity loan than other types of loans
- After securing a home equity line of credit, you merely ask for the money each time you need some, without reapplying for it
- The interest you pay is usually a tax deduction, within income limitations
- The one major disadvantage is that you place a lien on your home.

Question: Give five things you can do to obtain the most favorable rates on loans, which in essence will allow you to lower the lender's risk.
- Develop a strong credit rating.
- Use a variable-rate loan.
- Keep the term of the loan as short as possible.
- Provide collateral for the loan.
- Put a large down payment toward the purchase.

Question: Explain why add-on installment loans are more expensive than simple interest loans
The add-on method generally results in an APR of close to twice the level of the stated interest rate because you are paying interest on the original principal over the entire life of the loan
- Even though the amount of outstanding principal keeps decreasing as you pay back the loan, you still pay interest on the entire amount you originally borrowed.

Question: Why is the discount method more costly than the simple interest method on a single-payment loan?
Under the discount method, with the interest taken out before you receive the loan, you actually receive a smaller principal than the stated principal of the loan.

Question: List examples of loans or loan sources that fit into the categories of inexpensive, more expensive, and most expensive.
- Inexpensive: family, home equity loans, secured loans, loans against the cash value of life insurance
- More expensive: credit unions, S&Ls and commercial banks, unsecured loans
- Most expensive: financing from retail stores, finance and small loan companies


Question: Why is the debt limit ratio and 28/36 rule more important to conservative lenders like Banks and Credit Unions and not so important for lenders like small Finance companies and Payday lenders?
Principle 8 states that risk and return go hand in hand
- With the conservative lenders like Banks and Credit Unions, they are lending their depositors money and not their own money
- They are also regulated by the FDIC and NCUA
- This means that they generally will not lend money to people with no or poor credit or collateral, it's just too risky for them to do so
- With the other, more aggressive lenders, it's their investors' money
- These investors voluntarily provide money to earn the higher return associated with riskier loans
- Even if a portion of the loans fail, the return on the performing loans outweighs the losses
- These aggressive lenders take advantage of desperate or naive people who can't borrow from the conservative lenders for whatever reasons
- Desperate and naive people do desperate and naive things, many times causing severe financial distress.

Question: What are some of the leading causes of bankruptcy?
Major illness: This generally comes with major costs and can mean the loss of a job.
Credit: Easy availability of credit leads to living beyond your means.
Divorce: It's expensive, what with lawyers, child support, alimony, and splitting up assets.
Job loss: Bills continue to come in, and with no income, savings can be wiped out.

Question: How do you know how much debt you can comfortably afford?
By applying the debt limit ratio you can see, from a lender's point of view, the limitation on consumer debt
- It is calculated by dividing your monthly non-mortgage debt payments by your total monthly take-home pay
- Ideally, it should be below 15% because you will still have some borrowing reserve for emergencies and the unexpected, and it will be easier to obtain additional borrowing
- You should put a maximum of 20% on consumer debt
- Once you pass this point, it will be difficult to borrow more, and your ability to meet your monthly financial obligations will be severely limited.

Question: Debt consolidation loans can be a very good thing for some people but they can also be dangerous to some - Explain the benefits and dangers of a debt consolidation loan

If you are fortunate enough to have sufficient collateral and credit score to obtain a consolidation loan with an affordable APR and term, you can generally lower your monthly payments, especially when eliminating expensive credit card debt
- You have to choose however, whether the fixed payment commitment of an installment loan and, possibly, higher finance charges over the length of the loan outweigh the financial pressures of the original debt
- You also have to weigh your personal discipline and self control to not run up new debt on top of the consolidation loan
- Some unfortunate people end up worse off with additional debt than when they started
- If you use the equity in your home for collateral for the new loan, now you have put your home in financial jeopardy
- The non-profit Credit Counselors recommend cutting up your credit cards to remove the temptation.

Question: Samuel is having financial troubles - He owes a significant amount of money to his ex-wife for child support payments, he is also behind on his student loans and has not paid his taxes for the last five years - Sam is considering filing for personal bankruptcy - Why might this not be a wise financial decision for him?

This would not be wise decision because none of his listed debt: child support, student loans and back taxes are dischargeable through a bankruptcy filing
- He cannot get away from paying these debts.

Question: Name the four common loans available for college students
The four common loans include the Stafford Loan, Perkins Loan, Parent Loan, and Supplemental Loan for Students.

Question: Question: What are the opportunity costs associated with Student loans?
Depending on the amount you borrow and how long you are in school, you may end up with a fairly large loan balance to repay upon completion or termination of your education
- Ideally, your education will allow you to obtain a decent salary that is sufficient to allow you a good standard of living while repaying the loan
- Regardless, student loan payments are included in the debt limit ratio and 28/36 rule so they may prevent you from obtaining additional credit or a mortgage until you payoff the student loan
- Student loan payments can be a burden on young families with children
- You can't avoid or evade student loan debt via bankruptcy either.

Question: Name two tax credits available to help offset education costs.
american Opportunity Credit: allows you to claim $2,500 per year for the first four years.
Lifetime Learning Credit: allows you to claim $2,000 per year for college costs.

Question: How do you finance your college education without mortgaging your future?
The answer is to understand:
The consequences of your choice of school and of your course of study.
The costs, including tuition and living expenses, and how to borrow less and borrow smarter.
How to manage your money well while on campus.
How to repay your loans without sacrificing your financial goals.

Question: List three reasons why a student-loan borrower may be granted a deferment
The borrower might receive a deferment if he or she is enrolled at least half-time in school, is unemployed, or meets hardship standards.

Question: Describe the four types of student-loan repayment plans
Standard repayment (10-year term; you pay the lowest amount of interest): this is the automatic repayment plan, unless you choose another plan.
Extended repayment (10 - to 30-year term): additional number of payments and additional interest paid.
Income-based repayment (25-year term of payments before loan forgiveness): based on a percentage of discretionary income, not the amount owed; yields low monthly payments but additional interest paid.
Graduated repayment (25 - to 30-year term of payments before loan forgiveness): starts low, with monthly payment increasing every two years; yields low monthly payments but additional interest paid.

Question: Describe in detail the characteristics of the direct subsidized and unsubsidized student loans from the Federal government.
Based on income limitations, you may qualify for the direct, subsidized loan from the government
- With these loans, the government pays your interest on your loan disbursements while you are actively enrolled in school
- This prevents the interest on your loans from accruing interest while you are still a student
- Six months after you complete your degree program or withdraw from school, your loan amoritization payments with interest will start
- With a direct, unsubsidized loan, the interest starts accruing every time you receive a disbursement, resulting in the interest accruing interest while you are in school leaving you with a larger loan balance and payments when you start paying the loan back.


Question: Name the steps in smart buying
Step 1: Differentiate want from need
Step 2: Do your homework.
Step 3: Make your purchase.
Step 4: Maintain your purchase.


Question: Give at least six tips on smart buying
Take advantage of sales, but compare prices.
Don't assume an item is a bargain just because it is advertised as one.
Don't rush into a large purchase because the 'price is only good today.'
Be aware of extra charges and add them into the total cost.
Ask about the seller's refund and exchange policy.
Always read a contract before signing it.
Walk out or hang up on high-pressure sales tactics.
Don't do business over the phone with companies you don't know.


Question: How does smart buying improve your standard of living?
Following smart buying prevents you from wasting your money on impulsive purchases that you may not need or with features you don't really need or at a higher price than you should pay
- By saving money this way it makes it easier to stick with your budget and savings goals and still buy other products that you will enjoy
- Smart buying is not necessarily being frugal or stingy it just means getting the most value out of your limited budget
- Proper maintenance of products prolongs their useful life freeing up money that would go to replacement for some other worthwhile use.

Question: What are some tips on making a complaint to a company?
A good strategy is to write a brief, concise letter describing the problem and stating exactly how you would like the matter to be resolved
- Avoid writing an angry, sarcastic, or threatening letter
- When possible, include copies of all documents regarding your problem; be sure to keep the originals
- Maintain a record of whom you spoke to, along with dates and times of your contact.