Personal Finance: Loans and Housing Decisions

Introduction to Personal Finance

• Authors: John Grable and Lance Palmer

• Chapter Focus: Loans and Housing Decisions

Chapter Overview

• Topics Covered in Class:

• Loans and Housing Decisions: Understanding the various types of loans available, including mortgages and personal loans, and how they impact housing decisions.

• Alternative Financing and High-Cost Loans: Discussing different avenues for obtaining funds outside traditional lending institutions, including the risks of high-cost loans.

• Personal Loans: Exploring the nature of personal loans, their uses, and factors influencing loan approvals.

• Financial Aid and Student Loans: Providing an overview of financial aid options available for students, including scholarships, grants, and loans.

• Approaches to College Education Funding: Strategies for funding college education, including savings plans, federal aid, and income-based repayment options.

• Reminders regarding Homework due dates: Important reminders for upcoming assignments to keep students on track.

Alternative Financial System Loans

• Types of Lenders:

• Mainstream Lenders:

  • Banks: Offer conventional loans and mortgages with competitive interest rates based on creditworthiness.

  • Credit Unions: Member-owned institutions often providing lower rates and fees compared to banks.

  • Credit Card Issuers: Provide revolving credit lines which can contribute to consumer debt if not managed properly.

  • Auto Manufacturing Financing: Special deals and loans often offered by car manufacturers for vehicle purchases.

• Alternative Lenders:

  • Check Cashers: Facilitate quick cash access but often charge exorbitant fees.

  • Payday Lenders: Offer short-term, high-interest loans, usually against the borrower’s next paycheck.

  • Title Loans: Secured loans requiring the vehicle title as collateral, subjecting the borrower to high interest rates.

  • Pawn Shops: Offer short-term loans in exchange for valuable items, but items can be forfeited if the loan is not repaid.

  • Merchant Credit Cards: Business financing options that could be similar to personal credit but assist small business owners.

  • Seller-Financed Used Car Loans: Arrangements where the seller provides financing to the buyer, often at high-interest rates.

• Key Differences:

• Mainstream lenders rely on detailed credit reports and personal financial histories for loan approvals, while alternative lenders may not conduct thorough credit checks, making them more accessible but riskier.

Avoiding High-Cost Loans

• Strategies:

• Evaluate Alternatives: Avoid payday lenders by exploring more traditional and inexpensive options such as bank loans or credit unions.

• Build an Emergency Fund: Establish a financial cushion to manage unexpected expenses without resorting to high-cost loans.

• Consider Alternative Funding Methods:

  • Borrowing from family or friends can often be interest-free or low-interest.

  • Obtaining loans from credit unions or banks typically offers lower rates.

  • Selling valuable items can provide quick cash without the need for a loan.

Payday Loans

• Definition: Short-term loans needing repayment within a few weeks, generally aligning with the borrower's pay schedule, often leading to cycles of debt if not carefully managed.

• Example Process:

• Lenders may cash checks provided as collateral if repayment fails, often leading to additional fees and financial strain.

Key Provisions of the Truth in Lending Act (TILA)

• Consumer Protection Laws Include:

• Disclosure of Terms and Costs: Lenders must transparently disclose loan terms, fees, and interest rates.

• Right of Rescission: Borrowers have the right to cancel certain loans within three days if they change their minds.

• Advertising Rules: Guidelines stipulating truthfulness in advertisements related to loans.

• Enforcement Measures: Mechanisms in place for consumers to file complaints against lenders who violate TILA.

• Billing Statements: Lenders are required to provide clear billing statements to loan holders.

• High-Cost Mortgage Protection: Regulations to protect borrowers from predatory lending practices.

Importance of Personal Loans

• Definition and Use: Small-dollar debts commonly used for personal expenses like home renovations, medical bills, or emergencies.

• Example Scenario:

• Justin, needing $350 for an unexpected car repair despite his regular income, considers options such as cash advances on credit cards or loans from family but must weigh the costs.

Types of Personal Loans

• Categories Include:

• Secured Loans: Require collateral, making them less risky for lenders and potentially resulting in lower interest rates.

• Unsecured Loans: No collateral is required, but they often come with higher interest rates due to increased risk.

• Installment Credit: Borrowers receive the entire loan amount upfront and repay it in predetermined installments over a set time, typically 1 to 5 years.

• Line of Credit: A flexible borrowing option that resembles credit cards, allowing borrowers to draw funds as needed and only pay interest on the amount borrowed.

• Deposit Advance: Short-term loans automatically repaid with subsequent paycheck deposits, convenience often reflected in higher interest costs.

• Peer-to-Peer Lending: Involves borrowing from individuals rather than institutions, potentially lowering costs for borrowers and generating returns for investors, usually requiring a minimum credit score.

Paying for College

• Funding Options:

• Work: Part-time jobs or summer employment to offset college costs.

• Scholarships: Financial awards based on merit or specific criteria that don't require repayment.

• Family Contributions: Financial support from parents or relatives.

• Savings: Personal savings or dedicated education funds to cover college expenses.

• Federal Student Loans: Government-backed loans offering favorable terms to students, including repayment flexibility.

Federal Student Loans Explained

• Types Include:

• Direct Subsidized Loans: Need-based loans where the government pays interest while students are enrolled.

• Direct Unsubsidized Loans: Loans without need-based requirements that accrue interest while in school.

• Direct PLUS Loans: Loans available for parents of dependent undergraduate students, often requiring a credit check.

• Direct Consolidation Loans: Allow borrowers to combine multiple federal loans into one for easier management and potential lower payments.

Repayment of Federal Student Loans

• Grace Period: Borrowers have a 6-month grace period following graduation or enrollment reduction before repayment begins.

• Tax Benefits: The interest paid on federal student loans may be tax-deductible for borrowers under certain conditions.

Financial Aid Repayment Plans

• Types of Repayment Plans:

• Standard Plan: Fixed monthly payments over a decade.

• Graduated Repayment Plan: Payments start low and increase every two years, catering to those expecting wage growth.

• Extended Repayment Plan: Offers longer repayment terms up to 25 years, but generally only available for larger loan amounts.

• Income-Driven Repayment Plans: Payments adjusted based on income, allowing for financial flexibility and inclusion of programs such as Pay as You Earn and Income-Based Repayment.

Calculating Costs and Benefits of College

• Consideration: A comprehensive evaluation of whether investing in education yields sufficient return on investment through increased earning potential versus incurred debt.

Saving for College

• Popular Savings Options Include:

• Coverdell Educational Savings Account: Tax-advantaged savings account with contribution limits of $2,000 per beneficiary annually.

• 529 Plans: State-sponsored programs allowing for tax-free withdrawals for education expenses.

• Savings Bonds: Government-backed securities providing low-risk savings options.

• Roth IRA: While primarily a retirement account, contributions may be used for qualified educational expenses without penalty.

529 Plan Benefits

• Tax Advantages: Contributions to 529 plans may be tax-deductible, and account holders enjoy tax-free withdrawals for qualified education expenses.

• Investment Options: 529 plans often offer diverse mutual fund options that carry growth potential over time.

Coverdell Educational Savings Account (CESA)

• Contribution Limit: Up to $2,000 per beneficiary annually, designed for broad education-related expenses, including K-12 schooling.

• Tax Treatment: Tax-free withdrawals for qualified school expenses but subject to age restrictions for beneficiaries.

Alternative Sources for College Funding

• Types of Support Include:

• Need-based grants (e.g., Pell Grant): Federal-funded grants aimed at low-income students that don’t require repayment.

• Merit-based scholarships: Awards provided based on academic performance, talents, or specific criteria, enhancing access to higher education for eligible students