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CHAPTER 4 CONSUMER CREDIT (PART 2) - Coggle Diagram
CHAPTER 4
CONSUMER CREDIT
(PART 2)
Sources of Consumer Credit
WHAT KIND OF LOAN SHOULD YOU SEEK?
Inexpensive loans
Parents or family members
Loans based on assets- using Certificate of Deposit (CD) as collateral
Medium-priced loans
•Commercial banks, savings and loan associations, and credit unions
Expenses Loan
Expensive loans
•Finance and check cashing companies
•Retailers such as car or appliance dealers
•Bank credit cards and cash advanced
Major Sources of Consumer Credit in Malaysia
The Cost of Credit
Finance charge is the total dollar amount you pay to use credit. It includes interest costs, service charges, credit-related insurance premiums, or appraisal fees
Standardized Base Rate Vs Base Rate: How Does SBR Work?
●As announced by Bank Negara Malaysia (BNM) on 11 August 2021, the Standardised Base Rate (SBR) has replaced the Base Rate (BR). Since 1 August, 2022, SBR is the main reference rate for new retail floating-rate loans and financing facilities
From BLR, BR to SBR
●The old Base Lending Rate (BLR) was based on how much it costs to lend money to other financial institutions. Meanwhile, the cost to borrow money was determined by the Overnight Policy Rate (OPR) set by the central bank.
●When BR was implemented in 2022, interest rates were determined by the individual banks’ benchmark cost of funds and Statutory Reserve Requirement (SRR)
●How is SBR different? The main feature of the SBR is in its standardization as the common reference rate for all banks. Unlike the BR, which differs for each bank, the SBR is the same across banks.
●Another key aspect of the SBR is that it is linked solely to the overnight policy rate (OPR). This is another simplification compared to the previous BR, which was previously determined by both the banks’ individual benchmark cost of funds, as well as the cost of holding non-interest-bearing statutory reserves with BNM.
How does the switch to SBR affect you?
The switch from BR to SBR should make it easier to understand that repayment installments will only change when there is a change in the OPR, unless there is an increase in consumer credit risk, for example, if you fail to make repayments. This means that consumers will have a more transparent picture when it comes to repaying their loans.
●Additionally, since the SBR is standardized across all banks, there is no longer a need to compare differences in computation of BRs across banks. This makes it easier for consumers to compare their options across multiple banks.
How does it affect your loan interest rate?
For existing borrowers, the move to SBR does not affect lending rates of existing retail floating-rate loans.
●For new borrowers, the lending rates for retail borrowers are largely unaffected by the move to SBR.
●However, borrowers’ lending rates and loan repayments may still be affected by other factors, such as borrowers’ credit risk profile (e.g. repayment track record).
What should borrowers compare when applying for loans?
• To get the best loan deal, consumers should compare the effective lending rate (ELR) offered by different banks.
• Banks provide a Product Disclosure Sheet (PDS) online, which shows key details like ELR and total repayment.
• Monthly loan payments can go up or down if the Overnight Policy Rate (OPR) changes, so borrowers must plan whether they can still afford repayments if rates rise.
• The Standardised Base Rate (SBR) system is more transparent and helps customers make smarter choices when comparing loans.
TACKLING THE TRADE-OFFS
Term versus interest costs. Longer loans-lower payments, but more total interest
•Lender risk versus interest rate. Some ways to reduce the lender’s risk and the interest rate:
•Accept a variable interest rate
•Provide collateral to secure the loan
•Make a large down payment up front
•Have a shorter loan term
Calculating the Cost of Credit
Simple interest.
•Interest computed on principal only and without compounding.
•The dollar cost of borrowing.
•Interest = Principal × Rate of interest × Time, I = P × r × T.
•Simple interest on the declining balance.
•Used when more than one payment is made on a simple interest loan.
•Interest is paid only on the amount of original principal not yet repaid.
•The more frequent your payments, the lower the interest you will pay.
Add-on interest.
Interest is calculated on the full amount of the original principal.
•Then this interest amount is immediately added to the original principal.
•Then the total (interest plus principal) is divided by the number of payments to be made to arrive at the payment amount.
•When more than one payment is made, this method results in an effective rate of interest higher than stated rate of interest.
Cost of Open-End Credit 1
Adjusted Balance Method.
•Payments are subtracted before calculating finance charges.
•Previous Balance Method.
•Payments are not subtracted when calculating finance charges.
Cost of Open-End Credit 2
Average Daily Balance Method.
•The fairest method of computing finance charges.
•Creditors add your balances for each day in the billing period and then divide this total by the number of days in the billing period. Then they multiply this average balance by the monthly interest rate.
•New purchases during the billing period may be included or excluded from the average daily balance calculation.
Two-cycle Average Daily Balance
•May include or exclude new purchases.
•Method of computing finance charges that uses the average daily balance for two consecutive billing cycles.
•The Credit CARD Act of 2009 bans this method.
Cost of Credit and Expected Inflation
Borrowers and Lenders are concerned about dollars, then about goods and services those dollars can buy (purchasing power).
•Inflation erodes the purchasing power of money.
•Each percentage point increase in inflation means a decrease of approximately 1% in the quantity of goods and services you can purchase with a dollar.
When the Repayment is Early: The Rule of 78’s
The Rule of 78’s favors lenders.
•Also called the sum of the digits.
•Formula requires that you pay more interest at the beginning of the loan, when you have the use of more of the money and pay less and less interest as the debt is reduced.
Managing Your Debts
Notify creditors if you can’t make a payment.
•The Fair Debt Collection Practices Act regulates debt collection agencies
Reasons for Debt
Emotional problems such as the need for instant gratification
•The use of money to punish or get even
You request verification of the debt within 30 days; If not sent, you can insist that communication about the debt cease
If verification sent, you may pay the debt or give notice that you will not pay
Warning Signs of Debt Problems
Paying only the minimum balance each month
•Increasing the total balance due each month
•Missing or alternating payments or paying late
Using up your savings
•Borrowing money to pay old debts
•Not knowing how much you owe
•Going over your credit limit on credit cards
The Serious Consequences of Debt
Robbing Peter to pay Paul can affect family health.
•May result in loss of job due to garnishments.
•May result in neglecting the educational needs of children.
•May result in heavy drinking.
•May result in neglect of children.
•May result in marital difficulties.
