Deck 7: Using Consumer Loans: The Role of Planned Borrowing

Question 1

Explain the purpose of a convertible loan.

Answer 1

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 2

A ________ is tied to a market interest rate, such as the prime rate or the six-month Treasury bill rate.

A) prime-rate loan
B) convertible-rate loan
C) flexible-rate loan
D) variable-rate loan
E) none of the above

Answer 2

variable-rate loan

Question 3

What are the risks to the borrower with adjustable-rate loans?

A) During times of inflation your salary may increase during the term of the loan.
B) That the market rates of interest may increase during the term of the loan.
C) It is harder to budget for loan payments that may increase during the term of the loan.
D) Both B and C are correct.

Answer 3

Both B and C are correct.

Question 4

Variable-rate loans tied to long-term rates expose you to more risk of rate changes than variable-rate loans tied to short-term rates.

Question 5

A(n) ________ loan calls for the repayment of both the interest and the principal at regular intervals and is commonly referred to as loan amortization.

A) term
B) simple interest
C) installment
D) personal
E) none of the above

Question 6

Unsecured loans are generally less risky to lenders than secured loans. Therefore secured loans typically charge a higher APR than unsecured loans.

Question 7

Defaulting on a secured loan may lead to the collateral being repossessed.

Question 8

Bridge loans provide short-term funding until longer-term or additional financing is found.

Question 9

A balloon loan calls for repayment of both interest and principal at regular intervals, with the payment levels set so that the loan expires at a preset date.

Question 10

An acceleration clause states that if you default on a secured loan, not only can the lender repossess whatever is secured, but if the sale of the asset does not cover what you owe, you can also be billed for the difference.

Question 11

Which of the following characterize secured loans?

A) They are typically easier to get.
B) Interest rates tend to be lower than unsecured loans.
C) They reduce the lender's risk.
D) They are backed with either physical or investment assets.
E) All of the above

Question 12

If your before-tax cost of a home equity loan is twelve percent and you are in the thirty percent marginal tax bracket, your after-tax cost of the home equity loan is nine percent.

Question 13

Variable-rate loans

A) usually have rate caps that prevent them from varying too much.
B) always adjust every month.
C) are never a better option than fixed-rate loans.
D) All of the above

Question 14

You are considering building a new deck on your home, what factors should you consider when deciding whether to borrow the money or take the money out of your savings account?

A) You should compare the after-tax return on your savings with the after-tax APR on your loan.
B) It's simple, if you can afford to pay cash then you should not take out the loan.
C) What impact the savings withdrawal will have on your liquidity.
D) Both A and C are correct.

Question 15

Alice has fallen behind on her signature loan. She recently received a notice from the lender that her wages were going to be garnished to pay off the debt. What is the loan clause that allows the lender to take this action against Alice because she was in default?

A) recovery clause
B) default clause
C) recourse clause
D) deficiency payments clause
E) none of the above

Question 16

What is the loan clause stating that if you default on a secured loan, the lender can repossess whatever is secured, as well as bill you for the difference if that repossession does not cover what you owe?

A) insurance clause
B) default clause
C) recourse clause
D) deficiency payments clause
E) none of the above

Question 17

A recourse clause defines whatever actions a lender can take to recover money from you in case you default on the loan.

Question 18

A short-term loan that provides funding until a longer-term loan can be secured is called a(n)

A) bridge loan.
B) gap loan.
C) straddle loan.
D) amortized loan.
E) none of the above

Question 19

Which of the following is the correct formula to calculate the after-tax cost of a home equity loan?

A) after-tax cost of a home equity loan = before-tax cost (1 + marginal tax rate)
B) after-tax cost of a home equity loan = before-tax cost (1 ‑marginal tax rate)

Question 20

Name the advantages and disadvantages of an unsecured loan.

Question 21

Under a Federal Direct Loan, you don't begin making payments until six months after graduation.

Question 22

Which one of these clauses is not found in a typical loan contract?

A) recourse
B) deficiency payments
C) acceleration
D) withdrawal terms
E) insurance agreement

Question 23

An advantage that direct or subsidized student loans have over other types of loans is

A) the after-tax interest rates are very attractive compared with other loans.
B) you can borrow at a below-market rate, regardless of your credit situation.
C) in an emergency, you can declare bankruptcy and avoid repayment.
D) you have the rest of your life to pay it back.
E) both A and B are correct.

Question 24

You are considering a home equity loan. Your marginal tax bracket is 25%. You want to borrow $30,000 and are quoted an APR of 10%. How much money would you save in taxes each year if you use the tax-deductible home equity loan?

A) $1,300
B) $920
C) $750
D) none of the above

Question 25

Describe the four major parts of a typical loan contract.

Question 26

Frank ran up a large credit card bill as an undergraduate student, he also took out as much in student loans as possible. He is now unable to pay his credit card debt and his student loan debt. However, he has decided to declare bankruptcy to eliminate his debt. Frank will be able to eliminate his federally subsidized student loan debt by declaring bankruptcy.

Question 27

The "Repo Man" recently repossessed your car for failure to make payments. You still owed $5,000 on the loan, but since it was always broken, you were glad to get rid of it anyway. The bank sold the car at a wholesale auction for $3,000. The bank also paid the "Repo Man" $200 and paid attorney fees of $300. Based on the deficiency payments clause in your loan, what are you liable for?

A) $0; repossession means the bank must "eliminate" the debt
B) $500
C) $2,000
D) $2,500
E) none of the above

Question 28

Under a Stafford Loan, parents borrow money for their child's education.

Question 29

Suppose you borrowed the money you needed to purchase an automobile and then failed to make a scheduled payment by the due date. Technically, you

A) are bankrupt.
B) are in default.
C) are usually not given a chance to make good on the overdue payment.
D) none of the above

Question 30

The interest that you pay on your student loans will lower your taxable income if you meet IRS guidelines.

Question 31

What is your potential liability from the deficiency payments clause if you default?

A) Nothing, since the loan is in default it invalidates all loan clauses.
B) You will have to pay any legal or repossession fees incurred by the lender.
C) You will have to pay the remainder of the loan balance if the proceeds from the repossession are not sufficient to pay off the loan.
D) Both B and C are correct.

Question 32

A Federal Direct Student Loan has tremendous advantages over other types of loans, including

A) The interest is deferred while you are in school.
B) They have low monthly payments and a 20% balloon payment after 5 years.
C) They use the add-on method to determine your monthly payment.
D) None of the above.

Question 33

Student loans are a smart source of financing for school because you pay part of the interest charges and the rest is subsidized by

A) the bank or lender.
B) the state government.
C) the educational institution.
D) the federal government.

Question 34

What happens when you default on a car loan where your Title is held as collateral?

A) You damage your credit history but you keep the car.
B) You lose the car and damage your credit history.
C) You face liability under the deficiency payments clause.
D) Only choices B and C are correct.
E) All of the above choices are correct.

Question 35

When do the payments on a Stafford Loan begin?

A) When your school receives the money from the government.
B) When your loan balance gets over $5,000.
C) You can choose when your payments begin anytime within 24 months of your graduation date.
D) None of the above is correct.

Question 36

What is the name of the formal document that outlines the legal obligations of both the lender and the borrower?

A) default
B) claim
C) debenture
D) note
E) tort

Question 37

Joshua recently purchased a new home. His lender required him to purchase credit life insurance on the loan in the event that he died before the mortgage is paid off. What is the loan clause that allows his lender to require him to purchase this additional insurance.

A) insurance agreement clause
B) default contingency clause
C) early payment clause
D) recourse clause
E) none of the above

Question 38

Student loans are loans with federally subsidized interest rates given, based on financial need, to students making satisfactory progress in their degree programs.

Question 39

The loan contract is a formal document called a(n) ________ and may contain a(n) ________ specifying who retains control over the item being purchased in the case of default.

A) agreement, insurance clause
B) indenture, security agreement
C) note, security agreement
D) agreement, indenture
E) note, legal transaction

Question 40

The quoted rate on a home equity loan is 10% and you are in a 28% marginal tax bracket. What is the effective after-tax rate on this loan?

A) 7.2%
B) 5.4%
C) 4.1%
D) 2.8%
E) none of the above

Question 41

Home equity/second mortgage loans have two important advantages over most other types of loans. They are

A) tax deductibility of payments and longer terms.
B) tax deductibility of interest and lower interest rates.
C) no risk for borrower and less amortization.
D) increase in future financing flexibility and no recourse clause.
E) none of the above

Question 42

The APR is larger when money is lent under the discount method than when it is lent under the simple interest method.

Question 43

Ronald is borrowing $20,000 using the discount method. His bank is offering him an annual percentage rate of 8.5% and he is taking out the loan for 24 months. How large of a check will Ronald receive from this loan when he leaves the bank? How much will he repay?

A) $20,000; $23,400
B) $16,600; $20,000

Question 44

What are the advantages of a home equity loan, and what, if any, are the disadvantages?

Question 45

With a discount method single-payment loan, the entire interest charge is subtracted from the principal before you receive the money, and at maturity you repay the principal.

Question 46

Payday loans are a dangerous way to borrow money, and charge an annual interest rate of almost 400%.

Question 47

A payday loan is a reasonable option if you need a luxury item like a big screen TV.

Question 48

The annual percentage rate is the simple percentage cost of all finance charges over the life of the loan on an annual basis.

Question 49

Fred ran short on cash and borrowed $300 through a Payday Loan company. The company charged him a fee of $60 to borrow the $300 for 14 days. Using the simple interest method calculate what interest rate was Fred charged for the aforementioned loan.

A) 5.21%
B) 52.13%
C) 521.29%
D) None of the above.

Question 50

Describe in detail the characteristics of the direct subsidized and unsubsidized student loans from the Federal government.

Question 51

The finance charges for a loan may include

A) fees for a credit check.
B) required insurance fees.
C) interest payments.
D) Only choices A and B.
E) All of the above choices.

Question 52

The simple interest method is the most common method of calculating payments on an installment loan.

Question 53

Loans using the add-on method are a relative bargain, and should be sought out.

Question 54

Name the four common loans available for college students.

Question 55

Which of the following is not required by law to be on a loan disclosure statement?

A) annual percentage rate
B) all finance charges
C) the total amount financed
D) the total amount of payments
E) All of the above are required.

Question 56

Payday lenders

A) make money by providing one-time assistance during a time of financial need.
B) make money by keeping borrowers in debt.
C) encourage repeat borrowing.
D) All of the above

Question 57

Amortization refers to the process in which a large proportion of the early payments of an installment loan goes to cover interest, and the later payments have a larger proportion going towards the payment of principal.

Question 58

What is the distinguishing feature of an automobile loan?

Question 59

If you own a home with a market value of $175,000 and you have an outstanding balance on your mortgage of $60,000, your home equity is

A) $57,500.
B) $97,750.
C) $115,000.
D) $235,000.

Question 60

What are the opportunity costs associated with Student loans?

Question 61

A simple interest installment loan calculates interest on the unpaid balance. An add-on

A) calculates the same way with the addition of a factor.
B) calculates interest on the original balance.
C) is less costly.
D) is more costly.
E) both B and D

Question 62

A rule to determine what proportion of each loan payment is principal and interest is

A) the law of 72.
B) the N-ratio method.
C) the rule of 78.
D) the principal-interest mix.
E) the add-on method.

Question 63

You have just obtained a personal loan for a new home movie system under the simple interest method. You have borrowed $12,000 for 9 months at an annual rate of 10%. Your marginal tax rate is 28%. What are the total interest charges you would pay if the loan is paid off on time?

A) $1,200
B) $1,080
C) $900
D) $648
E) none of the above

Question 64

In driving around town one day, you noticed most of the payday loan companies were located close to the college and the local military base and there were none out in the newer neighborhoods. Why do you think this is so?

A) The rent on these locations is less expensive.
B) Payday lenders tend to focus on less experienced borrowers who typically don't make a lot of money.
C) Because their terms are so affordable people with low incomes really take advantage of them.
D) There are zoning laws that require these types of locations for these types of services.

Question 65

A loan that is paid back in a single lump sum payment at the due date of the loan is commonly called a(n)

A) fully amortized loan.
B) balloon loan.
C) installment loan.
D) secured loan.
E) none of the above

Question 66

You are headed to the mountains for some climbing this summer and you need some gear. The local mountaineering shop is offering 6% financing on all purchases before the end of the month. Your savings account is currently paying 5%, and you are in a marginal tax bracket of 28%. Which of the following is true?

A) Borrow from the mountain shop - it is cheaper.
B) Take the money out of savings - it is cheaper.
C) It does not matter where you get the money; it will cost the same.
D) You should seek competent financial help.
E) None of the above are true.

Question 67

The ________ is the true simple interest rate paid over the life of a loan and provides a reasonable approximation for the true cost of borrowing.

A) APP
B) APR
C) ADR
D) ARR
E) none of the above

Question 68

Which is better, a fixed-rate loan or a variable-rate loan?

A) a fixed-rate loan, because the lender bears the risk that interest rates will go up
B) a fixed-rate loan, because they generally cost less than variable-rate loans
C) a variable-rate loan, because they generally cost less than fixed-rate loans
D) a variable rate loan, because the lender bears the risk that interest rates will go up
E) Neither is necessarily better; the choice illustrates the "risk and return go hand in hand" principle.

Question 69

Calculate the interest on $6,000 borrowed at an annual rate of 9% under the simple interest loan method for 9 months.

A) $270
B) $360
C) $405
D) $450
E) $540

Question 70

Steven is beginning a new job but has not yet been paid. He needs $400 to pay his rent this month. Steven is going to borrow the money through a Payday Loan establishment. They are charging him an $80 fee to borrow the money for 10 days until he receives his first paycheck. What is the actual interest rate that Steven is being charged?

A) 7.3%
B) 73.0%
C) 730.0%.
D) .073%
E) none of the above

Question 71

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.

Question 72

Your brother, a banker, has just approved a loan for you, an add-on interest loan. You will borrow $2,000 for one year with a 12% annual interest rate. What is your monthly payment?

A) $166.67
B) $186.67
C) $240.00
D) $256.78
E) none of the above

Question 73

What is the name of the interest rate banks charge to their most creditworthy customers?

A) main rate
B) blue chip rate
C) prime rate
D) premier rate
E) none of the above

Question 74

What strategy should you use to obtain the lowest possible APR on a loan?

A) Get a variable-rate loan.
B) Keep the term (length) of the loan as short as possible.
C) Make a large down payment.
D) Provide collateral.
E) All of the above.

Question 75

Gary is taking out a $5,000 loan for 1 year at an APR of 12%. His bank has offered him a loan using the add-on method. Using first the financial calculator method and the add-on method calculate Gary's monthly loan payment.

A) $444.24; $466.67
B) $475.00; $448.94

Question 76

Veronica was offered a loan using the discount method of calculation by her bank. She will borrow $10,000 for one year at an APR of 11%. How large will the check be that Veronica receives? How much must she repay?

A) $11,100; $11,100
B) $10,000; $11,100
C) $8,900; $11,100
D) $8,900; $10,000
E) None of the above is correct.

Question 77

You just bought a car and borrowed $15,000 for 5 years at 8% APR. Using the simple interest method; by the time you pay off this loan your total finance costs will be closest to which of the following?

A) $6,000
B) $3,249
C) $3,784
D) $1,200

Question 78

Congratulations! You have just graduated from college and are determining what your monthly student loan payments will be. After consolidating all of your loans, you have a balance of $18,000. At 8% APR for 10 years, what will your monthly payments be?

A) $1,866.66
B) $161.50
C) $218.39
D) $1,440.14

Question 79

You just received a loan from your banker to buy seed and plant your alfalfa field. The loan is a discount loan and is for $5,000 for 1 year and the quoted rate was 10%. What is your APR?

A) 10.00%
B) 11.11%
C) 12.23%
D) 14.33%
E) none of the above

Question 80

Explain why add-on installment loans are more expensive than simple interest loans.