FIN533 Chapter 4: Consumer Credit Sources and Management

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Questions and Answers

What is the primary factor that determines the mortgage payment amount?

ELR (correct)

BLR

Cost of Credit

What is the effect of a longer loan term on the total interest paid?

It increases the total interest paid (correct)

It depends on the lender's risk

It reduces the total interest paid

It has no effect on the total interest paid

What is one way to reduce the lender's risk and subsequently the interest rate?

Provide collateral to secure the loan (correct)

Accept a fixed interest rate

Have a longer loan term

Make a small down payment

What type of interest is computed only on the principal amount without compounding?

Simple interest Signup and view all the answers

What is the requirement for banks regarding the display of interest rates?

They must display both the BLR and BR Signup and view all the answers

What is the primary consideration when deciding which kind of loan to seek?

The cost of the loan Signup and view all the answers

What type of loans are typically offered by parents or family members?

Inexpensive loans Signup and view all the answers

What is the primary purpose of the annual percentage rate (APR)?

To compare rates with other sources of credit Signup and view all the answers

What type of institutions offer medium-priced loans?

Commercial banks, savings and loan associations, and credit unions Signup and view all the answers

What is included in the finance charge?

Interest costs, service charges, credit-related insurance premiums, or appraisal fees Signup and view all the answers

What is the primary objective of developing a plan to manage debts?

To reduce the debt burden Signup and view all the answers

What formula is used to determine the interest rate by banks in Malaysia under the new Base Rate system?

Benchmark cost of funds and Statutory Reserve Requirement Signup and view all the answers

What was the main reference rate for new retail floating rate loans in Malaysia before January 2015?

Base Lending Rate Signup and view all the answers

What is reflected in a spread in the new Base Rate framework?

Borrower credit risk, liquidity risk premium, operating costs, and profit margin Signup and view all the answers

What is the minimum impact expected on borrowers with the introduction of the new Base Rate system?

Minimum impact Signup and view all the answers

What is Maybank's Base Rate set at?

1.75% Signup and view all the answers

What is the effective rate that the customer will have to pay on the mortgage with Maybank's Base Rate system?

3.25% Signup and view all the answers

What is the formula for calculating the dollar cost of borrowing?

PxrxT Signup and view all the answers

Which method of calculating interest includes new purchases in the average daily balance?

Average daily balance method Signup and view all the answers

What is the result of multiplying the monthly rate by the previous balance in the previous balance method?

The finance charge Signup and view all the answers

What is the purpose of notifying creditors if you can’t make a payment?

To develop a plan to manage debts Signup and view all the answers

Which method of calculating interest is based on the full amount of the original principal?

Add-on interest Signup and view all the answers

What is the result of dividing the total of both the interest and the principal by the number of payments to be made?

The monthly payment Signup and view all the answers

What should a debt collector provide to you within five days of contacting you?

A written notice of the amount owed, creditor's name, and right to dispute the debt Signup and view all the answers

What is a consequence of not requesting verification of the debt within 30 days?

You must pay the debt in full Signup and view all the answers

Which of the following is a reason for debt according to the text?

To show that they have as much money as other people Signup and view all the answers

What happens if a debt collector does not send verification of the debt?

You can insist that communication about the debt cease Signup and view all the answers

What can you do if you receive a written notice of debt from a debt collector?

All of the above Signup and view all the answers

Study Notes

Base Rate (BR) System

In January 2015, the Base Lending Rate (BLR) structure was replaced with a new Base Rate (BR) system in Malaysia.
Under BR, banks determine their interest rate based on a formula set by the central bank, taking into account their benchmark cost of funds and Statutory Reserve Requirement (SRR).
The BR system also considers other components of loan pricing, such as borrower credit risk, liquidity risk premium, operating costs, and profit margin.

How Does it Affect You?

The change to the BR system has a minimum impact on borrowers.
Banks like Maybank are required to reveal their base rate and disclose their margin, which determines the Effective Lending Rate (ELR).
For example, Maybank's Base Rate (BR) is 1.75%, and the ELR is presented as "base rate +1.50%", resulting in an effective rate of 3.25%.

Loans and Interest Rates

Loans approved and extended prior to January 2, 2015, will still follow the old BLR until the end of the loan tenure.
New loan applicants and refinancing applicants will be affected by the new BR framework, with interest rates taking effect from the date.

Tackling the Trade-Offs

Longer loans result in lower payments, but more total interest.
Lender risk versus interest rate: ways to reduce the lender's risk and the interest rate include accepting a variable interest rate, providing collateral, making a large down payment, and having a shorter loan term.

Calculating the Cost of Credit

Simple interest is computed on principal only and without compounding.
The finance charge is the total dollar amount you pay to use credit, including interest costs, service charges, credit-related insurance premiums, or appraisal fees.

Sources of Consumer Credit

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.
Expensive loans: finance and check cashing companies, retailers such as car or appliance dealers, and bank credit cards and cash advances.

The Cost of Credit

The annual percentage rate (APR) is the percentage cost of credit on a yearly basis.
APR is the true rate of interest, allowing you to compare rates with other sources of credit.

Methods of Calculating Interest

Simple interest on the declining balance: interest is paid only on the amount of original principal not yet repaid.
Add-on interest: interest is calculated on the full amount of the original principal, added to the principal, and the total of both is divided by the number of payments to be made.
Adjusted balance method: finance charges are calculated after payments made in the billing period have been subtracted.
Average daily balance method: creditors add your balances for each day in the billing period, divide this total by the number of days in the billing period, and then multiply this average by the monthly interest rate.

Managing Your Debts

Notify creditors if you can't make a payment.
The Fair Debt Collection Practices Act regulates debt collection agencies.
You can dispute the debt or pay it, and you have the right to verification of the debt within 30 days.

Reasons for Debt

Emotional problems such as the need for instant gratification or pleasure.
The expectation of instant comfort among young couples who overuse the installment plan.
To show that they have as much money as other people.
Overindulgence or excessive gratification of a children's wishes.

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Description

Test your understanding of consumer credit sources, interest calculation, debt management, and assistance programs. Analyze the major sources of consumer credit, determine the cost of credit, and develop a plan to manage your debts.