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Personal_Finance_1e_Ch06 - baj01275_c06_134-157.qxd 02:07am...

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6 USING CONSUMER LOANS The Wise Use of Debt Starting Point Go to www.wiley.com/college/bajtelsmit to assess your knowledge of using consumer loans. Determine where you need to concentrate your effort. What You’ll Learn in This Chapter Types and sources of consumer loans Warning signs of too much debt Bankruptcy and its alternatives After Studying This Chapter, You’ll Be Able To Compare types of consumer loans and lenders Assess the characteristics of different types of loans Manage your debts wisely Establish a plan for managing your consumer credit and reducing outstanding balances baj01275_c06_134-157.qxd 2/09/07 02:07am Page 134
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6.1 CHARACTERISTICS OF CONSUMER LOANS 135 INTRODUCTION The most common types of consumer loans are home equity loans, student loans, and automobile loans. Consumer loan contract terms vary, depending on the lender and type, so you must be informed to make the best choices. As with credit cards, lenders offer better loan terms to more creditworthy borrowers. In this chapter, you’ll learn how to challenge your credit information if it’s incor- rect and how to reduce your debt and get it under control before you get into financial trouble. 6.1 Characteristics of Consumer Loans Consumer loans vary in the interest rates charged, payment arrangements, and col- lateral required. Typically, a lender charges lower interest rates if you meet contract terms that reduce the risk of your defaulting on the loan. In this section, you’ll read about your options. 6.1.1 Interest Rates Interest rates on consumer loans can be either fixed or variable. With a fixed- rate loan, the same interest rate applies throughout the life of the loan. With a variable-rate loan, the periodic rate fluctuates along with a predetermined mea- sure, such as the prime rate or the Treasury bill (T-bill) rate. The prime rate is the rate banks charge to their most preferred customers, and it is commonly used as a base rate for variable-rate loans. For example, suppose you took out a loan in February 2004, when the prime rate was 4 percent, and agreed to pay the prime rate plus 2 percentage points in interest. The interest rate on your loan would have started out at 6 percent, but you took the risk of unexpected increases in future payments. For example, by October 2006, the prime rate had more than doubled, to 8.25 percent, so your loan rate increased to 10.25 percent, resulting in a substantial increase in your monthly payment. In periods when interest rates are rising, especially when they rise rapidly, a variable-rate loan can subject you to unexpected increases in required payments. However, variable-rate loans generally carry lower initial interest rates than fixed-rate loans because the lender isn’t facing the risk of hav- ing the interest rate fall behind market rates on comparable loans. Therefore, if the introductory rate is low enough, or if you don’t expect to borrow the money for a long period of time, you might find it worthwhile to take out a variable- rate loan, despite the risk of increased payments.
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