Lecture 5Consumer Lending

Learning objectives

1. Explain what consumer loans are

2. Outline the major types of consumer loans

3. Explain how different types of consumer loan applications are evaluated

4. Explain, with the help of a specimen consumer loan applications, how the principles of lending are applied in practice 2

5. Enumerate the precautions to be taken in assessing consumer loan applications

6. Discuss how credit scoring and consumer loan applications is done

7. Briefly explain the laws and regulations affecting consumer loans

8. Outline the trends in consumer credit9. Explain the pricing aspects of consumer

loans

Consumer loans

Consumer loans are generally regarded as loans for household and personal needs including:

Furniture, electrical appliances, travel, boats, homes and so on.

May be defined as: Types of loans made to finance consumption,

rather than productive purposes.4

Loans may be classified by: Purpose: Houses, holidays, motor vehicles higher

study, etc. Term: Short-term (< 1 year), Medium-term (1–3

years) and Long-term (> 3 years) Terms of repayment: Instalment loans with regular

P&I repayments, and non-instalment loans for emergency purposes repaid in one lump sum

Security: Secured and unsecured loans5

Types of consumer loans

Personal Loans: Generally 2–5 years with monthly instalments

(although can be non-instalment loan) Usually negotiated directly with the bank and

requires a loan application form Also includes

Overdrafts/revolving line of credit Margin lending for share investments with loan- to-value

ratio (LVR) between 40% and 70%

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Personal loans

Offered by banks and other companies under franchising agreement

Many consumer benefits including: Convenience Monthly summary Financial freedom No procedural hassles Low credit card fees

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Credit cards

Many card-provider benefits including: Relatively higher risk-adjusted returns Huge market Higher interest rates Expanding services Price-insensitive customers

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Merchant benefits including: Increased number of customers Prompt payment for credit sales Increase in number of prospects Customer profiling Advantage over other merchants

Important caveat — Card providers do face increased risk from credit card fraud and ensuing exposures

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1. Credit card swiped in terminal2. Cardholder and transaction details transferred

to merchant’s institution3. If card issued by different institution, details

routed to card-issuing firm4. Acceptance/Decline notification transferred to

merchant’s institution5. Acceptance/Decline sent to merchant6. Merchant verifies credit card signature

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Six steps in credit card transactions

Evaluation sees use of 3 Cs Character:

Track record of the individual Ability Purpose of loan Integrity of the borrower Spending habits

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Evaluating consumer loans

Capacity to Repay: Net income Deposit balances with bank Stability of job Stability of residence Borrower’s margin

Collateral: Assets that may be recovered in default, although

seizure must be a last resort12

1. Obtaining prescribed application form2. Conducting preliminary assessment 3. Accepting and loading application4. Taking securities5. Determining interest, fees, charges6. Approving/rejecting application7. Supervising of loan and follow-up

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Step-by-step assessment of personal loans

1. Obtain completed application form2. Conduct credit checks via Credit

Advantage, other institutions, employer3. If checks satisfactory, load details into

computer to assess whether sufficient points available

4. Create and provide card to applicant with letter of conditions etc.

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Step-by-step assessment of credit card loans

Personal Loan Application source www.commbank.com.au

Character: Lender obtains authority to collect information

from third parties Personal details to be provided and evidenced Applicant's employment history Information about personal referees

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Specimen form of consumer loans

Capacity: Current employment details Capacity to service the proposed debt Details about item(s) to be purchased Amount to be borrowed and proposed repayment

arrangements Whether existing bank customer to verify general

financial history

Collateral: What assets applicant has to indicate financial security

or requirement for financial guarantees 16

Application source www.commbank.com.au Largely similar to personal loan applications with

additional information: Type of card required Interest-free periods (if any) Membership of ‘rewards’ program(s)

The applicant’s choices in card requirements will be reflected in the interest rate charged on the credit card.

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Credit card loans

A great many precautions must be taken in granting consumer credit, including:

Inconsistent/withheld information Dangers of over-committed borrower Proper signing of all loan documentation Meticulously ensure bank’s lending policy is

adhered to Proper searches for bankruptcy or other credit

problems must be conducted

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Precautions to be taken in granting consumer loans

Credit scoring provides many advantages including: Large volume of credit applications can be handled

quickly Lower cost than judgemental methods Lower staff training time and costs Speedier approvals for client and can be done via

internet Uses key variables in statistical model such as

age, income, house ownership19

Credit scoring consumer loan applications

Consumer credit governed under numerous legislative acts

National Credit Code Applies to all credit contracts Applies for investment property loans as well Doesn’t apply to margin loans

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Anti-Discrimination Laws Credit may not be withheld on the basis of age,

sex, religion, race or nationality Code of Banking Practice

Voluntary code of Australian Bankers Assoc Trade Practices Legislation

Anti-competitive and deceptive conduct Privacy Legislation

Borrower must authorise information access

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Trends in Consumer Credit

Trends in Personal Lending Sustained growth Dominated by motor vehicles and other consumables

Trends in Credit Card Lending Credit card figures not reported separately and so

includes revolving lines of credit On consolidated figures, only around 50% of available

credit is actually being used

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Loan Pricing: Is a function of the cost of funds, risk,

macroeconomic factors, inflation and competitor’s pricing

Either fixed or variable rate with or without early payment penalties

Fees add to to profitability and an important loan pricing considerations

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Pricing and structuring

Loan Structuring: Refers to repayment structure and any other

relevant conditions Must be supported by appropriate documents

at all stages May contain guarantees or other collateral Finalisation of the terms

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What did you learn today?

You learnt the application of lending principles to consumer loan decisions.

In the next session we look at application of lending principles to specific situation of consumer loans: real estate loans

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