Chapter 10 - Other Financial Products Flashcards
What are the 3 ways that individuals can borrow money from banks and other lenders?
Other Financial Products
- Overdrafts
- Credit card borrowing
- Loans
What is an Overdraft?
When an individual draws out more money than they hold in their current account.
What is an ‘authorised’ overdraft?
An overdrawn amount that is within the limit previously agreed with the bank.
What is an ‘unauthorised’ overdraft?
An overdrawn amount that is not within the limit previously agreed with the bank.
What are the fees accosiated with ‘authorised’ overdrafts?
Agreed in advance so usually have lower rates of interest. Some banks allow small overdrafts with no fees to prevent angry customers.
What are the fees of ‘unauthorised’ overdrafts?
Often very expensive - high interest and a fee. Bank may refuse to honour payments from unauthorised overdrawn account.
Are overdrafts a good way to borrow money?
No.
* Expensive
* Borrowers should restrict use to temporary periods
* Avoid unauthorised overdrafts.
Where are Credit Cards most commonly used?
In the UK
Not so much in the rest of Europe
How do the credit card companies make money from retailors?
They charge a fee to them so that customers can use the credit card at their store. Where the credit card company pays on behalf of the customer and the customer is expected to pay that back at some other point.
Is interest high on Credit Cards?
Yes, compared to other forms of borrowing.
What 2 groups can Loans be divided into?
Secured and Unsecured Loans
What is an unsecured loan?
A loan that has no collatoral (i.e. no item to back it up if the borrower cant afford it)
Can be hard for the lender to get money back if it is unsecured. Usually they have to get legal proceedings (balifs) to reposses any of the borrowers property or items to recoup losses.
What are unsecured loans typically used to purchase?
Consumer Goods
i.e. if you were to finance a computer or papa johns pizza
What do lenders assess when deciding to offer out a loan?
The lender will check the creditworthiness of the borrower.
income, credit score - main quesiton is, can they afford to pay this?
Will an unsecured loan or secured loan have a higher interest rate?
Unsecured loan.
What is a commercial loan?
A loan given to a company (can be an overdraft or long-term borrowing)
Property can also be bought with this
What influences the cost of borrowing?
- Form of borrowing
- How long the money is required for
- Security offered
- Amount offered
What is the effective annual rate formula?
Other Financial Products (Loans)
To get the total amount to be paid:
A=P(1+(r/n))^(nt)
You can divide A by P and convert to a % to get the effective annual rate.
Alternative:
Take Quoted Rate per year, divide by frequency of charges per year and express the result as a decimal and add 1. Then multiple that by the frequency, take away one to have it easily converted into a percent.
- 12% divided by 4 = 3%, expressed as 0.03.
- 1 + 0.03 = 1.03.
- 1.034 = 1.03 x 1.03 x 1.03 x 1.03 = 1.1255.
- 1.1255 – 1 = 0.1255 x 100 = 12.55%.
A= final amount
P = Initial Amount
r = Interest rate
n = Number of times interest is applied per time period
t = Number of time periods elapsed
What is comprised in the APR (Annual Percentage Rate)
Other Investment Products (Loans)
Effective annual rate and any fees (e.g. loan arrangement fees)
APR is also known as the true cost of borrowing
This helps standardise and compare loans
What is a mortgage?
A mortgage is simply a secured loan, with the security taking the form of a property. (Typical loan time is 20-25 years)
How are applicants assesed for a Mortgage Loan
- Loan-to-income ratio
- Existing outgoings
- Future problems (child costs, redundancy etc, fluctuations in pay)
- Loan-to-value ratio
What are the four main methods by which the interest may be charged on a mortgage? (not to do with types of mortgage)
- variable rate
- fixed rate
- capped rate, and
- tracker rate.
What is the loan-to-value ratio?
Size of loan in relation to the value of property being purchased
What happens when you cancel a fixed-rate loan?
Penalties will apply
What is a lock-in period for mortgages?
When after finishing the fixed-rate term, you have to be on variable rate for a couple years after.
What is a variable rate mortgage?
One that has a variable rate on what the interest on the outstanding loan amount is
What is a a fixed rate mortgage?
One that has a fixed % on what the interest will be on the outstanding loan amount.
What is a capped rate mortgage?
One that is variable up to a theshold and should the rates go up above that you will remain at the theshold for paying interest on the outstanding amount of the loan.
What is a tracker mortgage?
One where the % rate of interest is linked to a benchmark, usually the bank of England’s rate
What are the 3 types of mortgages are there? (not referring to rates)
- Repayment
- Interest Only
- Offset
What is a repayment mortage?
This is the standard mortgage consisting of monthly payments to the lender with each month the payment comprising both interest and capital.
What is interest only mortgages?
One were only the interest amount is payed each month.
The borrower tends to put more money into investments instead each month with the aim of trying to beat the mortgage amount to pay it in a lump sum with a profit for themselves.
What is an Offset Mortgage?
A concept which works on the basis that, for the calculation and charging of interest, any mortgage is offset against, for example, any savings you may hold. (you will not recieve interst on savings)
Benefits include:
- higher-rate tax payer will not incur tax on any savings interest earned because it has been offset
against the mortgage borrowing.
- As interest is being paid on a slightly lower mortgage, it provides some flexibility to manage
finances, pay off the mortgage a little quicker and have more control.
What is a life assurance policy?
Inurance in the case of death. Your family/partner gets a lump sum of cash on death
What is the difference between whole-life assurance and term assurance?
- Whole-life covers a death at anytime
- Term covers death within the defined period when creating the policy.
What are the 3 types of whole-life assurance?
- Non-Profit (one-lump sum)
- With-Profits (lump sum with profits over the period that it was taken out from to death)
- Unit-Linked Policies (directly related to the investment performance of the units)
What are some reasons for taking out term assurance?
To cover the financial needs of a mortgage
To generate the financial needs of your partner through income
To cover the tax on death.
When can a lender repossess the specific property which was purchased with a loan?
Exam Question
How can the interest rates on different types of loans or accounts be readily compared?
Exam Question
APR - annual percentage rate
Firm A charges interest annually at 6% on loans and Firm B charges interest quarterly at 6%
pa. Which is the more expensive?
Exam Question
A firm offers fixed–rate loans at 6% pa charged quarterly. Ignoring charges, what is the APR
on the loan?
Exam Question
6.13%
An individual took out a second mortgage through a firm to finance the purchase of a second
home in Spain. It was secured on their property in the UK on which they had an existing
mortgage through another company. If the individual is unable to meet their outgoings, and
their UK property is repossessed, which mortgage will be repaid first?
Exam Question
What are the main differences between the different ways in which interest is calculated on
mortgages?
Exam Question
What are the principal risks associated with interest–only mortgages?
Exam Question
What is the difference between whole-of-life assurance and term assurance?
Exam Question
What are the key differences between non-profit, with-profits and unit-linked life policies?
Exam Question
What is a dicounted rate mortgage?
Lending institutions attract borrowers by offering discounted rate mortgages - e.g. 3% loan might be discounted to 2% for first 3 years.
What’s the key advantage of a repayment mortgage over other forms of mortgage?
As long as the borrower meets the repayments each month, they’re guaranteed to pay off the loan over the term of the mortgage.
