Chapter 10 - Other Financial Products

Question 1

What are the 3 ways that individuals can borrow money from banks and other lenders?

Other Financial Products

Answer 1

• Overdrafts
• Credit card borrowing
• Loans

Question 2

What is an Overdraft?

Answer 2

When an individual draws out more money than they hold in their current account.

Question 3

What is an ‘authorised’ overdraft?

Answer 3

An overdrawn amount that is within the limit previously agreed with the bank.

Question 4

What is an ‘unauthorised’ overdraft?

Answer 4

An overdrawn amount that is not within the limit previously agreed with the bank.

Question 5

What are the fees accosiated with ‘authorised’ overdrafts?

Answer 5

Agreed in advance so usually have lower rates of interest. Some banks allow small overdrafts with no fees to prevent angry customers.

Question 6

What are the fees of ‘unauthorised’ overdrafts?

Answer 6

Often very expensive - high interest and a fee. Bank may refuse to honour payments from unauthorised overdrawn account.

Question 7

Are overdrafts a good way to borrow money?

Answer 7

No.
* Expensive
* Borrowers should restrict use to temporary periods
* Avoid unauthorised overdrafts.

Question 8

Where are Credit Cards most commonly used?

Answer 8

In the UK

Not so much in the rest of Europe

Question 9

How do the credit card companies make money from retailors?

Answer 9

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.

Question 10

Is interest high on Credit Cards?

Answer 10

Yes, compared to other forms of borrowing.

Question 11

What 2 groups can Loans be divided into?

Answer 11

Secured and Unsecured Loans

Question 12

What is an unsecured loan?

Answer 12

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.

Question 13

What are unsecured loans typically used to purchase?

Answer 13

Consumer Goods

i.e. if you were to finance a computer or papa johns pizza

Question 14

What do lenders assess when deciding to offer out a loan?

Answer 14

The lender will check the creditworthiness of the borrower.

income, credit score - main quesiton is, can they afford to pay this?

Question 15

Will an unsecured loan or secured loan have a higher interest rate?

Answer 15

Unsecured loan.

Question 16

What is a commercial loan?

Answer 16

A loan given to a company (can be an overdraft or long-term borrowing)

Property can also be bought with this

Question 17

What influences the cost of borrowing?

Answer 17

• Form of borrowing
• How long the money is required for
• Security offered
• Amount offered

Question 18

What is the effective annual rate formula?

Other Financial Products (Loans)

Answer 18

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

Question 19

What is comprised in the APR (Annual Percentage Rate)

Other Investment Products (Loans)

Answer 19

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

Question 20

What is a mortgage?

Answer 20

A mortgage is simply a secured loan, with the security taking the form of a property. (Typical loan time is 20-25 years)

Question 21

How are applicants assesed for a Mortgage Loan

Answer 21

• Loan-to-income ratio
• Existing outgoings
• Future problems (child costs, redundancy etc, fluctuations in pay)
• Loan-to-value ratio

Question 22

What are the four main methods by which the interest may be charged on a mortgage? (not to do with types of mortgage)

Answer 22

• variable rate
• fixed rate
• capped rate, and
• tracker rate.

Question 23

What is the loan-to-value ratio?

Answer 23

Size of loan in relation to the value of property being purchased

Question 24

What happens when you cancel a fixed-rate loan?

Answer 24

Penalties will apply

Question 25

What is a lock-in period for mortgages?

Answer 25

When after finishing the fixed-rate term, you have to be on variable rate for a couple years after.

Question 26

What is a variable rate mortgage?

Answer 26

One that has a variable rate on what the interest on the outstanding loan amount is

Question 27

What is a a fixed rate mortgage?

Answer 27

One that has a fixed % on what the interest will be on the outstanding loan amount.

Question 28

What is a capped rate mortgage?

Answer 28

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.

Question 29

What is a tracker mortgage?

Answer 29

One where the % rate of interest is linked to a benchmark, usually the bank of England's rate

Question 30

What are the 3 types of mortgages are there? (not referring to rates)

Answer 30

* Repayment * Interest Only * Offset

Question 31

What is a repayment mortage?

Answer 31

This is the standard mortgage consisting of monthly payments to the lender with each month the payment comprising both interest and capital.

Question 32

What is interest only mortgages?

Answer 32

One were only the interest amount is payed each month. ## Footnote 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.

Question 33

What is an Offset Mortgage?

Answer 33

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) ## Footnote 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.

Question 34

What is a life assurance policy?

Answer 34

Inurance in the case of death. Your family/partner gets a lump sum of cash on death

Question 35

What is the difference between whole-life assurance and term assurance?

Answer 35

* Whole-life covers a death at anytime * Term covers death within the defined period when creating the policy.

Question 36

What are the 3 types of whole-life assurance?

Answer 36

1. Non-Profit (one-lump sum) 2. With-Profits (lump sum with profits over the period that it was taken out from to death) 3. Unit-Linked Policies (directly related to the investment performance of the units)

Question 37

What are some reasons for taking out term assurance?

Answer 37

To cover the financial needs of a mortgage To generate the financial needs of your partner through income To cover the tax on death.

Question 38

When can a lender repossess the specific property which was purchased with a loan? | Exam Question

Question 39

How can the interest rates on different types of loans or accounts be readily compared? | Exam Question

Answer 39

APR - annual percentage rate

Question 40

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

Question 41

A firm offers fixed–rate loans at 6% pa charged quarterly. Ignoring charges, what is the APR on the loan? | Exam Question

Answer 41

6.13%

Question 42

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

Question 43

What are the main differences between the different ways in which interest is calculated on mortgages? | Exam Question

Question 44

What are the principal risks associated with interest–only mortgages? | Exam Question

Question 45

What is the difference between whole-of-life assurance and term assurance? | Exam Question

Question 46

What are the key differences between non-profit, with-profits and unit-linked life policies? | Exam Question

Question 47

What is a dicounted rate mortgage?

Answer 47

Lending institutions attract borrowers by offering discounted rate mortgages - e.g. 3% loan might be discounted to 2% for first 3 years.

Question 48

What’s the key advantage of a repayment mortgage over other forms of mortgage?

Answer 48

As long as the borrower meets the repayments each month, they’re guaranteed to pay off the loan over the term of the mortgage.