Loans

Loans Script, Activity, and FAQ

Slides for the script can be accessed here.

Script

  1. Introduce yourself and the topic today (loans)
  2. Introduce the topics for today
  3. A loan is an act of providing leverage to another party in exchange for future repayments of the amount borrowed plus interest either. Forms of such leverage may be:
    • Large amounts of money,
    • A property, or
    • Other owned goods

Note that a loan consists of the repayments (called principal) and interest

A personal loan provides you with the credit you need:

  • This helps with large expenditures that require up-front payment (ie. tuition for school or to start a business)
  • These typ es of loans vary in size, rates, options, and payment schedules depending on the provider and your financial situation

 

Mortgages is another type of loan

  1. It’s a legal agreement by which a bank lends you money at an interest in exchange for taking title of your property (ie. house), where the house acts as a collateral
  2. A mortgage requires a down payment, which is a portion of the amount of the house upfront
  3. The remainder of the amount for the house will be paid off by monthly mortgage payments, which consists of repaying the amount of the house plus interest
  4. The interest depends on your credit history and economic conditions (such as the overnight rate determined by the Bank of Canada)
  5. There are 2 options for a mortgage:
    • Fixed rate mortgage where the interest rate is set and payment amount remains constant from month to month
    • Variable rate mortgage where interest rate adjusts periodically, leading to fluctuations in monthly payments
    • If cannot make mortgage payments, may result in foreclosure

 

Interest Rates

Interest rate is the proportion of the outstanding loan charged as extra to the borrower as a “fee” for borrowing. This represent a fee for you to use someone else’s money for a period of time

The interest rate is usually expressed as an annual percentage of the loan called the Annual Percentage Rate (APR):

  1. This is the annual interest rate
  2. Prime rate is the lowest rate that commercial banks charge their customers
    • Usual loan interests are quoted based on this rate in a “p + x”% charged for your loan
  3. The interest and repayment terms will vary based on loan amount and your financial situation

 

Interest Rate Activity

Goal: to distinguish between simple interest rate and compounding interest rate

Question: $2,000 loan at 20% APR is repaid at the end of 1 year, how much would you be paying in total? APR is the annual percentage rate, which is the rate that’s usually quoted on statements

Simple Interest Rate:

  • The principal payment is $2000
  • The interest is 20% of $2000, which is $400
  • So the total payment at the end of the year is $2400

Compounding Interest Rate:

For this example, go to the link: http://www.moneychimp.com/calculator/compound_interest_calculator.htm

 

This is actually how banks will calculate your payments (a compounding basis)

 

  • Current principal: 2000
  • Annual addition: 0
  • Years to grow: 1
  • Interest rate: 20
  • Compound interest: 12 (this means it compounds monthly)
  • Make additions at: start
  • Click calculate
  • Future value of $2438.78 is the amount you pay at the end of the year
  • This consists of $2000 as principal and $438.78 as interest

From this exercise, note that the payment amount with compounding interest is higher than the simple interest. This is because compounding interest  means that interest is calculated more often and involves both the principal and interest amount in recalculating the new interest. This leads to a higher interest payment

 

FAQ

1. Why do I need a loan? A loan is beneficial in times when you have a shortage of cash. For example you may need a safety net for when your business experiences cash shortfalls for a few weeks. This allows you to collect your funds within a short period of time and continue your business. A similar situation can be applied to your personal account.

2. What do I need to get a loan? A credit score (typically provided by Equifax), personal income statement or payslips (ie. your T-4), and any existing accounts. A loan is typically offered at your financial institution and can vary based on your needs.

3. How much loan can I get? The loan amount will vary greatly depending on your needs and the financial institution issuing the loan. This also depends on your credit history and how much interest you are willing to pay. Speaking with a financial advisor will provide you with the details of the loan.

4. What do I do if I cannot afford my loan payments? Speak to your lender as soon as possible. Try to ask for special arrangements if possible to pay off your loan. It is encouraged to understand the payment schedule before committing to a loan, and ask about options if you cannot make payments as per the loan schedule.

5. What is a collateral? A collateral is a something pledged as a security for repayment of loan. This reduces the risk the lender faces in case that loan payments are not received. Note that not all loans have a collateral. An example of a collateral for a mortgage is your property.