Kembara’s Financial Solutions - Focus on Retail Borrowing
What kind of borrowing is offered to retail customers, and how: loans, mortgage loans, and overdrafts are available from banks. Borrowing allows people to spend more money than they have on occasion because they want to or need to. Since they frequently put their money in retail bank accounts, the bank is frequently their first stop when they need to borrow money. Mortgages, loans, and overdrafts The three most popular borrowing options offered by banks to retail consumers are loans, mortgages, and overdrafts. The examples that follow show each of these. Example Dot, Jade, and Anna are three recent college grads who have started full-time jobs. Dot decides she needs to get a car because her employment is some distance from her house and public transportation is not excellent. She discovers the perfect car, a used Volkswagen Polo that will run her about $6,000. Dot requests a $6,000 loan from her bank because she doesn't have much saved up. The loan has a three-year repayment term with monthly payments and an 8% annual percentage rate of interest. In the aforementioned illustration, Dot obtained financing from a bank to buy the car. Bank loans can be obtained for any purpose; a car is not a requirement. However, the typical characteristics of a bank loan are that it is typically: • for a fixed term that is typically less than five years (in the example above, it is three years); • at a fixed rate of interest (8% in the example above); • with a defined repayment schedule (monthly in the above example). Another name for Dot's loan is an unsecured loan. This is due to the fact that the bank does not demand that any security, such as the car, be given to it while the loan is still open. Example Jade is blessed to have wealthy parents who have supported her efforts to purchase a home of her own. Jade has located the perfect property, but it will cost her $250,000 to buy it. Her parents have agreed to pay her $50,000, and she takes out a mortgage loan from the bank to borrow the remaining amount. The agreement stipulates that Jade will pay back the loan in equal monthly installments over a 25-year period at the bank's standard variable rate (currently 6%, but subject to change). If Jade defaults on the loan, the bank has the right to seize Jade's property in order to collect the outstanding debt. The mortgage loan in the aforementioned illustration is referred to simply as a mortgage. Mortgage loans are almost commonly obtained to purchase real estate, and because they frequently involve large sums of money, they are typically repaid over longer periods of time than other types of loans. The bank that lends the money typically charges a variable interest rate that can go up or down to keep in step with market interest rates because the money will be returned over such a long period of time. Furthermore, the mortgage loan has the added security feature of being secured on the property for the bank, unlike the majority of other types of loans. The bank may seize property to cover the loan balance if the borrower doesn't make the required payments. Other loans are referred to as unsecured since they typically lack the same feature. In conclusion, mortgages typically: • have a predetermined term (25 years in the example above); • have a variable interest rate (the bank's "standard variable rate" in the example above); • have a predetermined repayment schedule (monthly in the example above); and • are secured by the property for which the loan is being used. Example Anna makes a fluctuating living as a writer. She makes a lot of money in some months, but her revenue drops throughout the summer since she would rather travel than write. Anna enjoys eating and looks forward to dining out frequently. She enjoys eating out so much that in some months, the habit actually causes her to lose more money than she makes. Anna has a deal with her bank that allows her to spend up to $1,000 more than she has in her account due to her changeable income, usually during the lean summer months. Apparently, this is an overdraft facility. The bank may withdraw this facility at any time, but there is no defined deadline or timeline for repayment. During the busy winter months, it is anticipated that Anna will be able to pay off the overdraft. The bank will impose an overdraft fee on Anna that is now 10% per annum, but this rate is subject to change at any moment with at least 14 days' notice from the bank. In order to initiate the overdraft facility, Anna must additionally pay the bank a $50 one-time or yearly arrangement charge. An overdraft facility is an example of one that is typical. Since overdrafts are flexible, Anna is free to use all $1,000 as she sees fit. She can also pay off the overdraft and then use the opportunity to withdraw money once more in the future. Though it would be rare, the lending bank has the legal right to request repayment at any moment. In terms of the interest rate they impose, overdrafts are also rather pricey. In addition, there may be a setup fee for the facility (known as an arrangement fee). In conclusion, bank overdrafts typically involve: • adaptable, allowing withdrawals, repayments, and subsequent withdrawals up to the overdraft limit ($1,000 in the case above). • In addition, an arrangement fee of up to $50 may be charged at a variable rate of interest (in the example above, the bank's overdraft rate). • Unsecured and reimbursable upon request.
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