Consumer Finance

Prepared by

Prof. Rahul MailcontractorAssistant Professor,

Jain College of MCA and MBA,Belgaum.

Definition

• The term consumer finance refers to the activities involved in granting credit to consumers to enable them to possess goods meant for everyday use.

• Business procedure through which the consumers purchase semi durable and durable goods other than real estate in order to obtain a series of payments extending over a period of 3 months to 5 yrs.

Types of Consumer Credit

• Revolving credit: it is a ongoing credit arrangement where by the financier on a revolving basis grants credit. The consumer is entitled to avail credit to the extent sanctioned as credit limit ex: Credit Card

• Fixed credit: it is like a term loan where by the financier provides loans for a fixed period of time. The credit has to be repaid within a stipulated period ex: monthly installment loan, hire purchase.

• Cash Loan: Under this type of credit banks and financial institutions provide money with which the consumers buy goods for personal consumption here the lender and seller are different and lender does not have the responsibility of seller.

• Secured Finance: when the credit granted by financial institutions is secured by collateral it takes the form of secured finance. The collateral is taken by the creditor in order to satisfy the debt in the even of default by the borrower. The collateral may be in the form of personal property, real property or liquid assets.

• Unsecured Finance: When there is no security offered by the consumer against which money is granted by financial institutions, it is called unsecured finance.

Sources of Consumer Finance

• Traders : The predominant agencies that are involved in consumer finance are traders. They include sales finance companies, hire purchase and other such financial institutions.

• Commercial Banks: Commercial Banks provide finance for consumer durables. Banks lend large sum of money at wholesale rate to commercial or sales finance companies, hire purchase concerns and other such finance companies. Banks also provide consumers personal loans meant for purchasing consumer durable goods.

• Credit Card Institutions: These institutions arrange for credit purchase of consumer goods through respective banks which issue the credit cards. The credit card system enables a person to buy credit card services on credit. On presentation of credit card by the buyer, the seller prepares 3 copies of the sales voucher, one for seller, bank/credit card company and 3rd for the buyer. The seller forwards a copy to the bank for collection. The seller’s bank forwards all such bills to the card issuing bank or company. The bank debits the amount to the customers account. The buyer receives monthly statement from the card issuing bank or company and the amount is to be paid within a period of 20 to 45 days without any additional charges.

• (NBFC’s):Non banking Financial companies constitute an important source of consumer finance. Consumer finance companies also known as small loan companies or personal finance companies are non saving institutions whose prime assets constitute sale finance receivables, personal cash loans, short and medium term receivables. These companies charge substantially higher rate of interest than the market rates.

• Credit Unions: A credit union is an association of people who agree to save their money together and in turn provide loans to each other at a relatively lower rate of interest. These are caller co-operative credit societies. They are non profit deposit taking and low cost credit institutions.

Mode of Consumer Finance• Open Account: any number of purchases per

month up to a certain value

• Credit card: most popular mode of finance

• Revolving account: purchases during a month and payment on installment basis

• Option plan: option of paying in full or part

• Installment account: Equal periodic installments

• Cash loan : purchases are made through cash and payment is made periodically.

Demand for consumer finance(Factors)

• Increase in consumer disposable income

• Enhancement in real income of consumer

• Convenient size of installment payment

• Growth in nuclear families leading to number of house holds

• Lower charges

• Down payment and credit contract

Products covered

• Consumers financing covers a wide range of products such as cars, Televisions, washing machines, refrigerators, Air conditioners, computers etc. The products covered possess some distinct feature such as durability, sustainability, salability and serviceability etc.

Terms of Finance• Eligibility : The basic eligibility for consumer finance is the income of the

individual customer and the nature of employment. The EMI’s are worked out on the basis of number of installments and tenure of employment of the customer.

• Guarantee: Financiers insist on guarantee for the credit availed by the customer. Guarantee is obtained in order to ensure prompt payment of the installment.

• Tenure : Consumer finance is granted for short period ranging from 3 months to 5 yrs. The tenure also depends on the value of the asset purchased. Assets of smaller value are given short term credit and assets of higher value are given comparatively longer term credit.

• Rate of interest : the effective rate of consumer finance is much higher than the rates applicable to business finance. This is because the loans are granted based on the personal integrity of the customer. The effective interest varies between 20% and 30%. Finance companies use different methods of disclosing interest rates.

• Other charges : in addition to rate of interest finance companies also charge documentation fees, processing fees, management fees, service charges, collection costs etc. A deposit is also taken as a precautionary measure to guard against default in payment of installments.

• Mode of payment: in case of individual loans payments are usually collected in advance in the form of post dated checks.

• In the case of institutional financing there is an arrangement for deduction of installments from the salary of the employee which is remitted to the finance company.

• Credit evaluation: A verification of details furnished by the customer is carried out in order to ascertain the validity of the statement and the credit standing of customer. The evaluation may be carried out by the financier or an independent agency details collected include age, monthly income, status of employment, previous record, assets own, borrower’s equity, type of collateral offered etc.

Pricing of Consumer Finance• The pricing of consumer credit depends on the

extent of facility offered by the financier. The components of price are risk free rate of interest assuming no probability of default, default risk premium, administrative expenses.

Advantages of Consumer Credit(Finance)

• Enjoying position : An important benefit of consumer credit is that it allows people to enjoy possession of goods without having to pay for them immediately.

• Saving : consumer credit allows for a mechanism of compulsory saving this induces people to use their income wisely and promotes thrift among people.

• Convenient mode : Consumer credit offers a convenient mode of acquiring consumer durables.

• Meeting emergency : Consumer credit is useful in meeting emergencies such as illness, accident and death which involve unexpected expenses.

• Maximization of revenues: Consumer credit facilitates speedy disposal of goods which would have remained unsold in the absence of credit facility to consumers. This helps in increased sales and profits through credit sales.

• Accelerates industrial investment: Consumer credit accelerates investment in consumer durable industry giving rise to growing level of income and employment.

• Enhanced living standard : consumer credit enables people of limited means to acquire goods to enhance their general standard of living.

• Promoting Economic development : Consumer credit promotes higher levels of investment, employment and income thus raising the effective demand and promoting higher standard of growth and development.

Disadvantages of Consumer Finance

• Thoughtless buying : consumer credit being attractive tempts people to buy goods indiscriminately even if they are not needed.

• Insolvency : Credit forces people to mortgage a substantial portion of their fixed future income which may lead to insolvency and bad debts.

• Costly Credit : Consumer credit with its benefit of convenient buying brings with it severe consequence of costliness of credit because the effective rate of interest is much higher than on paper.

• Risk to traders : Consumer Credit posses considerable risk to traders because if the buyer defaults on payment the lender can acquire the good but cannot sell it at the original price.

• Artificial Boom: Consumer credit creates artificial boom in consumer durable industry.

• Bad Debt : Consumer credit generates a substantial amount of revenue for traders but there is a high risk of bad debt.

• Economic instability: Indiscriminate consumer credit leads to economic instability because of recurrence of booms and slumps. In boom there is credit extension and in recession there is credit tightening.