Question

John has completed an application for a 7-years personal loan for the amount of $28833. In the application, he indicated that the money would be used to repay (consolidate) various debts and to make a down payment on a car which he needs to buy for transportation to and from work.

John arrived in Australia two years ago. He has been living with his mum in his mum’s renting apartment. Two weeks ago he began working for Coles Ltd. as a store manager, and he plans to rent his own apartment at the beginning of next month. He has banked with you since he arrived in Australia and has an average credit rating.

His application was sent to Meri, a consumer lending officer at Monash Bank. After going over the application, Meri called John for a few details about his job, his new apartment and the car he was going to purchase. His net monthly income (after tax) is expected to be $6471 and good benefits. He was optimistic about his future job prospects.

John is expecting to rent an apartment for $1600 per month, and part of the Loan would be used for the first month, last month, and one-month deposit upfront. Another portion of the Loan was going to be used for a car which was selling for $30,000. The car dealer would finance him $25000 for 7 years at an annual interest rate 14%.

The remaining amount of the Loan was going to be used to pay off two utility bills (gas and water) and the $15,500 he owed to a credit union. John explained that his sister had an account with Monash Bank and if need be would be a guarantor for his Loan.

Meri worked on this loan application and considered that the interest rate to this loan would be 13% annually. Expected monthly expenses are: food $700, utility and car expenses $360 for each. Monash Bank has a minimum disposable income ratio of 20% for personal loans. [Note: Disposal income is the income net of all monthly expenses. Disposal income ratio is the disposal income over one’s income.]

Answer the following questions 1(A) to 1(D):

1(A). What are the monthly payments of the loan under assessment and the car loan, respectively? (Keep two decimals on figures)

PMT of Loan Under Assessment :

Car Loan PMT :

1(B). What is John’s ratio of disposable income? (Keep two decimals on figures, do not present your answers in percentages)

1(C). Should Meri recommend approval of the Loan, given the bank's policy? Why?

1(D). Should the bank require that John’s sister guarantee the Loan? Why or why not?

Answer 1

a) The best way to solve these kind of problems would through financial calculator or excel. Though we calculate it manually using formula as well.

The formula for emi (equal monthly installments) = {P∗i∗(1+i)^n}/{(1+i)^n −1}

where P: loan amount

i: monthly interest rate

n : no of installment

monthly payment for loan under assessment = {28833*0.13/12*(1+0.13/12)^84}/{[(1+0.13/12)^84] - 1}=524.52

note that monthly rate would be annual rate/12 hence 0.13/12

monthly payment under car loan would be = {25000*0.14/12*(1+0.14/12)^84}/{[(1+0.14/12)^84] -1}= 468.50

Let us take round off value of 525 and 469 as a round off value for Loan under assessment and car loan.

B) Let us form an table to estimate all the montly expense.

expense	value
personal loan emi	525
car loan emi	469
rent	1600
food	700
utility	360
car expense	360
total expense	4014

Total monthly Income (as mentioned in the problem)= 6471

Therefore monthly disposable income = total income- total expense = 6471-4014=2457

Disposable ratio = (Monthly disposable income)/ (Total Income) = 2457/6471= 0.3797=0.38 (closest to two decimal places)

C) Meri should recommend the approval of the loan as John disposable ratio is almost double than the requirement. Also he has an average credit score and has been there in Australia and regularly banking with the bank since last 2 years. Also his mother and sister are permement residents of Australia as well with sister's account with the same bank.

D) For banks one of major risks is credit default risk and any measure to safeguard the same is a welcome measure. Note that John has arived in Australia two years ago but the tenure of the loan is 7 years, though John has a good prospective future and earns enough to take care of all the expenses but a guarantor would safeguard the bank in case of a default.