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How much will the bank need to charge on its loan to make a profit?

Kevin Sutter

in Student Loans

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Roger Moore on November 25, 2018

The point of balance amount of a particular loan varies from bank to bank and customer-to-customer. To give an example, we will use a basic installment loan that is taken from an average consumer. Say a client takes out a personal loan of $3,000 and the loan will last for a period of twelve (12) months. The company has to account for the following MARGINAL elements in order to obtain a benefit: * Acquisition costs (how much is the cost to acquire the customer) * Cost of funds (how much they pay to borrow the money that they will loan) * Charge discount Rate (what is the failure rate of a similar vehicle of the customer) * Underwriting costs (how much does it cost to pay for the loan) * Incorporation of the costs (how much does it cost to setup the account) * costs of the service (how much does it cost to send instructions, receive payments, report to the credit bureau, etc) * The profitability of costs (how much does it cost to close the loan) to Make assumptions for each of the marginal elements: * Acquisition cost is $0 (we were told that the borrower was already a customer) * Cost of funds is 2%, or $60 * Freight rate is 5% (or $150) * The subscription costs are $40 * the Incorporation of the costs are $30 * the costs of the Service for 12 months $2/month $24 * cost effectiveness the costs are $10 for both, the basic marginal expense is $164 if we ignore cancellations. Let's assume that the client does not chargeoff, so that the rate required to break even is: $164 / $3000 = 5.47% However, on average, 5% of the customers chargeoff, so that account so that we can add $150 to the cost as follows: $314 / $3000 = 10.47% the Majority of the banks want to earn 1% on the asset side and 1% on the liability side, so the bank is likely to price the loan at 11.49% or 11.99% for a "good risk" customer.


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