2 Chapter 2 – Lending Products and Services
Learning Objectives
LEARNING GOALS
Upon completion of this chapter, you should understand:
- the different types of revolving accounts.
- the different types of installment accounts.
- the importance of time value of money lending calculations.
- the different types of consumer loan
Revolving Accounts
Revolving accounts allow clients continuous credit unless a payment is late or the account is over the established credit limit. The credit limit is set by the financial institution, and they determine the credit limit through their lending process if they are willing to extend credit to a client. Financial institutions lending processes can vary from one bank to another. Their determination is based on a thorough analysis by a lender. Credit gives clients the ability to make ongoing purchases. Examples of revolving accounts include credit cards, personal lines of credit, and home equity lines of credit.
Credit Cards
Image generated using the prompt “create an image of a Credit Card” sourced from OpenAI, 2025.
Credit cards are used by clients to make everyday purchases, and they will often provide clients with an “emergency” source of funds when they have no access to cash.
Credit card companies offer additional benefits and features to attract clients to their card, such as travel points or cash back on items like gas or groceries.
Some common credit cards include Visa, Mastercard, and American Express. Interest rates charged on credit card accounts can vary from card to card.
Repayment terms on credit cards usually range between 21 and 30 days after a billing cycle. Credit cards offer a grace period, which is a set period of time during which interest on the credit card debt is not accruing, and penalties are not being applied (O’Connell, 2019).
Lender Calculation for Credit Cards
Lenders calculate monthly minimum payments as 5% of the outstanding balance of the credit card.
Example:
For a Visa balance of $5500.25, the minimum payment would be calculated as:
$5500.25 x 0.05 = $275.01
Overdraft Protection
Image generated using the prompt “create an image of Overdraft Protection” sourced from OpenAI, 2025.
Overdraft protection (ODP) is a “safety net” offered to clients when they have insufficient funds in their bank account. This limit is set by the bank/financial institution.
ODP protects a client’s account when transactions are being processed, and there are not sufficient funds to cover these items. Transactions typically include the following:
- debit purchases;
- bill payments and pre-authorized debits;
- cheques;
- withdrawals; and
- transfers between bank accounts.
ODP protects clients from having non-sufficient funds (NSF) fees charged on their accounts. When there is no approved ODP in place, these fees can be up to $50.00 (Financial Consumer Agency of Canada, 2022). Clients are required to bring their account to a positive position at least one day over a 30/60/90-day period. This is to ensure that this source of credit is not abused as a perpetual source of funds. Lenders do not calculate this as a monthly payment because the interest charged each month is absorbed by the bank account each month.
Secured Lines of Credit
Image generated using the prompt “create an image of a Secured Line of Credit” sourced from OpenAI, 2025.
With a Secured Line of Credit (SLOC), a client pledges their assets to the bank/financial institution. While the SLOC is active, these assets (i.e., GICs, CSBs, MFs) cannot be liquidated. If clients do not repay the amount owed on the SLOC, they risk losing the asset(s) that was pledged at the time of application.
Lender Calculation for SLOC
Lenders typically calculate these payments as interest only. The interest rate is usually set at the prime rate.
Example:
A SLOC has a balance of $25,000 at 2.85%. The interest (I=prt) would be calculated as:
0.0285/365 * 30 (number of days in the month in question) * $25,000 = $58.56
If the client chooses to make a larger payment, the additional amount is applied to the principal.
Unsecured Lines of Credit
Image generated using the prompt “create an image of a Unsecured line of credit” sourced from OpenAI, 2025.
An Unsecured Line of Credit (ULOC) is an account that is approved based on a client’s financial situation at the time of application; there is no need for assets to be pledged. An unsecured line of credit is similar to a credit card, but it will have a higher limit. Typically, limits start at $10,000 and can go as high as $100,000. Clients who qualify for an unsecured line of credit are considered to have strong credit worthiness.
Lender Calculation for ULOC
Lenders calculate minimum payments as the greater of $50 or 3% of the outstanding balance.
Example:
An unsecured line of credit with an outstanding balance of $15,485.52 would be calculated as:
$15,485.52 * 0.03 = $464.57
Home Equity Line of Credit
Image generated using the prompt “create an image of a Home Equity line of credit” sourced from OpenAI, 2025.
With a Home Equity Line of Credit (HELOC), a client pledges real property as collateral to the bank/financial institution. An advantage of a HELOC to a client is that it offers the flexibility of having revolving and fixed account features. A HELOC can be financed up to 80% of the market value of the client’s home. Of that 80%, a maximum of 65% is a revolving line of credit; the other 15% must be in a fixed-term mortgage (Government of Canada, 2023). HELOC lending is discussed in greater detail in Chapter 6.
|
Value of the Home |
Potential maximum of HELOC and regular mortgage amount based on the appraised value (maximum 80% Loan To Values) |
LESS balance owed on mortgage |
Maximum credit limit on HELOC |
|---|---|---|---|
|
$450,000 |
$360,000 |
$200,000 |
$160,000 |
Since the example provided shows $160,000 is less than 65% of the value of the home, the entire $160,000 will be revolving.
Lender Calculation for HELOC
Lenders typically calculate these payments as interest only. The interest rate is usually set at the prime rate plus a value determined by the financial institution.
Example:
A HELOC has a rate of prime plus 1% where prime is 2.25%; the outstanding balance is $55,575.96. The lender would calculate the minimum payment as follows:
Step 1: (0.0325 * $55,575.96) = $1806.22
Step 2: $1806.22/365 = $4.95
Step 3: $4.95 * 30 = $148.50 minimum payment due
Instalment Accounts
Image generated using the prompt “create an image of a Installment Account” sourced from OpenAI, 2025.
Instalment accounts are often used to finance large ticket items (e.g., cars, recreational vehicles, or furniture.) They are usually offered by retailers or dealerships. Payments are a blend of principal and interest, depending on the number of payments and compounding periods.
Temporary Loans
With a temporary loan, payment may be made in full (demand loan) or in instalments (instalment loan), depending on the agreement. These types of loans can be used for debt consolidation, the purchase of a car, travel, investments, etc. Financial institutions offer this type of loan most frequently. The payments of instalment loans blend principal and interest based on an interest rate determined by the bank with specified compounding periods and scheduled payments.
Demand Loans
A demand loan can be an interest-only type of credit. The institution has the right to demand payment at any time.
A demand loan may be paid in several ways:
- equal amounts of principal plus interest based on the declining balance of the loan
- the full amount of principal and interest on demand in the future
- interest payments only with the principal repaid in a lump sum
Interest may be fixed or variable and is based on the prime rate. This type of credit is becoming increasingly uncommon for consumers and is reserved for specific transactions, such as bridge financing for a business.
An example of how demand loans operate: A bakery chain wants to buy a competitor. They secure a $500,000 demand loan from ABC Bank with a variable interest rate. The bakery owner pays interest monthly and repays the principal as a lump sum later. The bank can demand full repayment anytime. The bakery owner intends to pay the principal from the profits of the acquired business. This scenario illustrates how demand loans can serve as bridge financing.
A bank may demand repayment on a demand loan for a variety of reasons, including:
- Risk mitigation: If the bank perceives increased risk in the borrower’s ability to repay—perhaps due to changes in their financial circumstances, such as a significant loss in revenue, bankruptcy, or other adverse economic events.
- Regulatory requirements: To meet specific regulatory requirements or risk management standards.
- Market conditions: Changes in market conditions, like a sharp increase in interest rates or an economic downturn, might make the loan too risky to maintain.
- Internal policies: To meet internal liquidity needs or capital requirements based on changes in the bank’s loan policies.
Mortgage Loan
Image generated using the prompt “create an image of a Mortgage Loan” sourced from OpenAI, 2025.
A mortgage loan is a long-term lending of money secured by real estate. There are many payment options. The maximum length of amortization in Canada is 25 years. Clients can choose a term best suited to them. Terms can be 1, 3, 5, or 10 years, all with varying differences in interest rates. Mortgages can be obtained through a financial institution or a mortgage broker. Mortgage lending is discussed in greater detail in Chapter 10.
Time Value of Money Review
Lenders need to know how payments are calculated to ensure all calculated values are correct. If the values in an application are incorrect, the result could lead to deals being approved that should not be approved or deals being declined when they should be approved.
The Time Value of Money (TVOM) is a very important tool in lending. All students must be confident in using the TI BAII Plus calculator. The instruction book for your calculator is very useful if you require a refresher on TVOM. There is also a calculator tutorial available toward the end of this chapter.
Lenders need to understand how loan payments are calculated and how loans are amortized. If money received today is invested, its future value will be larger than its present value.
Example:
The future value of a $100,000 investment in one year if the interest is 7%:
PV-100,000 n1 i 7 PMT O COMP FV = 107,000
Periods per Year Setting
To check the current setting, press 2nd F p/y.
The display shows the setting for periods/year. The calculator comes preset at 12 periods per year; that is, it assumes calculations will be done on a monthly basis.
“p/y” is the number of payments per year.
Compounding Periods per Year
To check the current setting, press 2nd F c/y.
The display shows the setting for compounding periods/year. The calculator assumes that p/y and c/y will be equal.
“c/y” is the number of compounding periods per year.
Most loans are payable in monthly installments, and interest is compounded monthly. Therefore, 2nd F p/y 12 enter down c/y 12 2nd F QUIT.
It is important to reset p/y and c/y for every calculation!
APR vs. EAR
Interest is usually quoted as the “annual percentage rate” (APR). However, if it is compounded more than once per year, we need to know the “effective annual rate” (EAR).
Example:
The bank lends money at 6% APR. If the loan is payable monthly and interest is compounded monthly, the EAR can be found by:
2nd F ICONV nom=6 enter down c/y = 12 eff = CPT = 6.168%
The EAR > APR because of compounding; interest is charged on interest.
Example:
A firm plans to buy a warehouse for $100,000. The bank offers a 30-year loan with equal annual payments and an interest rate of 8% per year. The bank requires that the firm pay 20% of the purchase price as a down payment, so the firm borrows only $80,000. What is the annual loan payment?
Note that payments are annual, and it is assumed that compounding matches payments. In this case, the EAR = APR:
p/y 1 c/y 1 PV-80,000 n30 i8 FV0 comp PMT = $7,106.19
If payments were made monthly:
p/y12 c/y12 PV-80,000 n360 i8 FV0 comp PMT = $587.01
Note that n indicates the total number of payments in the loan schedule. In this case, EAR > APR. The calculator automatically compounds interest.
We can find the balance outstanding and interest paid to date by using the AMORT key.
Example:
After 18 payments have been made:
2nd F AMORT p1 = 1 p2 = 18
Bal = $78,977.01
Prn = $1,022.96
Int = $9,543.25
Where p1 and p2 are the range of payments.
Canadian mortgages are set up with semi-annual compounding, regardless of the number of payments per year. A 30-year mortgage of $400,000 at 4% APR has the following payment:
p/y 12 c/y2 PV-400,000 n360 i4 FV0 comp PMT 1902.07
In 5 years (after 60 payments), the balance owed will be $361,597.29.
Payments can be made bi-weekly, or 26 times per year, resulting in a payment of $877.10.
p/y 26 c/y2 PV-400,000 n780 i4 FV0 comp PMT 877.10
Complete review activity in Brightspace.
References
O’Connell, B. (2018, March 5). What Is a Credit Card? Experian. https://www.experian.com/blogs/ask-experian/what-is-a-credit-card/
Financial Consumer of Canada. (2022, March 11). Getting overdraft protection. Government of Canada. https://www.canada.ca/en/financial-consumer-agency/services/banking/overdraft-protection.html
Government of Canada (2023, April 28). Getting a home equity line of credit. Retrieved August 24, 2023, from https://www.canada.ca/en/financial-consumer-agency/services/mortgages/home-equity-line-credit.html
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