A customer is remodeling his kitchen and is interested in financing kitchen appliances, which cost $8,000. A bank offers the customer a loan, if the customer pays a 10% down payment. The bank charges application fee of $50 and estimates that on average the bank collects $30 per year in late fees from similar customers. No monthly payments are required and the full amount of borrowing is due in 12 month. What interest rate should the bank charge if you know the following:
Bank’s required return on equity is 12% Equity allocation for consumer lending division is 10%Banks’ tax rate is 40%
The bank can borrow at the current fed funds rate.Processing cost is $35 per loan. Customer’s credit score is 660.
It is expected that if the customer defaults, the appliances could only be resold for 25% of original value. Additionally, the customer is self- employed and does not provide a proof of income. In such cases the bank adds 2% to expected losses to cover additional risk.
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