1. 5A Consumer Credit #1
Credit – An arrangement to receive cash, goods, or services now and pay for them in the future.
Types of credit ???

2. Objective 1 Analyze Advantages and Disadvantages of Using Consumer Credit
Based on trust in people’s ability and willingness to pay bills when due
Consumer Credit
Use of credit by individuals for personal needs, except a home mortgage
Dates back to colonial times; exploded after invention of cars (installment loans; traveling)
A major force in our economy
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3. Uses and Misuses of Credit
Before you use credit for a major purchase, ask:
Do I have the cash for the down payment?
Do I want to use my savings for this purchase?
Does the purchase fit my budget?
Could I use the credit I’ll need in some better way?
Can I postpone this purchase?
What are the opportunity costs of postponing this purchase?
What are the dollar and psychological costs of using credit for this purchase?
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4. Advantages of Credit Current use of goods and services
Permits purchase even when funds are low
A cushion for financial emergencies
Advance notice of sales
Easier to return merchandise
Convenient when shopping
Provides a record of expenses
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5. More Advantages of Credit
One monthly payment
Safer than carrying cash
Needed for hotel reservations, car rentals, and shopping online
Take advantage of “float” time/grace period
Rebates, airline miles, cash-back rewards, or other “perks”
Credit indicates financial stability
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6. Disadvantages of Consumer Credit
Temptation to overspend
Can create long-term financial problems and slow progress toward financial goals
Potential loss of merchandise due to late or non-payment
Ties up future income
Credit costs money - more costly than paying with cash
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7. Objective 2 Assess the Types & Sources of Consumer Credit
Two Basic Types of Consumer Credit
Closed-End Credit
One-time loans for a specific purpose paid back in a specified period of time
Open-End Credit
Use as needed until line of credit max reached
Examples of each?
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8. Closed-End Credit
One-time loans for a specific purpose that you pay back in a specified period of time, and in payments of equal amounts
Mortgage, automobile, and installment loans for furniture, appliances and electronics
3 most common types of closed-end credit
Installment sales credit- loan for high-priced items
Installment cash credit- loan of cash for personal use
Single-lump credit- loan repaid on a specific day
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9. Open-End Credit Use as needed until line of credit max reached
Credit cards
Department store cards
Home equity loans
You pay interest and finance charges if you do not pay the bill in full when due
Revolving Check Credit (Bank Line of Credit)- pre-arranged loan for a specified amount; can be accessed with special checks
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10. Sources of Consumer Credit
Loans
Borrowing money with an agreement to repay, along with interest, within a certain amount of time (e.g., 3 years)
Inexpensive loans
Parents or family members
Medium-priced loans
Commercial banks, savings and loan associations, and credit unions
Expensive loans
Finance and check cashing companies
Retailers (e.g., department store credit cards)
Bank credit cards and cash advances
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11. Sources of Consumer Credit
Home Equity Loans
Loan based on home equity
Current market value of your home minus the amount you still owe on the mortgage
Interest is tax-deductible
Should only be used for major purchases
Credit Cards
Average cardholder has > 9 credit cards
Convenience users vs. borrowers
Finance charge = total amount paid to use credit
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12. Sources of Consumer Credit
Debit Cards
Debit cards electronically subtract money from savings or checking accounts
Most commonly used at ATMs
Widely accepted at stores also
Stored Value Cards
Gift cards
Prepaid cards
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13. Sources of Consumer Credit
Smart Cards
Plastic card equipped with a computer chip that can store times as much data as a normal credit card (e.g., health info)
Travel and Entertainment (T&E) cards
Not really “credit cards”; balance is due in full each month
Diners Club; American Express
You don’t pay for goods or services at the time of purchase
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14. Before you take out a loan, ask yourself...
Objective 3 Determine Whether You Can Afford a Loan and How to Apply for Credit
Before you take out a loan, ask yourself...
Can you meet all your essential expenses and still afford the monthly loan payments?
Add up basic monthly expenses and subtract from take-home pay; will the difference cover the monthly payment? (NO? Can’t afford it!)
What do you plan to give up in order to make the payment?
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15. General Rules of Credit Capacity
Debt Payments-to-Income Ratio
Monthly Debt Payments*
Net Monthly Income
Consumer credit payments should not exceed a maximum of 20% of your net income.
*Not including a house payment, which is a long-term liability
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16. General Rules of Credit Capacity
Debt To Equity Ratio
Total Liabilities =
Should be < 1
Net Worth*
*Excluding home value
The lower the ratio, the better; e.g., 0.5 or 0.25
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17. The Five C’s of Credit Character - Do you pay bills on time?
Capacity - Can you repay the loan?
Capital - What are your assets and net worth?
Collateral - What assets do you have to secure the loan?
Conditions- Lenders will review how general economic conditions will affect your ability to repay your loan
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18. FICO & VantageScore FICO Credit Score VantageScore 350 to 850
Higher score = less risk
Available from for a fee; can sometimes get for free from lenders
VantageScore
New scoring technique
Developed collaboratively by 3 credit agencies
Range = 501 to 990
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19. Credit Scoring Factors
Bill payment history, weighted to emphasize past 12 months (35%)
Proportion of outstanding debt to available credit limits (30%)
Length of credit history (15%)
Number of recent credit inquiries (10%)
Mix of types of credit used (10%)
This slide lists seven factors that affect credit scoring models:
Previous Payment History- On-time payments enhance a person’s credit score while late payments subtract points. The more bills that are late (e.g., 3 creditors versus 1) and the later the payments (e.g., 90 days instead of 30 days), or charged-off debts, the worse a credit score. A borrower’s previous payment history accounts for 35% of his or her credit score (Kiplinger’s Personal Finance, “The Secret Mix,” September 2000, p. 104).
Amount of Money Currently Owed- Potential lenders don’t like to see high amounts of debt. In addition, scoring models take points away from people who have a lot of open credit lines with zero balances (e.g., credit cards they don’t use) because they could go out tomorrow and borrow against them.
Proportion of Balances to Credit Limits- “Maxing out” credit lines (i.e., borrowing up to the credit limit) can decrease your credit score.
How Long You’ve Been a Borrower- Credit scoring models give more weight to people who have successfully used credit for longer periods of time.
Number of Recent Credit Inquiries- Scoring models take points away from people who have applied for a number of new credit lines within a short time period (e.g., six months to a year). Inquires made by lenders in advance of “pre-approved offers” are ignored and do not count against you.
Types of Credit Used- Credit scores can increase with a mix of credit (e.g., mortgage, car loan, credit cards) instead of just one type of credit.
Stability of Job and Home Address- Scoring models give more weight to “stability” as indicated by length of time at current job and current address.

20. Factors of Creditworthiness
ECOA (Equal Credit Opportunity Act)
Gives all applicants the same rights.
Credit providers may not discriminate based on:
Age
Social Security or public assistance
Housing loans (redlining)
If you are denied credit, you have the right to know the reasons
You can request a copy of your credit report within 60 days if you are denied credit based on what is in your files
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21. Your Credit Report Credit Reports
Record of your complete credit history
Credit Bureaus
Agencies that collect information on how promptly people and businesses pay their bills
Experian, Trans Union and Equifax are the 3 major credit bureaus
Credit Bureaus obtain information from banks, finance companies stores, credit card companies and other lenders
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22. Four Main Parts to a Credit Report
Identifying Information: name, SS Number, current/previous addresses, birthdate, employer
Public Record Information from Local Courthouse: liens, foreclosures, bankruptcy
Other Credit History Information: list of loans and credit cards, timeliness of payments, defaults and negative information (7 years)
Inquiries: Usually 2 years; self-initiated and promotional (for marketing purposes)

23. Your Credit Report Who can obtain a credit report?
Only authorized persons have access to your report for approved legitimate business purposes
Examples???
Time Limits on Unfavorable Data
Adverse data can be reported for 7 years
Bankruptcy can be reported for 10 years
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24. Wrap Up
Concept Check 5-1- Reasons to Borrow and Advantages/Disadvantages
Concept Check 5-2- Definition of Terms; Difference Between Credit and Debit Cards
Concept Check 5-3- Definition of Terms