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

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

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 Credit –Based on trust in peoples 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 5-2

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 Ill 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? 5-3

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 5-4

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 5-5

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 5-6

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 5-7 Examples of each?

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 1.Installment sales credit- loan for high-priced items 2.Installment cash credit- loan of cash for personal use 3.Single-lump credit- loan repaid on a specific day 5-8

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 5-9

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 5-10

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 5-11

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 5-12

13 Sources of Consumer Credit Smart Cards –Plastic card equipped with a computer chip that can store 500 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 dont pay for goods or services at the time of purchase 5-13

14 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? Cant afford it!) –What do you plan to give up in order to make the payment? 5-14

15 General Rules of Credit Capacity * Not including a house payment, which is a long-term liability 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. 5-15

16 General Rules of Credit Capacity Debt To Equity Ratio Total Liabilities Net Worth* = Should be < 1 *Excluding home value 5-16 The lower the ratio, the better; e.g., 0.5 or 0.25

17 The Five Cs 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 5-17

18 FICO & VantageScore FICO Credit Score –350 to 850 –Higher score = less risk –Available from for a fee; can sometimes get for free from lendershttp://www.myfico.com VantageScore –New scoring technique –Developed collaboratively by 3 credit agencies –Range = 501 to

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%)

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 5-20

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 5-21

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 5-23

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


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