2Section 6.1 – What is Consumer Credit? ObjectivesExplain the meaning of consumer creditDifferentiate between close-end credit and open-end credit
3What is credit?An arrangement to receive cash, goods, or services now and pay laterCredit cards, charge cards, loansConsumer credit - specific use of credit for personal needsCreditor – A person or institution that lends money
4Using Consumer Credit Wisely Why is having good credit important?Receive items now, pay later – homes, cars, collegeIndicator of consumer spending and demandCan be dangerous, so using it wisely is a valuable tool
5Different Forms of Credit Credit cardsCharge cardsLoansCash advancesDebit cardsSmart cards
6Credit CardsUse the card to pay for items and services up to a certain total amount -- your credit limitCarrying a balanceThe credit card company allows you to pay off what you owe little by little each month, as long as you pay a minimum amount each time. In exchange, you pay interest on the balance you owe (as high as 29% each year) at the end of each periodHow credit card companies make money. Credit card companies earn high profits in several ways.High rates of interest -- interest on credit cards accounts for the bulk of the profits earned by banks that issue credit cardsAnnual feesLate fees, over-the-limit fees, and other miscellaneous chargesCharging merchants and service providers a fee each time a customer uses the company's credit card in the merchant's establishment
7Charge CardsCharge cards, also called travel and entertainment cards, are a little different from credit cards because they have no credit limit. You can usually charge as much as you want, but are required to pay off your entire balance when your bill arrivesYou cannot carry a balance. If you don't pay your charge card bill in full, you'll get a one-month grace period without interest charges. After that, you'll be charged interest that can be as high as 30 to 35%. If you don't pay after about three months, your account will be closed and your bill sent to the collections departmentHow charge card companies make money.Charge card companies make their profits by charging high annual fees -- up to about $90Charging merchants relatively high fees each time a customer pays using the company's charge card. Some merchants don't accept charge cards for this very reason
8Loans Let you borrow money that must be repaid with interest You can obtain a loan for a specific purpose, such as financing a new car, paying college tuition and buying or renovating a home. You can get a debt consolidation loan, which combines all current debts from various creditors into a single reduced-interest payment planLoans are generally divided into two types: secured and unsecuredSecured loans are guaranteed by collateral, which is an item of equal or greater value than the amount of the loan, such as a car, home or cash depositUnsecured loans do not require collateral and are made based on your credit score and ability to repayInstallment loans are made for a fixed amount at the time of your application and approval. This type of loan is repaid in fixed monthly payments over a specific period of time. The finance charges are included in the payments. Auto loans and mortgages are examples of installment loans.
9Cash AdvancesMany people use their credit cards to obtain cash advancesCredit card issuers send cardholders "convenience" checks they can use to pay for goods or services. The amount of the check appears on your credit card statement as a charge, but is generally treated as a cash advanceCash advances are more expensive than standard credit card charges and offer more onerous terms for consumers, including:Transaction fees. Most banks charge a transaction fee of up to 4 to 6% for taking a cash advanceNo grace period. Most banks charge interest from the day the cash advance is posted, even if you pay it back in full as soon as your bill comesHigher interest rates. The interest rate is often substantially higher on cash advances that it is on ordinary credit card charges
10Credit Uses and Misuses When is it appropriate to use credit?When you can buy something now for less than it will cost with cash laterClearance items, big salesWhen you can afford itDon’t buy a sports car you can’t afford – get something cheap and reliableIncreased credit use decreases how much money you have later
11Factors to Consider Before Using Credit What should you know before using credit with a major purchase?Do you have the cash you need for the down payment?Do you want to use your savings instead of credit?Can you afford the item?Could you use the credit in some better way?Could you put off buying the item for a while?What are the costs of using credit?
12Advantages of Credit Enjoy things now and pay later Can combine several purchases in one monthly paymentNeed one to rent car, make reservations, buy onlineGives you a record of your expensesSafer to carry when shopping or travelingUse responsibly and you will get good credit
13Disadvantages of Credit Temptation to buy more than you can affordBad purchases may cause loss of income and propertyCredit does not give you more money – still have to pay laterMay have trouble paying bills
14Types of Credit Closed-End Credit Open-End Credit One time loan paid back in specific time period in payments of equal amountsLower interest rates than open-end creditExamples: mortgages and car loansOpen-End CreditCredit with a limit (line of credit) that you can use continuously on various items and pay at least a minimum amount per monthExamples: department store credit cards, Visa, Mastercard
16Credit Cards Average cardholder has more than nine cards Those who pay balance off every month are convenience users, those who carry a balance over every month are borrowersGrace period – a time when no interest is added to balanceFinance Charge – total amount you pay to useAnnual Fee – may have to pay $20 to $50 annual fee just for having card
17Loans Inexpensive Loans Medium-Priced Loans Expensive Loans Friends or family, little or no interest, potential problems with these?Medium-Priced LoansFrom banks, credit unions, may be patient with those late with payment for good reasonExpensive LoansEasiest to get, cash advances (billed to credit cards)Home Equity LoansBased on home equity (difference between the value of your home and what you owe on it)For major things such as education, home improvements, medical bills
18Other Forms of Credit Cards Debit CardsElectronically subtract money from savings or checkingCan be used at most stores, gas stationsEasier than writing a checkSmart CardsContains a computer chipExample: can be used to track frequent flyer milesTravel and Entertainment CardsBalance due each monthMay be used with business men who travel
19Section 6.2 Costs and Methods of Obtaining Credit
20Can You Afford a Loan? Total income minus monthly expenses Do you have enough money to pay the monthly loan payment?What types of things can people give up to make room for a needed loan?Going out to eatGoing to the moviesSmoking/drinkingShoppingComparison shop
21Debt Payments-to-Income Ratio % of debt you have in relation to your net incomeExperts suggest no more than 20% of net income goes to debtFormula Monthly Debt Payments = %Monthly Net Income$180 = .15 or 15%$1200
22The Cost of Credit Annual Percentage Rate (APR) APR is the cost of credit on a yearly basisAPR of 18% mean $18 on every $100 you oweSee chart on Pg. 165Truth in Lending Act, the creditor must inform you in writing of the finance charge and APR
23Tackling the Trade-Offs Term vs. Interest CostsLonger term (length of time to pay back loan) means smaller paymentsAlso means greater amount you will pay in interestAPRTerm of LoanMonthly PaymentsTotal Finance ChargeTotalCostCreditor A14%3 years$205.07$$Creditor B4 years$163.96$$
24Lender Risk vs. Interest Rate If you were to lend money, what would you worry about and how would you deal with those issues?Lender wants to reduce his/her risk, and you want a low interest rate – so what are your choicesVariable Interest Rate - rates rise when overall interest rates rise, so lender may offer you a lower beginning rate than you would have with a fixed-rate loanA Secured Loan – use collateral to guarantee payment – if you don’t pay they take the collateralUp-Front Cash – Make a big down payment upfront, so lender thinks that you have a greater chance of repayingA Shorter Term – the shorter time to pay it back, the less chance for something to stop you from repaying it
25Calculating the Cost of Credit Simple InterestSimple Interest on the Declining BalanceAdd-On InterestCost of Open-End CreditCost of Credit and Expected InflationThe Minimum Monthly Payment Trap
26Simple Interest Paid back in one payment normally Interest = Principal x Interest Rate x Amount of time borrowed forPrincipal - original amount of debt or amount loaned to you before interest is addedRate - expressed as percentage, the higher the rate, the less desirable the loanTime - expressed as a fraction of 1 year, 12 months, 52 weeks, or 360 days6 mo = ½ 90 days = 90/3603 mo = ¼ 4 mo = 1/3
27Installment InterestThe Kramers are buying a new couch. The cash price is $800. Instead they put down $100 and pay the balance in 12 monthly payments of $66.What is their finance charge?$100+ 792 (12 * 66)$892 total installment price paid$892 – 800 = $92 finance charges
28Installment Interest Cont. APR formulaR = 2*n*IP(N+1)R = annual percentage raten = # of payment periods in one yearl = total dollar cost of credit (finance charge)P = principal, or net amount borrowedN = total number of payments to pay off amount borrowed
29Using the Kramers example, $800 cash price for couch, put $100 down and pay 12 monthly payments of $66.R = 2 * 12 * 92700 (12 + 1)2,208 = 24.26%9,100
30Simple Interest on Declining Balance Used for simple interest loan paid back in more than one paymentOnly pay interest on amount of principal you have not repaidMore often you make payments, the lower the interest you will payMost credit unions use thisGood for those who pay off loans early
31Add-On InterestInterest based on full principal amount, no matter how many payments you make earlyLonger you take to pay the loan the more interest you will payNot good for those who take full term to pay back loan
32Cost of Open-End Credit Varies with the credit cardCreditors must inform you of how interest is calculatedThree method typesAdjusted balance methodPrevious balance methodAverage daily balance method
33Three Finance Charge Methods AdjustedBalance MethodPrevious Balance MethodAverage Daily BalanceMonthly Interest Rate1.5%Previous Balance$400Payments$300Interest Charge$1.50($100 x 1.5%)$6.00($400 x 1.5%)$3.75(avg. balance of $250 x 1.5%)
34Adjusted Balance Method Interest applied to the remaining balance AFTER you have made your monthly paymentIf you get a bill for $400, you decide to pay $100, the interest is based on the remaining $300If APR is 18%, to get the monthly rate divide 18% by 12 (months) = 1.5%So $300 x 1.5% = $1.50 added on for next month’s bill
35Previous Balance Method Finance charge is applies to entire amount owed from the previous monthIf you get a bill for $400, you decide to pay $100, the interest is still based on the $400If APR is 18%, to get the monthly rate divide 18% by 12 (months) = 1.5%So $400 x 1.5% = $6.00 added on for next month’s billWorst for the borrower
36Average Daily Balance Method Most credit cards use thisAdd your balance from each day of the billing cycle together and divide by the number of days in the cycle
37Cost of Credit and Expected Inflation You may pay a higher interest rate because lenders will figure in the expected inflation rate
38Minimum Monthly Payment Trap Lenders like you to only pay the minimum amountThe finance charges you pay on an item(s) could make it more expensive that it is worthIf you buy college books for $500 on a credit card that charges 19.8% per yearOnly make the minimum payment of $21.67It will take 2 ½ yrs to pay it off and will pay $150 in interest so a total of $650 dollars for books used 3 months
39Five C’s of Credit Character: Will You Repay the Loan? Capacity: Can You Repay the Loan?Capital: What Are Your Assets and Net Worth?Collateral: What If You Do Not Repay the Loan?Credit History: What Is Your Credit History?
40Character: Will You Repay the Loan? Are you trustworthy, stableMay ask for references, check criminal recordWhat would you ask someone if you were thinking about lending money to them?Have you used credit before?How long have you lived at your present address?How long have you held your current job?
41Capacity: Can You Repay the Loan? How much income do you have coming in?Job salaryOther incomeDo you already have a lot of debt?
42Capital: What Are Your Assets and Net Worth? What is your capital?Assets – Liabilities = Capital (Net Worth)Assets can be cash, property, investmentsItems of value you can sell to repay the loan
43Collateral: What If You Do Not Repay the Loan? May be asked to pledge collateral in order to get loanCar, home, personal items
44Credit History: What Is Your Credit History? How have you used credit in the past?Do you pay bills on time?Have you ever filed for bankruptcy?
45How Do Lenders Use the 5 C’s? Give a credit rating based on income, debt, character, past repayment historyUse various rating systemsMay have high standard, may rely on instinct, or may use credit scoring or statistics
46Credit Application Information Have you received credit from us beforeIf so, when and which officeChecking/savings acct. numbers, bank, branchName of nearest relative, address, phone numberMarital statusAmount neededUse of loanName, birthdateSS# and driver licensePresent and past street addressPresent and previous employersPresent salaryNo. and ages of dependentsOther income
47Equal Credit Opportunity Act Certain factors that lenders cannot consider: race, nationality, age, sex, marital status, religionAge – if you can legally sign a contract (18 or 21) they cannot turn down due to agePublic Assistance – cannot be denied because of, but source of income can be considered as to your creditworthinessHousing Loans - cannot deny based on your race and the race of neighborhood you want to buy in
48What if you are denied? Entitled to info in report No fee if asked for within 60 days after denialAlso can ask credit bureau to investigate inaccurate or incomplete information
49Credit Bureau Collect and store credit reports or files Three main ones: Experian, TransUnion, Equifax - several thousand smaller onesThey sell your credit info topotential creditorsWhere do they get your information?Stores, credit card companies, finance companies, banks, court records
50Your Credit File Employer, position, and income Previous address Previous employerSpouse’s name, SS#, employer, incomeHomeowner or renter statusChecks returnedEach time you take out a loan, payments made, missed, how much you owe
51Credit File Detailed credit information: Updated frequently Each time you take out a loan they are given your acct. #, date, amount, terms, and types of creditUpdated frequentlyNumber of payments madeNumber of payments missed or lateLawsuits or judgments
52Who Can Obtain a Credit Report May be in response to a court orderYour own written requestProvided for a credit transactionFriends, neighbors, and others cannot be given accessCan get free of charge if have been deniedLaw allows each person one free report per year
53Time Limits of Data in File Most is up to 7 years10 years if you declared bankruptcyCredit reporting agency cannot disclose information more than 7 or 10 years old unless:Being reviewed for credit application of $75,000 or moreApply to life insurance of $150,000 or more
54Protecting Your Credit Section 6.3Protecting Your Credit
55Billing Errors and Disputes 1. Notify creditor in writing2. Pay portion that is not in question3. Creditor must acknowledge within 30days4. Within 2 billing cycles (not more than 90days) creditor mustAdjust billTell you why it is correct5. If mistake, you pay no finance charges6. If no mistake, they send you an explanation andstatement of what you owe
56Protecting Credit Rating According to law, a creditor may notThreaten your credit ratingDo anything to damage your credit reputation when disputing a billMay not take action to collect the amount in question until complaint has been answered
57Defective Goods and Services According to the Fair Credit Billing Act you may tell your credit card to stop payment if you bought a defective item that the store will not return
58Identity Theft May not know until: You should: Get bills for cards you never openedSee charges for things you didn’t purchaseSee money withdrawn from bank acct.You should:1. Contact credit bureau – flag acct. and call youfor permission to open acct.2. Contact creditors for any fraudulent accts.opened3. File police report and keep a copy for proof
59Protect Yourself from Identity Theft Shred or tear papersClose accts. that have been tampered withStop payments on stolen checksCancel debit cardCredit cardsBe sure card is returned to youKeep a record of your numbersContact company immediately if stolen or lostMaximum you pay is $50 for illegal useNo $ payment if you contact them before illegal use
60How do thieves steal an identity? Identity theft starts with the misuse of your personally identifying information such as your name and Social Security number, credit card numbers, or other financial account information. For identity thieves, this information is as good as gold.Dumpster Diving. They rummage through trash looking for bills or other paper with your personal information on it.Skimming. They steal credit/debit card numbers by using a special storage device when processing your card.Phishing. They pretend to be financial institutions or companies and send spam or pop-up messages to get you to reveal your personal information.Changing Your Address. They divert your billing statements to another location by completing a change of address form.Old-Fashioned Stealing. They steal wallets and purses; mail, including bank and credit card statements; pre-approved credit offers; and new checks or tax information. They steal personnel records, or bribe employees who have access.
61What do thieves do with a stolen identity? Credit card fraud:They may open new credit card accounts in your name. When they use the cards and don't pay the bills, the delinquent accounts appear on your credit report.They may change the billing address on your credit card so that you no longer receive bills, and then run up charges on your account. Because your bills are now sent to a different address, it may be some time before you realize there's a problem.Phone or utilities fraud:They may open a new phone or wireless account in your name, or run up charges on your existing account.They may use your name to get utility services like electricity, heating, or cable TV.
62Other fraud:They may get a job using your Social Security number.They may rent a house or get medical services using your name.They may give your personal information to police during an arrest. If they don't show up for their court date, a warrant for arrest is issued in your name.
63Bank/finance fraud:They may create counterfeit checks using your name or account number.They may open a bank account in your name and write bad checks.They may clone your ATM or debit card and make electronic withdrawals your name, draining your accounts.They may take out a loan in your name.Government documents fraud:They may get a driver's license or official ID card issued in your name but with their picture.They may use your name and Social Security number to get government benefits.They may file a fraudulent tax return using your information.
64Protecting Your Credit on Internet Use a secure browserKeep records of online transactionsReview monthly statementsRead privacy and security policies of web site you visitKeep personal information privateNever give password to anyoneDo not download files sent to you from strangers
65Cosigning a LoanYou agree to be responsible for the loan payments if they fail to make themYou may also have to pay late fees or collection costsCreditor can collect from you before the borrowerWill appear on your record if not paid
66Your Rights Under Consumer Credit Laws 1. Complain to creditor and make themaware you know the laws2. File a complain with the govt.3. Sue creditor. If you win, you can receiveup to $10,000 in actual and punitivedamages, along with attorney’s fees andcourt costs
68Warning Signs of Debt Problems Only make minimum monthly payment on credit cardsHaving trouble making minimum monthly paymentsBalance on credit cards increases each monthMiss or late loan paymentsUse savings for necessitiesReceive 2nd or 3rd payment noticesBorrow money to pay debtsExceed credit limit credit cardsBeen denied credit/bad credit report
69Debt Collection Practices Creditors turn bad debt over to collection agenciesFederal agency protects legal rights of debtorsFTC Fair Debt Collection Practices Act prohibits certain practices by debt collectors
70Consumer Credit Counseling Service Provides debt counseling services for those with financial troublesMay be small fee for a debt repayment planTwo part to CCCSAiding families with serious debt by helping manage money and setting up a budgetHelping people prevent indebtedness by education of budgets and unwise credit purchasesMany other resources available in other institutions (banks, credit unions, universities)
71Declaring Personal Bankruptcy Legal process in which some or all of assets of debtor are distributed among creditors b/c debtors cannot pay debtsMay include a plan for debtor to repay creditors on installment basisShould be a last resort because it severely damages your credit
72Personal Bankruptcy Two choices in bankruptcy Both undesirable Chapter 7 (straight bankruptcy)Chapter 13 (wage-earner plan bankruptcy)Both undesirableNeither should be an easy way out of debt
73Chapter 7 BankruptcyDraw up petition listing assets and liabilities that could be sold to pay debtsPay a filing feeNot all debts are forgiven like child support or alimony70% of all filings
74Chapter 13 BankruptcyA chapter 13 bankruptcy is also called a wage earner's planThose with regular income develop a plan to repay all or part of debtIn repayment plan debtors make installment payments to creditors over three to five years29% of all filings
75Key TermsCredit – Arrangement to receive cash, goods, or services now and pay laterConsumer Credit – Use of credit for personal needsCreditor – Entity that lends moneyClosed-end credit – One time loan that you pay back over a specified time period in payments of equal amountsOpen-end Credit – A loan with a certain limit on the amount of money you can borrow for a variety of goods and servicesLine of Credit – Maximum amount of money of a creditor will allow you to borrowFinance Charge – Total dollar amount you pay to use creditNet Income – The income you receive (take home pay, allowance, gifts, and interest)
76APR (annual percentage rate) – The cost of credit on a yearly basis, expressed as a percentage Collateral – A form of security to help guarantee that the creditor will be repaid.Simple Interest – The interest computed only on the principalMinimum Monthly Payment – The smallest amount you can pay and remain a borrower in good standingCredit Rating – A measure of a person’s ability and willingness to make credit paymentsCosigning – Agreeing to be responsible for the loan payments if another person fails to make themBankruptcy – Legal process in which some or all of the assets of a debtor are distributed among the creditors because the debtor is unable to pay his or her debts