5-3 Consumer Credit 1.Analyze advantages and disadvantages of using consumer credit 2.Assess the types and sources of consumer credit 3.Determine whether you can afford a loan and how to apply for credit 4.Determine the cost of credit by calculating interest using various interest formulas 5.Develop a plan to protect your credit and manage your debts Chapter Objectives
5-4 Objective 1: Analyze advantages and disadvantages of using consumer credit Credit is an arrangement to receive cash, goods or services now, and pay for them in the future. Consumer credit is the use of credit for personal needs, except a home mortgage, by individuals and families. Three ways consumers can finance purchases. –Draw on their savings. –Use present earnings. –Borrow against expected future income. Each finance alternative has a trade-off. Consumer credit is a major force in our economy.
5-5 Use and Misuse of Credit Before you use credit for a major purchase, ask yourself some questions. –Do I have the cash for the down payment? –Do I want to use my savings for this purchase? –Does this 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?
5-6 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. One monthly payment. Safer than cash.
5-7 Advantages of Credit Needed for hotel and car reservations and shopping online. To take advantage of float time/grace period. May get rebates, airline miles, or other bonuses. Indicates financial stability. (continued)
5-8 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.
5-9 Objective 2: Assess the types and sources of consumer credit 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 cash credit 2.Installment sales credit 3.Single-lump credit
5-10 Objective 2: Assess the types and sources of consumer credit Open-End Credit. –Use as needed until reaching line of credit max. Credit cards, departments store cards, and home equity loans. –You pay interest and finance charges if you do not pay the bill in full when due –Also called revolving check credit (continued)
5-11 Sources of Consumer Credit Loans. –Loans involve borrowing money with an agreement to repay along with interest. Inexpensive loans. –Parents or family members. –Loans based on assets, such as a CD. Medium-priced loans. –Commercial banks, savings and loan associations, and credit unions. Expensive loans. –Finance and check cashing companies. –Retailers such as car or appliance dealers. –Bank credit cards and cash advances.
5-12 Sources of Consumer Credit Home Equity Loans –Loan based on your home equity—the difference between the current market value of your home and the amount you still owe on the mortgage. Credit Cards –Average cardholder has more than nine credit cards –Convenience users vs. Borrowers Debit Cards –Debit cards electronically subtracts money from your savings or checking accounts –Most commonly used at ATMs (continued)
5-13 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 afford the loan? –What do you plan to give up in order to make the payment?
5-14 General Rules of Credit Capacity * Not including 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 max of 20% of your net income.
5-15 General Rules of Credit Capacity Debt To Equity Ratio total liabilities net worth* = Should be < 1 *Excluding home value (continued)
5-16 Applying for Credit The Four 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 do you have of value that you pledge to the lender that they can repossess if you fail to honor the terms of the agreement? Credit History- Lenders will review your credit history to find out whether you have used credit responsibly in the past.
5-17 Credit Rating Credit rating is a measure of person’s ability and willingness to make credit payments on time Factors include income, current debt, information about your character, and how debts have been repaid in the past Creditors use various rating systems The Equal Credit Opportunity Act (ECOA) gives all credit applicants the same basic rights ECOA is very specific about how a person’s age may be used to determine credit rating Those on Public Assistance may not be denied credit as well
5-18 Credit Rating The ECOA also covers applications for mortgages or home improvement loans ECOA gives you the right to know the reasons if you are denied credit You can request a copy of your credit report within 60 days if you are denied credit based on what is in your files Credit Bureaus –Agency that collects information on how promptly people and businesses pay their bills –Experian, Trans Union and Equifax are the 3 major credit bureaus –Credit Bureaus get the information from banks, finance companies stores, credit card companies and other lenders Credit Files –Considerable personal information is maintained on a typical credit bureau file (continued)
5-19 Fair Credit Reporting Is your credit report accurate? If you are denied credit based on your report, you can get a copy of your credit report free within 60 days of your request. Credit card companies must correct inaccurate or incomplete information. Only authorized persons have access to your report. Adverse data can be reported for seven years and bankruptcy for ten years.
5-20 The Cost of Credit Finance charge is the total dollar amount you pay to use credit. It includes interest costs and fees, such as service charges, credit-related insurance premiums, or appraisal fees. The Annual Percentage Rate (APR) is the percentage cost of credit on a yearly basis. The APR provides the true rate of interest so you can make comparisons with other sources of credit. This rate lets you compare like with like when shopping for rates. It is important to shop for credit.
5-21 Trade-Offs of Financing Choices Term (length of loan) versus interest cost. Lender risk versus interest rate. To reduce the lender’s risk and thus the interest rate you can... –Accept a variable interest rate. –Provide collateral to secure the loan. –Make a large down payment up front. –Have a shorter loan term.
5-22 Calculating the Cost of Credit Simple interest. –Computed on principal only and without compounding. The dollar cost of borrowing. –I = P x r x T Simple interest on a declining balance. –Interest is paid only on the amount of original principal not yet repaid. Add-on interest. –Interest is calculated on the full amount of the original principal, then added to the principal, and then the total of both is divided by the number of payments to be made.
5-23 Calculating the Cost of Credit Cost of Open-End Credit –Truth in Lending Act requires that open-end creditors inform consumers as to how the finance charge and APR will affect their costs Cost of Credit and Expected Inflation –Lenders incorporate the expected rate of inflation when deciding how much interest to charge Avoid the Minimum Monthly Payment Trap –The longer you take to pay off the bill, the more interest you pay (continued)
5-24 Objective 5: Develop a plan to protect your credit and manage your debts Fair Credit Billing Act Notify creditor of error in writing within 60 days. Include your explanation of the error and your account number to the billing inquiries address. They must respond within 30 days. Credit card company has two billing periods but no longer than 90 days to correct your account or tell you why they think the bill is correct. The disputed item won’t affect your credit rating while in dispute.
5-25 Objective 5: Develop a plan to protect your credit and manage your debts Fair Credit Billing Act You can withhold payment on damaged or shoddy goods or poor services if you have paid for them with a credit card, as long as you make a sincere attempt to resolve the problem with your creditor. (continued)
5-26 What to do if Your Identity is Stolen? Contact the fraud department of each of the three major credit bureaus and tell them to flag your file with a fraud alert, including a statement that creditors should call you for permission before opening any new accounts in your name. Contact creditors to check for any accounts that have been tampered with or opened fraudulently. File a police report and keep a copy. Check www.consumer.gov/idtheft for help.
5-27 What to do if Your Identity is Stolen? Protecting Your Credit From Theft or Loss –Shred any papers that contain personal information before you throw them out –Close your accounts if you suspect an identity thief has accessed the account Protecting Your Credit Information on The Internet –Take necessary steps to make the online transactions secure and personal information protected (continued)
5-28 Cosigning a Loan The creditor will give you a notice that tells you… –You are being asked to guarantee the debt, so consider if you can afford it if the borrower defaults. –If the borrow does not pay you may have to pay up to the full amount and also any late or collection fees. –If a payment is missed the creditor can collect the debt from you without first trying to get it from the borrower.
5-29 Complaining About Consumer Credit First try to solve the problem directly with the creditor. If that does not work there are more formal complaint procedures. There are a variety of Consumer Credit Protection Laws and Federal Agencies who administer and assist with complaint procedures. –Truth in Lending and Consumer Leasing Acts –Equal Credit Opportunity Act (ECOA)
5-30 Complaining About Consumer Credit Consumer Credit Protection Laws Fair Credit Billing Act –Fair Credit Reporting Act –Consumer Credit Reporting Act –Your Rights Under Consumer Credit Laws Complain to the creditor File a complaint with the government If all else fails, sue the creditor (continued)
5-31 Managing Your Debts Warning Signs of Debt Problems Paying only the minimum balance each month. Increasing the total balance due each month. Missing or alternating payments or paying late. Using savings to pay routine bills such as food. Getting second or third payment notices. Borrowing money to pay old debts. Exceed the credit limits on your credit cards
5-32 Managing Your Debts Debt Collection Practices –The Federal Trade Commission enforces the Fair Debt Collection Practices Act (FDCPA) –Prohibits certain practices by debt collectors –Does not eliminate legitimate debts Consumer Credit Counseling Services (CCCS) If you can’t pay your bills, postpone further credit purchases, talk with your creditors, or seek help from a non-profit credit counseling service. –CCCS is non-profit and supported by contributions from banks, merchants, etc. –Provides education about credit. –Provides help with spending plan. –Provides debt counseling services for those with serious financial problems. –Can develop a debt consolidation plan and negotiate reduced interest rates (continued)
5-33 Other Counseling Services Besides the CCCS universities, local county extension agents, credit unions, military bases, and state and federal housing authorities provide nonprofit counseling services. You can check with your financial institution or consumer protection office to see if it has a listing of reputable, low-cost financial counseling services. Sometimes the answer is bankruptcy
5-34 Declaring Personal Bankruptcy Personal bankruptcy rate is the highest it has ever been, and is increasing annually. Bankruptcy was designed as a last resort but has become an “acceptable” tool of credit management.
5-35 Bankruptcy Stays on your credit report for 10 years, making it difficult to get credit. Potential employers may look at your credit report. Chapter 7. – Submit a petition to the court that lists assets and liabilities, and pay a filing fee. – Many, but not all, debts are forgiven. – Assets are sold to pay creditors. – Can keep some assets. – Idea is a fresh start. – Most filed are this type.
5-36 After Chapter 7 You May No Longer Owe... Retail store charges. Bank credit card charges. Unsecured loans. Unpaid hospital or physician bills. After Bankruptcy You Still May Owe... Certain taxes and fines. Child support and alimony. Educational loans. Debts from willful or malicious acts.
5-37 Life after Bankruptcy Bankruptcy is all about getting a fresh start. This is a collection of ideas for your financial life after bankruptcy, to cushion the impact of the bankruptcy, and to help you rebound. None are magic: they are practical, step by step ways to regain your financial footing. They focus, not on your credit history, but your financial present.
5-38 Life after Bankruptcy Join a credit union. Credit unions are a likely source for car loans after bankruptcy. Their mission is helping members financially. Put the money you have been spending to make credit card minimum payments into a savings account for yourself.
5-39 Life after Bankruptcy Have contributions to a savings account or retirement plan automatically withdrawn from your paycheck. Save it before you see it. Check your credit report to make sure the discharged debts are noted as discharged. MoreMore Understand how expensive credit can be. Get a single credit card, use it sparingly and pay it off every month.
5-40 Life after Bankruptcy Teach your children about money: help them distinguish "wants" from "needs". Help them see that the commercial world tries to manipulate them into spending rather than saving. The stronger and cleaner your present financial condition is, the better candidate you are for future credit. Work to focus attention of lenders on how you have handled money since the bankruptcy.
5-41 Life after Bankruptcy Avoid "credit repair" There are lots of scam artists who prey on debtors' concern about their credit reports and will take your money to "fix" things. There is nothing legal a credit repair organization can do that you can't do yourself. You need to know that credit reporting agencies are entitled to report truthful, if unpleasant, financial history. You have rights to have removed the inaccurate and to comment on the disputed.