Unit Five Credit: Buy Now, Pay Later

Questions to be answered: What is credit? What does it cost to use credit? What are the advantages of using credit? Where can you get credit? What questions should you ask yourself before you use credit? What happens if you misuse credit?

Overview: Credit 101 CREDIT – means someone is willing to loan you money – called principal – in exchange for your promise to pay it back, usually with interest. INTEREST – the amount you pay to use someone else’s money. The higher the interest rate, the greater the COSTS OF USING CREDIT.

All interest rates are quoted as an ANNUAL PERCENTAGE RATE (APR) All interest rates are quoted as an ANNUAL PERCENTAGE RATE (APR). Which is the amount it cost you a year to use credit, expressed as a percentage rate. It includes the interest, transaction fees, and service charges. In addition to the APR, there may be other costs of using credit: ANNUAL FEE – most often used by credit card companies, an annual fee is a yearly charge for the privilege of using credit. FINANCE CHARGE – the actual dollar cost of using credit – which is calculated by a lender. ORGINATION FEE - usually associated with home loans, is a charge for setting up a loan.

Another key piece of information for using credit wisely is the LOAN TERM – how long the loan last. THE LONGER THE LOAN TERM – THE GREATER THE COST OF USING CREDIT. The longer you keep a balance on a credit card – the more money you have to pay in interest over that time. Example - $100,000 loan @ 10% for 30 years Total pay out = $215,926.00

Benefits of Credit Access to cash in an emergency The ability to use it now. Safety and convenience. Earn bonus points or miles.

Sources of Credit CREDIT CARDS – is synonymous with “buy now, pay later.” Unfortunately, ease of use often translates into big bills down the road. Unlike other forms of credit, there is no LOAN TERM with credit cards. You can pay the balance owed over a varied and extended time – that’s where many people get into trouble. The longer you take to pay the balance owed – THE MORE IT COSTS YOU IN FINANCE CHARGES.

Using Credit Cards to your Advantage ANNUAL PERCENTAGE RATE (APR) – Compare all costs on credit cards – look for the lowest rates. ANNUAL FEE – look for cards with no annual fees. GRACE PERIOD – the number of days during which no interest of finance charges will apply. PAY OFF THE ENTIRE BALANCE OF YOUR CARD DURING THE GRACE PERIOD. MINIMUM PAYMENT – 2% of purchases or minimum payment per month. PAY YOUR BALANCE IN FULL EACH MONTH – CAN AVOID INTEREST CHARGES ALTOGETHER. CREDIT LIMIT – is amount as to how much you can charge. Once you reach your limit your card is “MAXED OUT.” Higher credit limits sound good, but big purchases quickly compound into big interest payments with high APR!

Shop for best credit card Go on to the Internet and shop for three different credit cards. Compare: APR ANNUAL FEE GRACE PERIOD MINIMUM PAYMENT CREDIT LIMIT OTHER FEES/NOTES

Other Sources of Credit INSTALLMENT LOANS – require you to make payments on a regular basis – usually monthly. Interest rates are generally lower than credit cards rates. You borrow a set amount with the loan term and payments are fixed for the life of the loan. Typically run from two to six years. One needs to check for prepayment penalties.

Credit Sources (cont) STUDENT LOANS – banks, credit unions and federal government make loans available to pay for higher education. Usually carry low interest rates – 4% to 8% MORTAGES – much like an installment loan, except the length of the mortgage extends over a longer period of time – usually 15 to 30 years – the amount borrowed is usually much larger.

Setting Limits on Credit How much is to much? Two good rules of thumb: Maximum of 20% of your net income should go toward all of your loan payments (excluding a mortgage). Credit Cards, Car Loans, any other Loans. 33% of net income is maximum about for mortgage loans.

Comparing Credit Offers Remember to check for: The APR The loan term or length of the loan The maximum amount of the loan The minimum payment amount Any annual or up-front fees Any payment penalties Additional fees, such as those for exceeding your credit limit, making a late payment, or bouncing a check to the lender The amount of income to qualify for the credit

Credit Reports CREDIT REPORT – is simply your credit history, a record of you personal financial transactions. It will be with you for a long time, so make it shine! Lenders review it to see how well you have managed credit in the past. It is your credit scoreboard, and it reflects your credit history for the past seven to 19 years.

Three Major Credit Reporting Agencies Equifax Experian (formerly TRW) Trans Union

Building a good Credit History When using a checking account – don’t bounce checks. When using a savings account – make additional deposits – regardless of the size. Always pay your bills on time – shows lenders you are responsible.

Credit Scoring Factors generally included: CAPACITY – lenders want to know if you have the ability to repay a loan. A pattern of rising income and/or steady employment. CHARACTER – lenders want to know if you are trustworthy. One way to measure this is by looking at you credit record. CAPITAL - lenders take comfort in knowing you have personal items of value. In a worst-case scenario when you don’t pay your bills at all, a lender might sell your personal possessions to repay your loans. Items of value include a car, investments account and your home.

Ask yourself before signing on the Dotted Line Do I really need this item right now or can I wait? Can I qualify for credit? What is the interest rate (APR)? Are there additional fees? How much is the monthly payment and when is it due? Can I afford to pay the monthly payments? What will happen if I don’t make the payments on time? What will be the extra cost of using credit? What will I have to give up to pay for it? (Opportunity cost) All things considered, is using credit worth it?

Rights and Responsibilities DEBIT – the entire amount of money you owe to lenders when you sign the application of a loan or a credit card. You are legally obligated to uphold what’s written in the agreement. If you fail to keep your part of the bargain, lenders may take legal action against you to recover what they can. YOUR RIGHTS – can cancel a credit agreement with a lender within three days – assuming you return the money borrowed. Are responsible to pay only $50 if someone uses your credit card without your permission.

Getting Out from Under Excessive Debt Spend less than you earn!!! Delay gratification today to clean up yesterday’s mess. Apply your budget, if you consistently spend less than you earn, you can use the additional money to pay off your debt. If you have several loans, try to make the minimum required payments on all of them. Talk to your credits, let them know you are doing what you can to pay them back. If money left after you’ve made the minimum payments, use it to begin paying off one loan at a time. Start with the loan with the largest interest rate – not with the largest balance.

Bankruptcy BANKRUPTCY - is a legal process that allows someone deeply in debt to create a plan to get out of it. Is very costly to everyone involved. Because of the growing incidence of bankruptcy abuse, Congress has made changes in the law. CHAPTER 7 BANKRUPTCY - allows you to effectively erase most of your debt. Typically must be unemployed or have a very low income, and must go through financial counseling. CHAPTER 13 BANKRUPTCY – allows you to pay back some your debts, but with more time. A court typically oversees the repayment plan to ensure accountability.