Garman/Forgue Personal Finance Ninth Edition Chapter 7 Credit Cards and Consumer Loans

7 | 2 Learning Objectives 1.Compare the common types of consumer credit, including credit cards and installment loans 2.Describe the types and features of credit card accounts 3.Manage your credit card accounts to avoid fees and finance charges 4.Describe the important features of consumer installment loans 5.Calculate the interest and annual percentage rate on consumer loans

7 | 3 Closed-End Credit (installment credit) –One-time loans for a specific purpose Paid back in a specified period of time Payments of equal amounts (installment debt) Examples? Open-End Credit (revolving credit) –Use on an as-needed basis, up to a limit Examples? 1. Types of Consumer Credit

7 | 4 2. Credit Card Accounts Common Terms:Common Terms: –Annual Percentage Rate –Annual Fee –Minimum payment –Principal –Cash Advance –Convenience Checks –Balance Transfer –Credit Limit –Default

7 | 5 2. Types of Credit Cards Bank credit cards –Lender = the financial institution –VISA / MC etc = the service provider that provides the network to handle the transactions Co-Branded Cards Prestige Cards Affinity Cards Retail (Store) credit cards Secured credit cards

7 | 6 Common Aspects of Credit Card Accounts (PG 202)Credit card disclosure box (PG 202) Preapproved Credit Card Offers Annual fees & Other fees Liability for lost or stolen cards Late-payment, bounced check, over-the-limit fees Teaser Rates Default rates / penalty APR Variable interest rate (based on the prime rate) Did You Know? Credit card rules can change any time!Did You Know? Credit card rules can change any time! Rules may be changed, but lender must notify account holder at least 45 days in advance. How to properly close a credit card account [pg 201]

7 | 7 Credit Card Disclosure Info

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7 | 9 3. Managing Credit Cards Wisely Example Statement (pg 207) Billing date (or cycle closing date) Due date –Fed law requires bills to be sent at least 21 days before payments are due Transaction date vs Posting date Grace period –Time between posting date and due date… full payment must be made within this time to avoid finance charges –There is no grace period if you carry a balance (pg 206) Returns and credits: be sure to check! Minimum payment amount

7 | 10 The Cost of Making a Minimum Payment ItemPriceAPR Interest Paid Price Actually Paid Years to Pay Off TV $50018%$439$9398 Computer $100018%$1899$ Furniture $250018%$6281$878134

7 | 11 The Benefit of Making Larger Payments Original Balance APR Monthly Payments Years to Pay Off Total of Payments $250018% Minimum Payment 34$8781 $250018%$508$4698 $250018%$1003$3163

7 | 12 Computation of Finance Charges APR vs. Periodic Rate Monthly finance charges => Average daily balance x periodic rate Example: Kohls Credit Card with 12% APR What is the periodic rate? If average daily balance is $1000, what is the finance charge for the month?

7 | Installment Loans Secured loans vs unsecured loans –Unsecured loans: granted based on good credit character –Secured loans require collateral or a cosigner –Collateral: Lender places a lien (legal right to seize) on property that is pledged as collateral –Which poses more risk for lender? –Acceleration clause: one missed payment can result in all remaining installments being payable upon demand

7 | 14 TIL Act requires lenders to disclose finance charge and APR Installment loans: usually fixed interest rate and monthly payment remains same To calculate monthly payments on an installment loan: use chart, pg 213 To calculate finance charges on a loan: TOTAL PAYMENTS – PRINCIPLE BORROWED Calculating an Installment Loan Payment

7 | 15 Monthly Installment Payment Required to Repay $1000

7 | 16 Methods of Calculating Interest The Declining-Balance Method (PG 214) (AKA: Simple-interest loans or fully-amortized loans) –Used for mortgages –Equal monthly payments: part goes toward interest and part toward principle: much more toward interest in earlier years –Periodic interest rate is applied to the loan balance at the end of each month –Fact: you only pay interest on the balance, which is constantly being reduced –Fact: there are usually no prepayment penalties )

7 | 17 This chart shows an amortized loan Each monthly payment is a fixed amount The balance on the loan gradually declines as payments are made What happens if the borrower decides to pay off the loan early? Watch out for pre-payment penalties! Calculations for amortized loans: /amort.html

7 | 18 The Add-On Method (PG 215) –Used on some installment loans –Interest is calculated up front, added to loan –Add-on rate is used to determine interest (I) I = PRT –Note: the add-on rate is not equal to the APR –(the APR is approximately double the add-on rate) Example: You borrow $2000 at 9% add-on interest for 2 yrs I = PRT I = 2000 x.09 x 2 I = 360 Total Payments = = 2360 Monthly Payment = 2360 / 24 = $98.33