Garman/Forgue Personal Finance Ninth Edition Chapter 6 Building and Maintaining Good Credit

6 | 2 Learning Objectives 1.Explain reasons for and against using credit 2.Establish your own debt limit 3.Achieve a good credit reputation 4.Describe common sources of consumer credit 5.Identify signs of overindebtedness and describe options available for debt relief

6 | 3 1. Reasons For and Against Using Credit Credit represents a form of TRUST established between a lender and borrower Good uses (advantages) of credit: A cushion for financial emergencies Convenient when shopping One monthly payment Making reservations Rewards, sometimes To obtain an education Helps establish good credit history ( if used wisely )

6 | 4 The downside (disadvantages) of credit:  It is tempting to overspend  Interest (the price of credit) can be costly  Becoming financially “overstretched”  Interest is costly

6 | 5 2. You Should Set Your Own Debt Limits YOU, rather than the lender, should set your own debt limit Typically, your debt limit should be lower than what lenders are willing to lend Debt payments-to-disposable income: Monthly Debt Payments Monthly Net Income 16%

6 | 6 Debt payments-to-disposable income:

6 | 7 Loan Affordability Before you apply for a loan, determine if you can afford it… –Will the payments fit into your budget? (what might you have to give up in order to afford the new payment each month?) –Are you prepared to make this trade-off? –The effects of SQUEEZING new monthly debt payments into a budget. (p. 176)

6 | 8 Dual-earner households: consider a lower debt limit –Our spending GROWS in tandem with our rising income –“How can we be so broke when we make so much money?” –GOOD ADVICE, PG. 178!

6 | 9 Credit agreement or Promissory note 3. Obtaining Credit and Building a Good Credit Reputation Who gets approved and who doesn’t? 1.Apply for credit: Credit Application 15% applicants are DENIED (due to no established credit history or negative information) 2.Lender conducts credit investigation Evaluates applicant’s creditworthiness: ability AND willingness to repay All 3 major credit bureaus calculate and report scores to lenders. Ex: FICO score (most popular scoring system) 3.Approval or rejection 4.If approved, a contract is created => 5.Tiered pricing

6 | 10 Your Credit Reputation The information in your credit files is one of the most important aspects of your financial life! Ex: jobs, insurance, rental housing, auto loans Must confirm that information is accurate 3 major credit bureaus collect information to create a credit file: Experian, Trans Union, Equifax The information is used to create a credit score FICO score is most well-known, reflects your creditworthiness Building a credit history / increasing your score: –Establish both a checking account and savings account –Have telephone / utilities billed in your name –Apply for a gas credit card –Apply for a bank credit card or secured credit card –Apply for small bank loan –Pay off student loans

6 | 11 What’s in MY report? Be curious…! One free each year from all 3 major bureaus: – – aspxhttp:// aspx Instant Message! Closing accounts does not help your credit score! Accuracy is important! Agencies must correct inaccurate information Negative data can remain for up to 7 years (bankruptcy for 10 years!)

6 | 12 Making Sense of Your FICO Credit Score Your FICO score is extremely important because it dictates whether you will be granted credit and at what interest rate. WHAT FACTORS DETERMINE MY SCORE? PG 180

6 | Signs of Overindebtedness 1.Exceeding debt limits and credit limits 2.Not knowing how much you owe 3.Running out of money 4.Paying only the minimum amount due 5.Requesting new credit cards and increases in credit limits 6.Paying late or skipping payments 7.Using debt-consolidation loans 8.Getting late payment notices 9.Experiencing garnishment 10.Experiencing repossession or foreclosure Humorous College Student: t.com/pages/article_ college_credit_video _ html

6 | How to Get Out from Under Excessive Debt Get organized: determine your account balances Prioritize: focus on debt reduction Contact your creditors if necessary Don’t take on new credit Refinance Find good help!Find good help!

6 | 15 Consumer Credit Counseling Services Look for a non-profit credit counseling service! Its activities are twofold: 1.Help Debt counseling services Debt consolidation plans Negotiated reduction in interest rates Spending plan / budget 2.Prevention Education about credit BEWARE of other agencies that offer to consolidate debt! NO ALTERNATIVE LENDERS!! NO ALTERNATIVE LENDERS!! PG. 185

6 | 16 Consumer Credit Counseling Service of Rochester (CCCS) non-profit DMP is a non-profit community service agency dedicated to educating and empowering individuals and families to take control of their financial lives. Free, confidential budget and credit counseling, Group education programs, Debt management programs (DMP), Telephone or in person counseling, Interest education, Information on how to stop collection calls, Bankruptcy avoidance education, Realistic budget education University Avenue Suite 900 ▪ Rochester, NY ▪

6 | 17 Sometimes… the answer is Personal Bankruptcy Designed as a last resort, it has become an “acceptable” tool of credit management Bankruptcy stays on your credit report for 10 years Who should file? Who CAN file? What debts are discharged? How will it affect your life?

6 | 18 Chapter 7 Immediate Liquidation Plan (straight bankruptcy) Submit a petition to the court; must go through counseling Must pass a “means” test New York: $46,320 $57,902 $69,174 $82,164 If eligible, most debts discharged All non-exempt property can be sold off to pay your creditors Most debts are forgiven, except for: –Certain taxes and fines –Child support and alimony –Educational loans –Debts from willful or malicious acts State and federal laws determine which assets are EXEMPT

6 | 19 Chapter 13 (Wage Earner Plan) A 3-5 year repayment plan is established Person keeps most possessions regular payments made to bankruptcy trustee Person pays less than the full amount owed For much more information: