Calculating Cost Of Credit. Types of Credit Closed-End Credit ◦ One-time loan that you pay back over a specified period of time in payments of equal amounts.

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Presentation transcript:

Calculating Cost Of Credit

Types of Credit Closed-End Credit ◦ One-time loan that you pay back over a specified period of time in payments of equal amounts.  Ex. Mortgage, vehicle, furniture (installment loan) Open-End Credit/line of credit ◦ Certain limit on the amount of money you can borrow for a variety of goods and services (credit limit)  Ex. Department store credit cards, Visa, Mastercard,

Sources of Credit Loans Credit Cards ◦ Debit Cards  Finance charges – the total dollar amount you pay to use credit If you pay your balance before the due date you do not have to pay a finance charge!!!!!!!!!

Debt Payment-to-Income Ratio The percentage of debt you have in relation to your net income Net Income – gifts, allowances, interest, and income you take home after all deductions have been made Net income monthly =$1200. Students loan and gas card total = $180. What is the debt payments-to-income ratio? $180/$1200 =.15 = 15%

Annual Percentage Rate APR – the cost of credit on a yearly basis, expresses as a percentage. ◦ Ex. 18% APR means that you pay $18 each year on every $100 you owe ◦ Finance charges is for that year is $18

Trade-offs Term vs. Interest Costs ◦ Longer term = smaller monthly payments ◦ Longer term = greater you will pay in interest Lender Risk vs. Interest Rate ◦ Minimum down payment or ◦ Low fixed payment with LARGE final payment =more expensive loan

So, how to get a lower interest rate….. Variable interest rate ◦ Based on changing rates in the banking system Secured Loan ◦ Pledge collateral (one of the 5 C’s of credit) Up-Front Cash ◦ Make a large down payment Shorter Term ◦ Less amount of time that something may prevent you from repaying your loan

Simple Interest The interest computed only on the principal amount that you borrow. ◦ Principal amount X Interest rate X ◦ Amount of time the principal is borrowed = Simple Interest ◦ Todd’s brother gave him $500 to buy a new tires for his car. He agreed to only charge 5 percent simple interest if Todd promised to pay him back in 6 months. How much interest will Todd pay in those 6 months? ◦ $500 x.05 x.6 = $15

Minimum Monthly Payment The smallest amount that you can pay to remain a borrower in good standing ◦ It will take you longer to pay off the loan ◦ 41 percent of cardholders from the ages of 18 to 29 made only the minimum required payment on a credit card in some of the past 12 months. (Source: FINRA Investor Education Foundation, "Financial Capability in the United States," December 2009)