Consumer and Business Credit ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

PERFORMANCE OBJECTIVES Section I Open-End Credit—Charge Accounting, Credit Cards, and Lines of Credit 13-1: Calculating the finance charge and new balance by using the unpaid or previous month’s balance method 13-2: Calculating the finance charge and new balance by using the average daily balance method 13-3: Calculating the finance charge and new balance of business and personal lines of credit Section II Closed-End Credit—Installment Loans 13-4: Calculating the total deferred payment price and the amount of the finance charge of an installment loan ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

PERFORMANCE OBJECTIVES continued Section II Closed-End Credit—Installment Loans 13-5: Calculating of the regular monthly payments of an installment loan by the add-on interest method 13-6: Calculating the annual percentage rate of an installment loan by APR tables and by formula 13-7: Calculating the finance charge and monthly payment of an installment loan by using the APR tables 13-8: Calculating the finance charge rebate and the payoff for loans paid off early by using the sum-of-the-digits method ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Open-End Credit—Charge Accounts, Credit Cards, and Lines of Credit A loan arrangement in which there is no set number of payments. As the balance of the loan is reduced, the borrower can renew the amount of the loan up to a pre-approved credit limit. A form of revolving credit. finance charge Dollar amount that is paid for credit. Total of installment payments for an item less the cost price of that item. annual percentage rate (APR) Effective or true annual interest rate being charged for credit. Must be revealed to borrowers under the Truth in Lending Act. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Open-End Credit—Charge Accounts, Credit Cards, and Lines of Credit continued unsecured loan Loan that is backed simply by the borrower’s “promise” to repay, without any tangible asset pledged as collateral. These loans carry more risk for the lender and therefore have higher interest rates than secured loans. secured loan Loan that is backed by a tangible asset which can be repossessed and sold if the borrower fails to pay back the loan. These loans carry less risk for the lender and therefore have lower interest rates than unsecured loans. revolving credit Loans made on a continuous basis and billed periodically. Borrower makes minimum monthly payments or more and pays interest on the outstanding balance. A form of open-end credit extended by many retail stores and credit card companies. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

EXHIBIT 13-1 Parts of a Credit Card ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

How Credit Card Reforms Affect You EXHIBIT 13-2 How Credit Card Reforms Affect You ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

To calculate the finance charge and new balance by using the unpaid balance method Step 1 Divide the annual percentage rate by 12 to find the monthly or periodic interest rate. (Round to the nearest hundredth percent when necessary.) Periodic rate = Step 2 Calculate the finance charge by multiplying the previous month’s balance by the periodic interest rate from Step 1. Finance charge = Previous month’s balance × Periodic rate Step 3 Total all the purchases and cash advances for the month. Step 4 Total all the payments and credits for the month. Step 5 Use the following formula to determine the new balance: Annual percentage rate 12 New balance Previous + Finance charge Purchases and cash advances – Payments and credits = ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Calculating Finance Charge and New Balance by the Unpaid or Previous Month’s Balance Method Carl has a charge account with an annual percentage rate of 15%. His previous month’s balance is $318.20. During July, he charged $35.50 for dry cleaning, made a payment of $45, bought new shoes for $59.25, went to a restaurant at $41.10, purchased medicine for $19, and received a credit of $9.12. Calculate the finance charge for July. What is his new balance? 1.25% Finance charge = Previous balance × Periodic rate Finance charge = 318.20 × .0125 = $3.98 New balance = 318.20 + 3.98 + 154.85 – 54.12 = $422.91 ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Sum of the daily balances To calculate the finance charge and new balance by using the Average Daily balance Step 1 Starting with the previous month’s balance as the first unpaid balance, multiply each by the number of days that balance existed until the next account transaction. Step 2 At the end of the billing cycle, find the sum of all the daily balance figures. Step 3 Find the average daily balance. Average daily balance = Step 4 Calculate the finance charge. Finance charge = Average daily balance × Periodic rate Step 5 Compute the new balance as before. Sum of the daily balances Days in billing cycle New balance Previous + Finance charge Purchases and cash advances – Payments and credits = ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Open-Ended Credit Example Morgan has a revolving credit account with an 15% annual percentage rate. The finance charge is calculated by using the average daily balance method. The billing date is the first day of each month, and the billing cycle is the number of days in that month. During the month of March, Morgan’s account showed the following activity: How much is the finance charge for August and what is Morgan’s new balance? ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Open-Ended Credit Example continued Dates Days Activity/ Amount Unpaid Balance Daily Balance March 1-6 6 Previous balance $215.60 $1,293.60 7-9 3 Charge +$125.11 340.71 1,022.13 10-11 2 Charge +23.25 363.96 727.92 12-16 5 Payment –75.00 288.96 1,444.80 17-22 Credit –54.10 234.86 1,409.16 23 1 Charges +79.00 +19.43 333.29 24-31 8 Charge +94.19 427.48 3,419.84 31 $9,650.74 ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Open-Ended Credit Example continued = Finance charge = Average daily balance × Periodic rate Finance charge = 311.31 × .0125 = $3.89 New balance = Previous balance + Finance charge + Purchases and cash advances – Payments and credits New balance = 215.60 + 3.89 + 340.98 – 129.10 = $431.37 ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Lines of Credit line of credit U.S. prime rate Pre-approved amount of open-end credit, based on borrower’s ability to pay. U.S. prime rate Lending rate at which the largest and most creditworthy corporations borrow money from banks. The interest rate of most lines of credit is tied to the movement of the prime rate. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

EXHIBIT 13-4 Consumer Rates and Returns to Investors – October 15, 2012 ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Lines of Credit Example A firm has a $75,000 line of credit. The annual percentage rate is the current prime rate plus 4.5%. The balance on November 1 was $12,300. On November 7, the firm borrowed $16,700 to pay for merchandise, and on November 21 it borrowed another $8,800. On November 26, a $20,000 payment was made on the account. The billing cycle for November has 30 days. If the current prime rate is 8 ½%, what is the finance charge on the account, and what is the firm’s new balance? ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Lines of Credit Example continued APR = Prime rate + 4.5% = 8.5 + 4.5 = 13% Dates Days Activity/ Amount Unpaid Balance Daily Balance November 1-6 6 Previous balance 12,300 73,800 7-20 14 Charge +$16,700 29,000 406,000 21-25 5 Charge +8,800 37,800 189,000 26-30 Payment -20,000 17,800 89,000 30 757,800 ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Lines of Credit Example continued Finance charge = Average daily balance x Periodic rate Finance charge = 25,260 × .0108 = $272.81 New balance = Previous balance + Finance charge + Purchases and cash advances – Payments and credits New balance = 12,300 + 272.81 + 25,500 - 20,000 = $18,072.81 ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Closed-End Credit—Installment Loans Loan made for a specified number of equal monthly payments. A form of closed-end credit used for purchasing durable goods. mortgage An installment loan made for homes and other real estate property. down payment Portion of the purchase price that the buyer must pay in a lump sum at the time of purchase. cash or purchase price Price paid for goods and services without the use of financing. amount financed After the down payment, the amount of money that is borrowed to complete a sale. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Total amount of installment payments = Finance charge = Calculating the Total Deferred Payment Price and the Amount of the Finance Charge of an Installment Loan Amount financed = Purchase price – Down payment Down payment = Purchase price × Down payment percent Total amount of installment payments = Amount financed + Finance charge Finance charge = Total amount of installment payments – Amount financed Monthly payment amount × Number of monthly payments Total deferred payment price = Total of installment payments + Down payment ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Calculating the Total Deferred Payment Price and the Amount of the Finance Charge of an Installment Loan Orlando had the option of paying $12,500 in cash or financing a car with a 4-year installment loan. The loan requires a 15% down payment and equal monthly payments of $309.90 for 48 months. What is the finance charge on the loan? What is the total deferred payment price? Down payment = 12,500 × .15 = $1,875 Amount financed = 12,500 – 1,875 = $10,625 Total amount of installment payments = 309.90 × 48 = $14,875.20 Finance charge = 14,875.20 – 10,625 = $4,250.20 Total deferred payment price = 14,875.20 + 1,875 = $16,750.20 ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

To calculate the regular monthly payment of an installment loan using add-on interest Step 1 Calculate the amount to be financed by subtracting the down payment from the purchase price. Note: When the down payment is expressed as a percent, the amount financed can be found by the complement method because the percent financed is 100% minus the down payment percent. Amount financed = Purchase price(100% – Down payment percent) Step 2 Compute the add-on interest finance charge by using I = PRT, with the amount financed as the principal. Step 3 Find the total of installment payments by adding the finance charge to the amount financed. Total of installment payments = Amount financed + Finance charge Step 4 Find the regular monthly payments by dividing the total of installment payments by the number of months of the loan. Regular monthly payments = Total of installment payments Number of months of the loan ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Calculating the Monthly Payment Using Add-on Interest Example Caroline bought furniture with a 6% add-on interest installment loan from her bank. The purchase price of the furniture was $1,500. The bank required a 10% down payment and equal monthly payments for 2 years. How much are her monthly payments? Amount financed = 1,500 (100% – 10%) = 1,500 × .9 = $1,350 Finance charge = 1,350 × .06 × 2 = $162 Total of installment payments = 1,350 + 162 = $1,512 24 = Monthly payments = 1,512 ÷ $63 ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Finance charge × 100 Amount financed To find the annual percentage rate of an installment loan by using APR tables Step 1 Calculate the finance charge per $100. Finance charge per $100 = Step 2 From Table 13-1, scan down the Number of Payments column to the number of payments for the loan in question. Step 3 Scan to the right in the Number of Payments row to the table factor that most closely corresponds to the finance charge per $100 calculated in Step 1. Step 4 Look to the top of the column containing the finance charge per $100 to find the APR of the loan. Finance charge × 100 Amount financed ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Annual Percentage Rate (APR) Finance Charge per $100 TABLE 13-1 Annual Percentage Rate (APR) Finance Charge per $100 ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Finding the Annual Percentage Rate by Tables Example Erin purchased appliances for $4,500. She made a $500 down payment and financed the balance with an installment loan for 24 months. If her payments are $190 per month, what APR is she paying on the loan? Amount financed = 4,500 – 500 = $4,000 Total payments = 190 × 24 = 4,560 Finance charge = 560 × 100 = $14 4,000 From Table 13-1 APR for $14.00 = 13% ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Calculating APR by Formula Where: I = finance charge on the loan P = principal, or amount financed n = number of months of the loan ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Calculating APR by Formula Example Sharon repaid a $2,200 installment loan with 18 monthly payments of $140 each. Use the APR formula to determine the annual percentage rate of her loan. Total payments = 140 × 18 = 2,520 I = Finance charge = 2,520 – 2,200 = 320 n = months = 18 P = principal = 2,200 ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Amount financed × Table factor To find the finance charge and the monthly payment of an installment loan by using the APR tables Step 1 Using the APR and the number of payments of the loan, locate the table factor at the intersection of the APR column and the Number of Payments row. This factor represents the finance charge per $100 financed. Step 2 Calculate the total finance charge of the loan. Finance charge = Step 3 Calculate the monthly payment. Monthly payment = Amount financed × Table factor 100 Amount financed + Finance charge Number of months of the loan ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

13.25%, 24-month table factor = $14.38 Finding Finance Charge and Monthly Payment by Using the APR Tables Example A firm uses a finance company that is offering up to 24-month installment loans with a 13.25% APR. If a buyer finances a purchase for $3,550, what are the finance charge and the amount of monthly payment on the loan? 13.25%, 24-month table factor = $14.38 ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Early Loan Payoffs finance charge rebate Unearned portion of the finance charge that the lender returns to the borrower when an installment loan is paid off early. sum-of-the-digits method, or Rule of 78 Widely accepted method for calculating the finance charge rebate. Based on the assumption that more interest is paid in the early months of a loan, when a greater portion of the principal is available to the borrower. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Distribution of a $1,000 Finance Charge over 12 Months EXHIBIT 13-6 Distribution of a $1,000 Finance Charge over 12 Months ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

To calculate the finance charge rebate and loan payoff Step 1 Calculate the rebate fraction. Rebate fraction = Step 2 Determine the finance charge rebate. Finance charge rebate = Rebate fraction × Total finance charge Step 3 Find the loan payoff. Sum of the digits of the number of remaining payments Sum of the digits of the total number of payments ( ) Loan payoff Payments remaining × amount – Finance charge rebate = ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Calculating an Early Loan Payoff Example Libby has financed a $4,000 installment loan for 36 months. The payments are $141 per month, and the total finance charge was $1,076. After 20 months, she has decided to pay off the loan. How much is the finance charge rebate, and how much is her loan payoff? 16 months remaining of original 36 months on loan ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Calculating an Early Loan Payoff Example continued Finance charge rebate = Rebate fraction × Total finance charge Finance charge rebate = .2042 × 1,076 = $219.72 Loan payoff = (Payments remaining × Payment amount) — Finance charge rebate Loan payoff = (16 x 141) – 219.72 = 2,256 – 219.72 = $2,036.28 ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter Review Problem 1 April has a charge account with an annual percentage rate of 16%. Her previous month’s balance is $523.45. During October, she charged $75.00 for groceries, made a payment of $200, bought jeans for $61.95, went to a restaurant at $35.23, and received a credit of $11.35. Calculate the finance charge for October. What is her new balance? Finance charge = Previous balance × Periodic rate Finance charge = 523.45 × .0133 = $6.96 New balance = 523.45 + 6.96 + 172.18 – 211.35 = $491.24 ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter Review Problem 2 Stephen remodeled his kitchen with a 6% add-on interest installment loan from his bank. The remodel cost $5,500. The bank required a 15% down payment and equal monthly payments for 2 years. How much are his monthly payments? Amount financed = 5,500 (100% – 15%) = 5,500 × .85 = $4,675 Finance charge = 4,675 × .06 × 2 = $561 Total of installment payments = 4,675 + 561 = $5,236 Monthly payments = 5,236 ÷ 24 = $218.17 ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.