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Chapter 5 Credit Management

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Presentation on theme: "Chapter 5 Credit Management"— Presentation transcript:

1 Chapter 5 Credit Management
What is Credit? Credit is created/extended when a consumer acquires money, goods, and services based on an agreement with lender called a LOAN. The loan states that credit is extended for a specified period of time with a specified rate of interest

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The Bad News About Credit Americans are becomingly increasingly dependent on credit Credit encourages people to live beyond their means, leading to financial disaster

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Classifying Consumer Credit Revolving or Open-ended Consumers make purchases up to certain limit Finance charge on unpaid balance Regular 30-day charge accounts (open-ended) balance must be paid off each month (Amex) Installment Loans Repayment of loan plus interest on regular basis Home mortgage loan an example

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How Much Should You Borrow? It is IMPORTANT to set DEBT LIMITS Rule of thumb for borrowing No more than % of take-home pay should be used to pay installment debt Mortgage debt should be excluded in this calculation

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The Right Reasons for Borrowing Purchasing large goods and services Emergencies Taking advantage of opportunities Convenience Establishing credit

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The Wrong Reasons to Borrow Using credit to live beyond your means Examples: To meet basic living expenses To make impulse purchases To purchase short-lived goods and services

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Some Major Credit Sources

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National Credit Cards Issued by large corporations as well as financial institutions Consumer controls how to pay it off Balance paid off each time -- usually no interest is charged Balance not paid off in full -- finance charge incurred Still one of the most expensive sources of credit

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Retail Credit Cards Good only in stores where issued Rates comparable to those charged on bank credit cards

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Consumer Finance Companies Assume more risky loans and charge higher interest rates Loans can be made in small amounts Easier to receive a loan and more convenient than using bank Loans are speedily processed

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Life Insurance Companies Policy holders build up not only protection, but also cash value over the years Amount = to cash value can be borrowed in form of a loan

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Brokerage Account Loans Rates competitive with banks Amount borrowed a function of the value of securities held

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Personal Loans Written agreements help reduce misunderstandings Agreement should specify: Terms of loan Interest charged Obligations of both borrower and lender Advisable ONLY if funds are not borrowed from traditional sources

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Pawnbrokers Pawn brokers accept valuables as collateral Issue loans for % of valuables Charge high interest rates ( %) Demand quick repayment (usually within days) Should be used only as last resort

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Three C’s of Credit : Capacity Creditors examine: Current income vs. current Current debts Number of dependents Alimony and child support payment Future income potential

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Three C’s of Credit: Character -- Past credit Timeliness of payments Accuracy of information you provided on income, employment, etc.. Stability

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Three C’s of Credit: Collateral Collateral -- something of Value pledged as promise to repay the loan Protects creditors should loan not be repaid

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Credit Bureaus Clearinghouse of consumer credit information No judgments made by bureau on credit worthiness of person Information provided weighed differently by different lenders

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Steps to Establishing Credit Open checking, savings account Install telephone in your name Obtain gas credit card Apply for bank credit card even if offered only low limit Have parents co-sign loan Begin repaying student loan

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Denial of Credit Some reasons lenders may deny credit are: Not enough income vs. expenses Negative factors such as late payments in credit history Several job changes Incomplete credit background If denied, lender must give written explanation

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Finance Charges Finance charge -- difference between amount repaid and original amount borrowed Annual percentage rate (APR) -- interest rate paid per dollar per year for credit

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Which Credit Card is Best for You? The answer depends on your credit card use. Weigh the following attributes accordingly: If you pay off the balance each month No annual fee A grace period If you carry a balance each month A low annual percentage rate

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Consequences of Credit Abuse: Repossession of Property Failure to make a loan payment means the borrower defaults on a loan If borrower defaults, creditor can seize property and sell it to recover funds

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Consequences of Credit Abuse: Wage Garnishment One of the strongest actions creditors can take Court order requiring portion of borrower’s wages paid directly to the lender Amount deducted by employer from paycheck Deductions continue until debt repaid

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Bankruptcy A legal process where A person or business that cannot meet financial obligations is relieved of debt Courts divide assets and income among creditors

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Repercussions of Bankruptcy Borrowers not relieved of Back taxes Alimony Child support payments Bankruptcy judgment on person’s credit record for next 10 years Credit will be difficult to obtain for that time period

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First Bankruptcy Alternative – Chapter 7 Filing Liquidation plan where assets are seized by court and sold Funds then prorated among creditors Usually creditors receive only small portion of funds owed them

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Second Bankruptcy Alternative -- Chapter 13 Filing Also known as the wage earner plan Individuals establish three-year repayment plan Allowed to retain possession of their property Creditors receive % of amount owed them

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