1. Consumer Credit: Advantages, Disadvantages, Sources, and Costs
Chapter 5

2. What is Consumer Credit?
Credit: an arrangement to receive cash, goods, or services now and pay for them in the future
Consumer Credit: the use of credit for personal needs (except a home mortgage) by individuals and families

3. The Importance of Consumer Credit in Our Economy
Consumer credit dates back to colonial times
Privilege for the affluent
Farmers came to use credit extensively
Finance charges were not imposed
Cost of credit added to price of goods
Installment credit: debt paid in equal installments over a specified period of time
Exploded with the invention of the automobile in the early 1900s
Credit is a driving force in the U.S. economy

4. Uses and Misuses of Credit
May allow consumers to be more efficient or more productive
Increases the amount of money a person has to spend on goods and services
Questions to ask before making a major purchase:
Do I have the cash I need for the down payment?
Do I want to use my savings for this purchase?
Does the purchase fit my budget?
Could I use the credit I need for this purchase in some better way?
Could I postpone the purchase?
What are the opportunity costs of the purchase?
What are the dollar costs and psychological costs of using credit?

5. Advantages of Credit
Allows people to enjoy goods and services now and pay for them through a payment plan based on future income
Permit purchases even when funds are low
Safe—don’t have to carry a lot of cash
Convenient—make hotel reservation, rent a car, shop by phone or Internet
Provides a 50 day “float” before payment is required
Offer rewards and privileges

6. Disadvantages of Credit
Temptation to overspend
Can lead to long-term financial problems, loss of income, court action, and bankruptcy
Does not increase purchasing power—ties up future income
Costs money—monthly finance charges can add up

7. Types of Credit Closed-End Credit
Pay back one-time loans in a specified period of time and in payments of equal amounts
Used for a specific purpose and involves a specified amount
Mortgage loans, automobile loans, installment loans
Three common types:
Installment sales credit
Installment cash credit
Single lump-sum credit

8. Types of Credit Closed-End Credit Installment Sales Credit
Loan that allows you to receive merchandise, usually high priced items (appliances, furniture)
You make a down payment and sign a contract to repay the balance plus interest and service charges
Equal installments over a specified time period

9. Types of Credit Closed-End Credit Installment Cash Credit
Direct loan of money for personal purposes, home improvements, or vacations
You make no down payment and make payments in specified amounts over a set period
Single Lump-Sum Credit
Loan that must be repaid in total on a specified day, usually within days
Generally used to purchase a single item

10. Types of Credit Open-End Credit
Using a credit card issued by a department store, using a bank credit card
30 day grace period before finance charges or interest are charged
Used to make purchases whenever you wish
Line of credit—maximum dollar amount of credit the lender has made available to you
Revolving line of credit—prearranged loan for a specified dollar amount that you can use by writing a special check
Repayment is made in installments over a set period
Finance charges are based on the amount of credit used and the outstanding balance

11. Sources of Consumer Credit
Credit Source
Type of Loan
Commercial Banks
Single-payment loan
personal installment loans
passbook loans
check-credit loans
credit cards
second mortgages
Consumer Finance Companies
Personal installment loans
Credit Unions
share-draft credit plans
Life Insurance Companies
Single-payment or partial payment loans
Federal Savings Banks (Savings and Loan)
Home improvement loans
Education loans
Savings account loans
Second mortgages

12. Credit Cards
The average cardholder has more than nine credit cards, including:
Bank
Retail
Gasoline
Telephone
Convenience User—pays balance in full each month
Borrower—does not pay balance in full each month

13. Credit Cards
Cost of credit depends on type of card you have and the terms set forth by the lender
You may have to pay interest or other finance charges
Some companies charge annual fees of $20-$25
Be sure to shop around for the best deal

14. Other Types of Plastic Debit Cards Smart Cards
Electronically subtracts money directly from your savings or checking account
Smart Cards
Equipped with a computer chip that can store 500 times as much data as a normal credit card
Combine credit card balances, driver’s license, health care identification, medical history all in one place
Travel and Entertainment Cards
Balance is due in full each month
American Express, Diner’s Club

15. Can You Afford a Loan? Make an accurate and sensible budget
Can you meet all of your expenses and still afford a monthly loan payment?
General Rules of Credit Capacity
Debt Payments-to-Income Ratio
Divide monthly debt payments by net monthly income
Should be no more than 20% of net income
15% or less is optimal
Debt-to-Equity Ratio
Divide total liabilities by net worth
Do not include value of home

16. The Five C’s of Credit Character Capacity Capital Collateral
Will you repay the loan?
Capacity
Can you repay the loan?
Capital
What are your assets and net worth?
Collateral
What if you don’t repay the loan?
Conditions
What if your job is insecure?

17. Other Factors Considered in Determining Creditworthiness
Age
If you are old enough to sign a legal contract
Cannot be denied a loan because of age
Public Assistance
Cannot be denied a loan because you receive public assistance or social security
Housing Loans
Bans discrimination against you based on the race or nationality of the people in the neighborhood where you live or want to buy your home

18. Your Credit Report
When you apply for a loan, the lender will review your credit history (credit report, credit file)
Credit Bureau
Agency that collects information on how promptly people and businesses pay their bills
Three major credit bureaus:
Experian
Trans Union
Equifax
Maintain more than 200 million credit files on individuals that they receive from lenders

19. Your Credit Report What’s in your credit files?
Your employer, position, income
Previous address
Previous employer
Spouse’s name, social security number, employer, income
Whether you rent or own your home
Checks returned for insufficient funds
Detailed credit information
Account number, date, amount, terms, type of credit for each loan you take out
Updated regularly to show how many payments you’ve made, how many payments were late or missing, and how much you owe

20. Your Credit Report Fair Credit Reporting
1971 Fair Credit Reporting Act
Regulates use of credit reports
Requires deletion of out-of-date information
Gives individuals access to files as well as ability to change misinformation
Places limits on who can access your credit report
Who Can Obtain a Credit Report?
Properly identified persons with approved requests
Supplied in response to a court order or at your request
Provided for use in connection with a credit transaction, underwriting of insurance, some legitimate business need

21. Your Credit Report Time Limits on Unfavorable Data
May be reported for only seven years
Up to 10 years if you have declared personal bankruptcy
Incorrect Information in Your Credit File
Contact bureau to dispute information
Credit bureau must check its records and change or remove incorrect items
What are Your Legal Rights?
Sue a credit bureau or creditor that has caused you harm by not following the rules established by the Fair Credit Reporting Act

22. The Cost of Credit Finance Charge and Annual Percentage Rate
Finance charge: the total dollar amount you pay to use credit
Includes interest costs and sometimes other costs such as service charges, credit-related insurance premiums, or appraisal fees
Annual Percentage Rate (APR): percentage cost of credit on a yearly basis
Key to comparing costs, regardless of the amount of credit or how much time you have to repay it

23. The Cost of Credit Tackling the Trade-Offs Term versus Interest Cost
Many people choose longer term financing because they want smaller payments
The longer the term of the loan, the greater the amount you must pay in interest charges
Size of down payment makes a difference

24. The Cost of Credit Tackling the Trade-Offs
Lender Risk versus Interest Rate
Minimize borrowing costs by accepting conditions that reduce the lender’s risk:
`variable interest rate—based on fluctuating rates in the banking industry
Secured loan—pledge property or another asset as collateral
Up-front cash—pay cash for a large portion of what you are financing
Shorter term—shorter period of time to repay what you owe

25. Calculating the Cost of Credit
The most common method of calculating interest is the simple interest formula
Simple Interest: interest is computed only on the principal (the amount you borrow)
Based on three factors:
Principal
Interest
Time
Simple Interest on the Declining Balance: when simple interest is paid back in more than one payment, the method of computing interest is known as the declining balance method
The more payments you make, the lower the interest you will pay

26. Calculating the Cost of Credit
Add-On Interest
Interest is calculated on the full amount of the original principal, no matter how frequently you make payments
Also known as compound interest
The longer you take to repay the loan the more interest you will pay

27. Calculating the Cost of Credit
Cost of Open-End Credit
Truth in Lending Act
Requires that open-end creditors inform consumers as to how the finance charge and APR will affect their cost
Must explain how finance charges are calculated
Must inform you when finance charges on your credit account begin to accrue, so that you know how much time you have to pay your bills before the finance charge is added

28. Calculating the Cost of Credit
Cost of Credit and Expected Inflation
Inflation reduces buying power of money
Each percentage point increase in inflation means a decrease of about 1% in the quantity of goods and services you can buy with the same amount of money
Lenders incorporate the expected rate of inflation when deciding how much interest to charge

29. Calculating the Cost of Credit
Avoid the Minimum Monthly Payment Trap
Minimum monthly payment is the smallest amount you can pay and remain in good standing
Lenders encourage you to pay the minimum so that you take longer to pay off your debt
The longer it takes to pay off a bill, the more interest you pay
Finance charges could be more than the item was worth

30. Protecting Your Credit
Billing Errors and Disputes
Fair Credit Billing Act (FCBA) 1975
Sets procedures for promptly correcting billing mistakes, refusing to make credit card or revolving credit payments on defective goods, and promptly crediting your payments
Protecting your credit rating
According to the law, a creditor may not threaten your credit rating or do anything to damage your credit reputation while you’re negotiating a credit dispute
Defective goods and services
You may tell your credit card company to stop payment on goods and services if you have tried to return defective goods and the store has not accepted the return

31. Identity Crisis: What to do if Your Identity is Stolen
Contact the Credit Bureau
Contact the Creditors
File a Police Report
Key Websites for Identity Theft

32. Protecting Your Credit From Theft or Loss
Tear or shred any papers that contain personal information before throwing them out
Close bank accounts immediately
Stop payment on checks
Cancel debit card and get a new one with a new PIN number
Protecting credit cards:
Be sure cards are returned after a purchase
Keep a record of your credit card number
Notify the credit card company immediately if your card is lost or stolen

33. Protecting Your Credit Information on the Internet
Use a secure browser
Keep records of your online transactions
Review monthly bank and credit card statements
Read the privacy and security policies of the Web site you visit
Keep your personal information private
Never give your password to anyone online
Don’t download files sent to you by strangers

34. Cosigning a Loan
Cosigning means that you agree to be responsible for loan payments if the other party fails to make them
If you cosign a loan and the borrower does not pay the debt, you may have to pay up to the full amount of the debt as well as any late fees or collection costs
The creditor can collect the debt from you without first trying to collect it from the borrower
The creditor can use the same collection methods against you that can be used against the borrower
If the debt is not repaid, that fact will appear on your credit report

35. Complaining About Consumer Credit
Consumer Credit Protection Laws
Truth in Lending and Consumer Leasing Acts
If a lender does not disclose information as required, you can sue for any money loss you suffer
Equal Credit Opportunity Act
If you can prove that a creditor has discriminated against you, you can sue for actual damages as well as punitive damages, up to $10,000
Fair Credit Billing Act
If a creditor fails to follow the rules that apply to correcting any billing errors, they will be required to give up the amount owed on the item in question as well as any finance charges on it, up to $50

36. Complaining About Consumer Credit
Consumer Credit Laws
Fair Credit Reporting Act
You may sue any credit bureau or creditor that violates the rules regarding access to your credit records, or that fails to correct errors in your credit file
Consumer Credit Reporting Reform Act
Places the burden of proof for accurate credit reporting on the credit bureau rather than you
Under this law, the credit bureau must prove that disputed information is accurate

37. Your Rights under Consumer Credit Laws
Complain to the creditor
Let them know that you are aware of the law
File a complaint with the government
Report violations to the appropriate agency
If all else fails, sue the creditor
If you win, you can receive actual damages and punitive damages up to $10,000

38. Warning Signs of Debt Problems
You’re making only the minimum monthly payment on credit cards
You’re having trouble making minimum monthly payments on credit cards
Your total balance on credit cards increases every month
You miss loan payments or are often late
You use savings to pay for necessities
You borrow money to pay off old debts
You receive second and third payment due notices from creditors
You exceed credit limits on your credit cards
You’ve been denied credit because of a bad credit report

39. Debt Collection Practices
The Federal Trade Commission enforces the Fair Debt Collection Practices Act
Prohibits certain practices by debt collectors
Does not eliminate legitimate debts, but it does control the ways in which debt collection agencies may do business

40. Financial Counseling Services
Consumer Credit Counseling Services
Consumer Credit Counseling Service (CCCS) is a nonprofit organization affiliated with the National Foundation for Consumer Credit (NFCC)
Local branches provide debt counseling for families and individuals with serious financial problems
Counseling is usually free
When the organization supervises debt repayment, there is usually a small charge to cover administrative costs
Assist people in managing debt better and set up a realistic budget
Help people prevent indebtedness by teaching them about budget planning, educating them about pitfalls of unwise credit buying, and encourage credit institutions to withhold credit from people who cannot afford it

41. Financial Counseling Services
Other Counseling Services
Universities
Credit unions
Military bases
State and Federal housing authorities
Sometimes provide nonprofit credit counseling services
Usually charge little or nothing for assistance

42. Declaring Personal Bankruptcy
U.S. Bankruptcy Act of 1978
Chapter 7 Bankruptcy
An individual is required to draw up a petition listing his or her assets and liabilities
Straight bankruptcy in which many, but not all, debts are forgiven
Most of debtor’s assets are sold to pay off creditors
Protected assets: Social Security payments, unemployment compensation, net value of your home, vehicle, household goods and appliances, tools used in work, and books
Does not affect alimony, child support, certain taxes, fines, certain debts arising from education loans, or debts you fail to disclose properly
Does not affect debts arising from fraud, DWI, or certain other crimes

43. Declaring Personal Bankruptcy
U.S. Bankruptcy Act of 1978
Chapter 13 Bankruptcy
A debtor with a regular income proposes a plan for using future earnings or assets to eliminate his or her debts over a period of time
The debtor normally keeps all or most of his or her property
During the time when the plan is in effect (can be as long as 5 years), the debtor makes regular payments to a Chapter 13 trustee, or representative, who then distributes the money to the creditors

44. Declaring Personal Bankruptcy
Effects of Bankruptcy
People have varying experiences in obtaining credit after bankruptcy
Obtaining credit may be easier for people who file Chapter 13 and repay some of their debts than those who file Chapter 7 and make no effort to repay debt
Cannot fine another bankruptcy case for some time