CONSUMER CREDIT

1. CHAPTER 3: CONSUMER CREDIT ROSELIZA HAMID/UITM KELANTAN/2010

2. Chapter Outline • What is credit? • Types of credit • Credit cards • Loans • Financial charges • Interest computation methods ROSELIZA HAMID/UITM KELANTAN/2010

3. CREDIT Definition: • A power to buy or borrow on trust • A contractual agreement in which a borrower receives something of value now and agrees to repay the lender at some later date. • E.g.: When a consumer purchases something using a credit card, they are buying on credit (receiving the item at that time, and paying back the credit card company month by month). Any time when an individual finances something with a loan (such as an automobile or a house), they are using credit in that situation as well. (http://www.investorwords.com) ROSELIZA HAMID/UITM KELANTAN/2010

4. WHY BORROW? • As a shopping convenience • To increase total consumption benefit • As an inflation hedge • An investment designed to protect against inflation risk. Such an investment's value will typically increase with inflation. • As a source of an emergency fund ROSELIZA HAMID/UITM KELANTAN/2010

5. DISADVANTAGES OF USING CREDIT • Temptation to overspend • Credit costs • Less flexibility with future budgets ROSELIZA HAMID/UITM KELANTAN/2010

6. TYPES OF CREDIT • Open account credit • A credit facility offered by retailers or financial institutions that allow us to borrow up to pre-determined amount to pay for our purchases • Loans • An arrangement in which a lender gives money or property to a borrower, and the borrower agrees to return the property or repay the money, usually along with interest, at some future points(s) in time. www.bankinginfo.com.my ROSELIZA HAMID/UITM KELANTAN/2010

7. OPEN ACCOUNT CREDIT • Credit card • Charge card • Retail charge card • Revolving credit line or overdraft ROSELIZA HAMID/UITM KELANTAN/2010

8. Credit card • A credit card is part of a system of payments named after the small plastic card issued to users of the system. • It is a card entitling its holder to buy goods and services based on the holder's promise to pay for these goods and services. • The issuer of the card grants a line of credit to the consumer (or the user) from which the user can borrow money for payment to a merchant or as a cash advance to the user. • Credit cards allow the consumers to 'revolve' their balance, at the cost of having interest charged. • Examples: Visa, Master cards, American Express, Diner's Club and Carte Blanche . ROSELIZA HAMID/UITM KELANTAN/2010

9. Charge card • A card used for making payments. • A charge card requires the balance to be paid in full each month. • Examples of charge cards are American Express, Diners Club International, and HSBC Amanah Mastercard. ROSELIZA HAMID/UITM KELANTAN/2010

10. Retail charge card • Offered by departmental stores, retailers or petrol stations to encourage customers to purchase goods or services from their stores only. • Retail stores require customers to pay full amount within 10-20 days after the billing date. Discounts are normally offered to encourage customers to apply for and use their cards. ROSELIZA HAMID/UITM KELANTAN/2010

11. Revolving credit lines or overdraft • It allow us to borrow up to predetermined amount (credit limit) whenever the need arise. • The overdraft account is activated when we write cheques to pay for goods and services purchased. • The amount of credit given by banks depends on our income, profession and potential earnings. • Interest rates on overdraft are often based on the prime rates of banks and are computed daily on the outstanding balance. ROSELIZA HAMID/UITM KELANTAN/2010

12. ANATOMY OF CREDIT CARDS • BNM requirements of annual income: • Classic card : at least RM18 000 • Gold Card : at least RM48 000 • Platinum Card : at least RM100 000 • Interest free period for the period between the purchase date and the payment due date normally 20 days. • Spending limit or charge limit is maximum dollar amount we can charge to our credit card at any point in time. • Credit limit is usually lower than the spending limit ROSELIZA HAMID/UITM KELANTAN/2010

13. BENEFITS OF CREDIT CARDS • Delay payment for the purchases until the payment due date i.e. an interest free loan for all the purchases for the period between transaction date and payment due date. • Very convenient • Bank will send a statement summarizing all the credit card transactions for each month. • Minimum payment ROSELIZA HAMID/UITM KELANTAN/2010

14. FINANCIAL CHARGES • Joining fee • Some credit card issuers impose a one-time joining fee for credit cards and the fee varies depending on each issuer.   • Annual fee • This is a flat fee which you pay annually once you've accepted the credit card. Bear in mind that this fee is still applicable regardless if you use your card or not. Fees may range from RM60 to RM90 for a classic card and RM130 to RM195 for a gold card. ROSELIZA HAMID/UITM KELANTAN/2010

15. FINANCIAL CHARGES… cont. • Interest charges • Charges imposed on the outstanding balance which have not been paid after the payment due date. • These charges are usually calculated on a daily basis. • With effect from 1 July 2008, interest charges will be on a tiered basis based on the repayment record of cardholders. The intention is to encourage and instill good financial discipline amongst cardholders. ROSELIZA HAMID/UITM KELANTAN/2010

16. FINANCIAL CHARGES… cont. • With effect from 31 March 2009, the tiered charges are as follows: ROSELIZA HAMID/UITM KELANTAN/2010

17. FINANCIAL CHARGES… cont. • Cash advances charges • a fee charged ranges from 3% to 5% of the total cash advanced. • This fee is in addition to the finance charges imposed on the amount of advance given. • The finance charge is calculated from the transaction date or when the amount is posted to the credit card account. • Late charges • A charge imposed when you fail to pay the minimum monthly payment by the due date. • The charges can be as high as 1% of the outstanding balance, subject to a maximum amount of RM75 while the minimum amount is RM5. ROSELIZA HAMID/UITM KELANTAN/2010

18. HIDDEN COST • Balance transfer fees • Move the existing credit card outstanding balance to another just to get a lower interest rate. • Conversion fee • Charged when using credit card outside the country • Closure fee • Charge when to terminate the credit service • Inactivity charge • When card is inactive for a period, the bank will charge a fee ROSELIZA HAMID/UITM KELANTAN/2010

19. INTEREST COMPUTATION METHOD • Previous balance method • Adjusted balance method • Average daily balance method • Including current purchases • Excluding current purchases • Two-cycle average daily balance method ROSELIZA HAMID/UITM KELANTAN/2010

20. Previous Balance Method • Interest rate applied to balance at end of previous month. • Example: • Previous balance RM500 • Monthly interest rate (18% ÷ 12) 1.5% • Interest charge (1.5% × 500) RM7.50 ROSELIZA HAMID/UITM KELANTAN/2010

21. Adjusted Balance Method • Equal to the previous balance less any payments or returns made during the current billing cycle • Example: • Previous balance RM500 • Less current payment RM34 • Adjusted balance RM466 • Monthly interest rate (18%/12) 1.5% • Interest charge (1.5% × RM466) RM6.99 ROSELIZA HAMID/UITM KELANTAN/2010

22. Average Daily Balance Method(including current purchases) ROSELIZA HAMID/UITM KELANTAN/2010

23. Computation • Average daily balance • Total balance/totaldays • RM17,177/31 days RM554.10 • Monthly interest rate (18%/12) 1.5% • Interest charge (1.5% × RM554.10) RM8.31 ROSELIZA HAMID/UITM KELANTAN/2010

24. Average Daily Balance Method(excluding current purchases) ROSELIZA HAMID/UITM KELANTAN/2010

25. Computation • Average daily balance • Total balance/totaldays • RM14,786/31 days RM476.97 • Monthly interest rate (18%/12) 1.5% • Interest charge (1.5% × RM476.97) RM7.15 ROSELIZA HAMID/UITM KELANTAN/2010

26. Interest Charges on Balances Illustrations: • Previous balance method RM7.50 • Adjusted balance method RM6.99 • Average daily balance method • Including current purchases RM8.31 • Excluding current purchases RM7.15 ROSELIZA HAMID/UITM KELANTAN/2010

27. Two-Cycle Average Daily Balance Method • When you fail to completely pay off the balance in the present month, the grace period is eliminated in the previous month. • The lender can go back two periods to collect interest on unpaid balance. • This method hurts those cardholders who pay off their balances every other month. ROSELIZA HAMID/UITM KELANTAN/2010

28. LOAN TYPES • Personal loan • Car loan/Hire purchase • Education loan ROSELIZA HAMID/UITM KELANTAN/2010

29. LOANS: Personal Loan An unsecured loan usually made for the purpose of debt consolidation, renovate the house, vacation or the purchase of durable goods. Also called a signature loan. Interest charged tend to be higher and quoted on monthly basis or flat basis(usually 4% - 7% p.a.) ROSELIZA HAMID/UITM KELANTAN/2010

30. LOANS: Hire purchase • Borrower become the hirer while the company financing the asset is the owner. • The hirer have to pay installment to the financier based on an agreed duration while having possession of the asset. • Should default on monthly payments , the banking institution has the right to repossess the asset hired based on the following circumstances: • Defaults payment for two successive monthly installments or the final installment   • Defaults payment for four successive monthly installments in the case where the hirer is deceased • The balance due will increase as it is subject to late payment penalty. ROSELIZA HAMID/UITM KELANTAN/2010

31. LOANS… Cont. • Housing loan • A loan for the purchase, renovation or construction of housing • the tenure can last up to 30 years or when the borrower reaches the age of 65, whichever is earlier. • Loan for investment • Loans used for investment purposes, such as the purchase of an investment property, ASB loans, etc. ROSELIZA HAMID/UITM KELANTAN/2010

32. LOANS: Education loan • Loans taken by parents of students who pursue their studies at higher level to finance tuition fees, purchases of books, personal computer, hostel and living expenses. ROSELIZA HAMID/UITM KELANTAN/2010

33. FINANCE CHARGES ON LOANS Interest charged normally based on: • single payment loans • It requires the borrower to pay interest once either at the beginning or at the end of the loan period. • installment loans. • Interest and principal are repaid with a series of regular fixed payments. ROSELIZA HAMID/UITM KELANTAN/2010

34. Single Payment Loans • Simple Interest Method • Interest is paid at the end of the loan period. • Total interest; i = Loan amount (L) x interest (i) x Tenure (T) • Discount Method • Interest paid at the beginning of the period. • the finance charges is paid in advance • Amount received; P = L – (L x i x T) ROSELIZA HAMID/UITM KELANTAN/2010

35. INSTALLMENT LOANS • Loans where interest and principal are repaid with a series of regular fixed payments. • 3 most common types: • Simple interest method/monthly rest • Discount method • Add-on method/Flat basis ROSELIZA HAMID/UITM KELANTAN/2010

36. Simple interest method • Interest payment is computed by applying a % rate to the outstanding loan balance during each payment period • The principal outstanding is reduced monthly and the interest payments decline with the principal outstanding each month. • Amortisation ROSELIZA HAMID/UITM KELANTAN/2010

37. Discount method • The lenders deduct the interest to be paid on the loan from the credit extended at the beginning of the loan. • The face amount of the loan will exceed the amount of principal. ROSELIZA HAMID/UITM KELANTAN/2010

38. Add-on method • The interest charged on the original loan over the entire loan period eventhough the principal outstanding is reducing overtime. • The lender charge the interest to the value of the purchase of financing to determine the total payments. ROSELIZA HAMID/UITM KELANTAN/2010

39. SOURCES OF CONSUMER CREDIT • Banks: all type of credits • Finance companies: housing, car loan • Building societies: mortgage finance • Credit union • Life insurance ☼ ROSELIZA HAMID/UITM KELANTAN/2010

40. END OF CHAPTER NEXT: HOUSING PLANNING ROSELIZA HAMID/UITM KELANTAN/2010