5A Consumer Credit #1

1. 5A Consumer Credit #1 Credit– An arrangement to receive cash, goods, or services now and pay for them in the future. Types of credit ???

2. Objective 1Analyze Advantages and Disadvantages of Using Consumer Credit • Credit • Based on trust in people’s ability and willingness to pay bills when due • Consumer Credit • Use of credit by individuals for personal needs, except a home mortgage • Dates back to colonial times; exploded after invention of cars (installment loans; traveling) • A major force in our economy 5-2

3. Uses and Misuses of Credit Before you use credit for a major purchase, ask: • Do I have the cash 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’ll need in some better way? • Can I postpone this purchase? • What are the opportunity costs of postponing this purchase? • What are the dollar and psychological costs of using credit for this purchase? 5-3

4. Advantages of Credit • Current use of goods and services • Permits purchase even when funds are low • A cushion for financial emergencies • Advance notice of sales • Easier to return merchandise • Convenient when shopping • Provides a record of expenses 5-4

5. More Advantages of Credit • One monthly payment • Safer than carrying cash • Needed for hotel reservations, car rentals, and shopping online • Take advantage of “float” time/grace period • Rebates, airline miles, cash-back rewards, or other “perks” • Credit indicates financial stability 5-5

6. Disadvantages of Consumer Credit • Temptation to overspend • Can create long-term financial problems and slow progress toward financial goals • Potential loss of merchandisedue to late or non-payment • Ties up future income • Credit costs money - more costly than paying with cash 5-6

7. Objective 2Assess the Types & Sources of Consumer Credit Two Basic Types of Consumer Credit • Closed-End Credit • One-time loans for a specific purpose paid back in a specified period of time • Open-End Credit • Use as needed until line of credit max reached Examples of each? 5-7

8. Closed-End Credit • One-time loans for a specific purpose that you pay back in a specified period of time, and in payments of equal amounts • Mortgage, automobile, and installment loans for furniture, appliances and electronics • 3 most common types of closed-end credit • Installment sales credit- loan for high-priced items • Installment cash credit- loan of cash for personal use • Single-lump credit- loan repaid on a specific day 5-8

9. Open-End Credit • Use as needed until line of credit max reached • Credit cards • Department store cards • Home equity loans • You pay interest and finance charges if you do not pay the bill in full when due • Revolving Check Credit (Bank Line of Credit)- pre-arranged loan for a specified amount; can be accessed with special checks 5-9

10. Sources of Consumer Credit Loans • Borrowing money with an agreement to repay, along with interest, within a certain amount of time (e.g., 3 years) • Inexpensive loans • Parents or family members • Medium-priced loans • Commercial banks, savings and loan associations, and credit unions • Expensive loans • Finance and check cashing companies • Retailers (e.g., department store credit cards) • Bank credit cards and cash advances 5-10

11. Sources of Consumer Credit • Home Equity Loans • Loan based on home equity • Current market value of your home minus the amount you still owe on the mortgage • Interest is tax-deductible • Should only be used for major purchases • Credit Cards • Average cardholder has > 9 credit cards • Convenience users vs. borrowers • Finance charge = total amount paid to use credit 5-11

12. Sources of Consumer Credit • Debit Cards • Debit cards electronically subtract money from savings or checking accounts • Most commonly used at ATMs • Widely accepted at stores also • Stored Value Cards • Gift cards • Prepaid cards 5-12

13. Sources of Consumer Credit • Smart Cards • Plastic card equipped with a computer chip that can store 500 times as much data as a normal credit card (e.g., health info) • Travel and Entertainment (T&E) cards • Not really “credit cards”; balance is due in full each month • Diners Club; American Express • You don’t pay for goods or services at the time of purchase 5-13

14. Objective 3Determine Whether You Can Afford a Loan and How to Apply for Credit Before you take out a loan, ask yourself... Can you meet all your essential expenses and still afford the monthly loan payments? • Add up basic monthly expenses and subtract from take-home pay; will the difference cover the monthly payment? (NO? Can’t afford it!) • What do you plan to give up in order to make the payment? 5-14

15. General Rules of Credit Capacity Debt Payments-to-Income Ratio Monthly Debt Payments* Net Monthly Income Consumer credit payments should not exceed a maximum of 20% of your net income. *Not including a house payment, which is a long-term liability 5-15

16. General Rules of Credit Capacity Debt To Equity Ratio Total Liabilities = Should be < 1 Net Worth* *Excluding home value The lower the ratio, the better; e.g., 0.5 or 0.25 5-16

17. The Five C’s of Credit • Character - Do you pay bills on time? • Capacity - Can you repay the loan? • Capital - What are your assets and net worth? • Collateral - What assets do you have to secure the loan? • Conditions- Lenders will review how general economic conditions will affect your ability to repay your loan 5-17

18. FICO & VantageScore • FICO Credit Score • 350 to 850 • Higher score = less risk • Available from http://www.myfico.com for a fee; can sometimes get for free from lenders • VantageScore • New scoring technique • Developed collaboratively by 3 credit agencies • Range = 501 to 990 5-18

19. Credit Scoring Factors • Bill payment history, weighted to emphasize past 12 months (35%) • Proportion of outstanding debt to available credit limits (30%) • Length of credit history (15%) • Number of recent credit inquiries (10%) • Mix of types of credit used (10%)

20. Factors of Creditworthiness ECOA (Equal Credit Opportunity Act) • Gives all applicants the same rights. • Credit providers may not discriminate based on: • Age • Social Security or public assistance • Housing loans (redlining) • If you are denied credit, you have the right to know the reasons • You can request a copy of your credit report within 60 days if you are denied credit based on what is in your files 5-20

21. Your Credit Report • Credit Reports • Record of your complete credit history • Credit Bureaus • Agencies that collect information on how promptly people and businesses pay their bills • Experian, Trans Union and Equifax are the 3 major credit bureaus • Credit Bureaus obtain information from banks, finance companies stores, credit card companies and other lenders 5-21

22. Four Main Parts to a Credit Report • Identifying Information: name, SS Number, current/previous addresses, birthdate, employer • Public Record Information from Local Courthouse: liens, foreclosures, bankruptcy • Other Credit History Information: list of loans and credit cards, timeliness of payments, defaults and negative information (7 years) • Inquiries: Usually 2 years; self-initiated and promotional (for marketing purposes)

23. Your Credit Report • Who can obtain a credit report? • Only authorized persons have access to your report for approved legitimate business purposes • Examples??? • Time Limits on Unfavorable Data • Adverse data can be reported for 7 years • Bankruptcy can be reported for 10 years 5-23

24. Wrap Up • Concept Check 5-1- Reasons to Borrow and Advantages/Disadvantages • Concept Check 5-2- Definition of Terms; Difference Between Credit and Debit Cards • Concept Check 5-3- Definition of Terms