Unit 8: Budgeting and Finance

Unit 8:Budgeting and Finance Part IV: Consumer Credit Business Essentials April 27, 2012 Mr. Archambeau

Consumer Credit • After discussing this PowerPoint, you will be able to do the following: • Identify the types of consumer credit • Describe the pros and cons of using credit • Calculate interest in consumer credit situations • Explain the activities of a credit bureau • Identify credit application regulations

Consumer Credit • What is credit? • Credit is the privilege of using someone else’s money for a period of time. • There are two parties involved in every credit transaction: • Anyone who buys on credit or receives a loan is a debtor. • The one who sells on credit or makes a loan is the creditor. • Credit system is based on trust. Credit trusts the debtor to honor the promise to pay back the money borrowed.

Types of Credit • Charge accounts represent a contract between the firm offering the account and the customer. • Types of Charge Accounts: • Regular – requires the buyer to make full payment within a state period—usually 25 to 30 days • Budget – budget charge accounts requires that a customer make payments of a fixed amount over several months. Usually used by stores and utility companies

Types of Credit • Revolving – Most common form of sales credit. You may charge purchases at any time, but only part of the debt must be paid each month. • A maximum amount may be owed at one time, called a credit limit. • A payment is required once a month, but the total amount owed need not be paid at one time for every revolving account • A finance charge is added if the total balance is not paid. A finance charge is the total dollar cost of credit, including interest and all other charges. • Average finance charge is 18% yearly, or 1.5% per month. • Usually not a finance charge is balances are paid in full every month.

Credit Cards • Credit cards are issued to consumers through several different outlets (banks, credit companies, retail stores, etc.) • Bank Cards – MasterCard and VISA are examples. Issued through your financial institution. Sometimes include an annual fee. • Charge Cards – American Express and Diners Club are common examples. Subscribers pay a yearly membership fee. No spending limit but balance has to be paid in full every month. • Affinity Cards – Organizations affiliate themselves with a credit card. For example, the Braves MasterCard. • Retail Store Cards – Many retail stores offer their own card to customers. Terms are set by the store and must be followed.

Installment Credit • Installment sales credit is a contract issued by the seller that requires periodic payments at specified times. • Unlike credit cards, installment sales credit is a contractual agreement directly between the buyer and the seller. • Consumers often purchase furniture and household appliances with installment sales credit. • Installment sales credit usually requires a down payment, which is a payment of part of the purchase price that is made at time of purchase.

Consumer Loans • A loan is an alternative to charge account buying or installment sales credit. • An installment loan is one in which you agree to make monthly payments in specific amounts over a period of time. • The total amount you repay includes the amount you borrowed plus the finance charge of your loan. • Another kind of loan is a single-payment loan. • You do not pay anything until the end of the loan period, usually 60 or 90 days. • You repay the full amount you borrowed plus the finance charge.

Consumer Loans • A promissory note is a written promise to repay based on a debtor’s excellent credit history. Promissory notes include the following components: • Principal – amount that is promised to be paid • Time – the days or months from the date of the note until it should be paid • Date of maturity – date on which the note is due • Payee – the one to whom the note is payable • Interest Rate – rate paid for the use of the money • Maker – one who promises to make payment • In some cases, you may be required to provide collateral for the loan. Collateral is the property used as security. • When collateral is used, that type of loan is referred to as a secured loan.

Consumer Loans • What if you don’t have credit history or can’t provide collateral? • You may be able to get someone to sign your note. They become the legal cosigner. • The cosigner is responsible for payment of the note if you do not pay as promised.

Benefits of Credit • Both businesses and consumers can benefit from credit use.

Finding Interest • Borrowing money has a cost. Interest is the cost of using someone else’s money. • To determine interest, use the following equation: • I = P x R x T • P: Principal or amount of the loan • R: Interest rate or percent of interest charged or earned • T: Time or length of time for which interest will be charged • On single-payment loans, interest is usually simple interest.

Finding Interest • Time in Years: • If you borrow $100 at 12% for one year. • I = 100 x 0.12 x 1 • I = $12 • Time in Months: • If you borrow $100 at 12% for one month. • I = 100 x 0.12 x 1/12 • I = $1 • Time in Days: • If you borrow $100 at 12% for 60 days. • I = 100 x 0.12 x 60/360 • I = $2

Finance Charges • Before you borrow money or charge a purchase, you should know the exact cost of using credit. • Three things to consider: • Annual Percentage Rate (APR) – the percentage cost of credit on a yearly basis. All credit agreements are required by law to disclose the APR. • Total Dollar Charges – Federal Law requires that lender must tell you the finance charge, or the total dollar cost of credit. • Compare Credit Costs – compare the total cost of credit among alternative sources. Compare finance charges and APR.

Applying for Credit • To obtain a loan or credit card, you must prove that you are a good credit risk by applying with the creditor. • Lenders, or creditors, will check with credit bureaus to see your credit history. • A credit bureau, or credit reporting agency, is a company that gathers information on credit users. • Three main credit bureaus are: Experian, Equifax, and TransUnion • Credit Bureaus look at the 3 C’s of Credit: • Character – refers to your honesty and willingness to pay a debt when it is due • Capacity – refers to a person’s ability to pay a debt when it is due • Capital – the value of a borrower’s possessions

Applying for Credit • A credit bureau uses your debt records to grade you as a credit risk. • A credit report shows: • Debts you owe • How often you use credit • Whether you pay your debts on time • Other credit data (personal information, employment history, delinquent accounts, etc.) • Every credit bureau values things differently. • Credit reports are confidential. Only you and the person pulling your credit can see it.

Applying for Credit • Once the bureaus see your credit report, they give you a rating. • Rating goes from 350 – 850. • 350 is lowest • 850 is highest • Ratings: • 350 – 500 rating means you are an extremely high risk • 501 – 650 rating means you are a risk • 651 – 700 rating means you are average • 701 – 799 rating means you are a low risk • 800 – 850 rating means you are an extremely low risk

Credit Regulations • Truth-in-Lending Act of 1968 – requires that you be told the cost of credit before signing an agreement. Lender must clearly state the APR and total finance charge. • Credit Card Accountability Responsibility and Disclosure Act of 2009 – designed to establish fair and transparent credit card practices. Keep credit card companies from charging fees and interest rates without cardholder approval

Credit Regulations • Equal Credit Opportunity Act – prohibits creditors from denying a person credit because of age, race, sex, or marital status. • Fair Credit Billing Act – requires prompt correction of billing mistakes. Consumers must notify the creditor of errors in writing within 60 days after your statement was mailed. • Fair Credit Reporting Act – the law that gives consumers the right to know what information credit bureaus are giving to potential creditors, employers, and insurers. If someone is denied credit, consumer must be told why and provided the name, address and phone number of the credit bureau that provided the information.

Credit Regulations • The Consumer Credit Reporting Reform Act – places the burden of proof for accurate credit information on the credit reporting agency rather than on you. If a creditor or the credit bureau verifies incorrect data, you can sue for damages. • Fair Debt Collection Practices Act – requires that debt collectors treat you fairly. It bans various debt collection actions but does not take away the debts you owe. • Cannot contact you before 8 a.m. or after 9 p.m. • Cannot contact you at work • May contact you in person, by mail, telephone, telegram or fax

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Unit 8: Budgeting and Finance