CHAPTER 6 Using Credit

1. CHAPTER 6 Using Credit

2. The Basic Concepts of Credit Why Borrow? • Avoid paying cash for large purchases (a car, a home) • Meet financial emergencies • Convenience • Investment purposes

3. Improper Uses of Credit • Meet basic living expenses • Make impulse purchases • Purchase non-durable goods (like restaurant meals)

4. Rule of Thumb! • THE PRODUCT PURCHASED SHOULD OUTLIVE THE CREDIT PAYMENTS Don’t let credit squash you!

5. Minimum Payments means Maximum Years Calculations here are based on a minimum 3 percent payment and 15.0 percent annual interest rate.

6. Some Credit Danger Signs

7. Establishing Credit • Open checking and savings accounts. • Get one card and make small purchases. • Build a good credit history by: • Not getting overextended. • Fulfilling all terms of credit obligations. • Consistently paying on time. • Immediately notifying creditors if unable to pay. • Being truthful when applying.

8. How Much Credit Can You Stand? DEBT SAFETY RATIO = Total monthly consumer credit payments Monthly take-home pay Monthly consumer credit payments (excluding mortgage) should not exceed 20% of your monthly net income.

9. Credit Guidelines Based on Ability to Pay

10. Monthly Consumer Loan Payments and Debt Safety Ratio

11. Monthly Consumer Loan Payments and Debt Safety Ratio

12. Steps for Women in Establishing Credit • Consistently use your own legal name when filing a credit application. Ex: Mary Brown, not Mrs. John Brown • Have information reported to credit bureau in your name as well as your husband’s. • Consider retaining separate credit file when you marry.

13. Open Account Credit MyStore • Credit extended to a consumer in advanceof any transaction • Consumer can buy/borrow up to a specified amount, the credit limit. • Generally offered by financial institutions and retail stores/merchants • Monthly credit statements • Usually interest can be avoided by paying balance in full.

14. Bank Credit Cards MyBank • Issued by financial institutions • Features include: • Line of credit dependent upon applicant’s financial status and ability to pay • Cash advances and balance transfers • Other services or rebates • Interest rates and fees

15. MyBank Credit Card Fees MyStore • Interest • Generally high • Prime rate + a percentage • Annual fees • Transaction fees • Late-payment fees • Over-the-limit fees • Balance transfer fees • Foreign transaction fees

16. Special Types of Bank Credit Cards • Reward cards • Frequent flyer programs • Auto rebate programs • Other merchandise rebates • Affinity cards • Secured credit cards • Student credit cards

17. Retail Charge Cards • Second largest category • Department stores • Oil companies, etc. • Build loyalty • Users expected to pay in full on receipt of monthly bill

18. Debit Cards • Looks like a credit card but works like writing a check—accesses your checking account. • Does not provide line of credit. • Greater liability exposure in event of fraudulent use. • Prepaid card is a debit card with fixed amount available—does not access your checking account.

19. Revolving Credit Lines • Open account credit offered by banks and other financial institutions • Usually offer higher credit linesand lower interest ratesthan credit cards • Money accessed by writing checks

20. Forms Of Revolving Credit • Overdraft protection lines • Unsecured personal credit lines • Available on an as-needed basis • Home equity credit lines • Secured by equity in owner’s home • Interest tax deductible (if deductions are itemized)

21. Obtaining and Managing Open Forms of Credit Steps in opening an account: 1. Complete and submit application. 2. Lender investigates creditworthiness. 3. Lender obtains credit bureau report. 4. Lender makes credit decision; may use credit scoring.

22. The Credit Application Applicant submits information on income, marital status, employment history, existing accounts, etc.

23. The Credit Application Applicant submits information on income, marital status, employment history, existing accounts, etc. The Lender Verifies application; turns it over to the Credit Bureau.

24. The Credit Application Applicant submits information on income, marital status, employment history, existing accounts, etc. The Lender Verifies application; turns it over to the Credit Bureau. The Credit Bureau • Reporting agency that • gathers and sells info • about people. • Gets information from: • subscribing creditors • creditors you use as reference • public documents

25. The Credit Application Applicant submits information on income, marital status, employment history, existing accounts, etc. The Lender Verifies application; turns it over to the Credit Bureau. Credit Bureau submits report back to lender; lender then makes The Credit Bureau • Reporting agency that • gathers and sells info • about people. • Gets information from: • subscribing creditors • creditors you use as reference • public documents The Credit Decision

26. Fair Isaac & Co. Scores (FICO Scores) • Uses only credit information in its calculations • Payment history 35% • Amounts owed 30% • Length of credit history 15% • New credit 10% • Types of credit used 10%

27. FICO Scores • Range from a low of 300 points to a maximum of 850 points • The higher the score, the lower the risk to the lender • Distribution of FICO scores in 2005:

28. Computing Finance Charges • Lenders must disclose: • Annual percentage rate (APR), the true rate of interest paid over life of loan. • Method used in computing finance charges. • Balance to which interest rate is applied generally determined using one of four variations of Average Daily Balance (ADB)

29. Computing Finance Charges • ADB excluding new purchases Most consumer friendly • ADB including new purchases Most frequently used—no grace period on new purchases if you carry a balance. • Two-cycle ADB excluding new purchases Calculated using last 2 billing cycles. • Two-cycle ADB including new purchases Least consumer friendly

30. Example: A consumer starts the first month with a zero balance and charges $1,000, of which he pays off only the minimum amount due (1/36 of balance due). The next month, he charges another $1,000. He then pays off the entire balance due. This same pattern is repeated three more times during the year. The interest rate is 19.8 percent.

31. ADB Including New Purchases: # of Days Balance Weighted (1) (2) Balance (1x2) 5 $582 $ 2,910 7 932 6,524 15 986 14,790 4 961 3,844 Total: 31 $28,068 ADB = $28,068  31 = $905.42 Monthly APR = 0.18  12 = 0.015 Finance charge = $905.42 x 0.015 = $13.58

32. Managing Your Credit Cards • Review statements promptly each month and verify each entry. • Pay at least the minimum monthly payment • Or, if possible, pay off the entire amount each month to avoid finance charges • Pay by due date. • Returned merchandise credited to your account.

33. Using Credit Wisely • Shop around, comparing: • Annual fees & other fees • APR • Length of grace period • Balance method

34. Using Credit Wisely • Advantages of Credit Cards • Short, interest-free loan • Simplified record keeping • Easier resolution to unsatisfactory purchases • Convenience and emergencies • Disadvantages of Credit Cards • Easy to overspend • High interest costs

35. Avoid Credit Problems • Using discipline when purchasing. • Reducing the number of cards you carry. • Being selective in accepting preapproved credit offers. • Not making new charges. • Paying more than the minimum. • Paying off cards with highest finance charges first. • Transferring balances to card with low introductory rate and paying off quickly.

36. Important Consumer Credit Legislation • Key legislation deals with • Credit discrimination. • Disclosure of credit information. • Billing procedures, errors, complaints, and recourse on unsatisfactory purchases. • Disclosure of finance charges, other fees, credit terms, and loss of credit card. • Protection against collector harassment.

37. Credit Card Fraud • Never give account number to someone who calls you—you must initiate the call. • Use only secure Internet sites. • Never put credit card info on checks or personal info on charge slips. • Keep your eye on your card! • Draw line through blank spaces on slip. • Destroy old cards and shred old statements and slips. • Report lost or stolen cards immediately!

38. Options If You’re In Trouble • File Bankruptcy • Chapter 13—wage earner plan: debt restructuring. • Chapter 7—straight bankruptcy: wipe the slate clean. • Try credit counselors • Help you prepare a budget and repayment schedule. • Deal with creditors to possibly reduce some interest & fees.