Credit

2. 9 Credit

3. Chapter Objectives • Explain the advantages and disadvantages of using credit. • Identify the different types of consumer credit. • Describe how to establish a sound credit rating. • Define the key terms in credit contracts and agreements. continued

4. Chapter Objectives • Compare credit terms and charges. • Outline the steps involved in managing credit. • Identify steps to take in resolving credit problems. • Summarize the laws that govern the use of credit.

5. Understanding Consumer Credit • Credit plays an important role in the economy • Provides extra buying power that supports mass production and distribution • Helps make more goods and services available to consumers at lower prices continued

6. Understanding Consumer Credit • Credit is a medium of exchange • It is an agreement between two parties • Creditor supplies money, goods, or services to the borrower • Borrower agrees to make future payment by a particular date or according to an agreed-upon schedule continued

7. Understanding Consumer Credit • There is a risk that the borrower cannot repay what is owed • Creditors minimize risk by • having borrowers sign a contract • taking a borrower who defaults to court and even taking back property

8. Reasons to Use Credit • Gives you the opportunity to buy costly items that you may not be able to buy with cash continued

9. Reasons to Use Credit • You can use goods and services as you pay for them • Credit can be used as a source of cash for emergencies and unexpected expenses • You can take advantage of sale prices when you don’t have cash continued

10. Reasons to Use Credit • Convenience • eliminates the need to carry a lot of cash • provides a purchase record • simplifies shopping by phone, mail, and Internet • You can make purchases that are part of a long-range financial plan: education, furniture, vacation

11. Drawbacks of Credit Use • Using credit reduces future income • Expense—using credit costs money (finance charges) • Temptation—using credit makes it easy to spend money you don’t have • Risk of serious consequences—financial problems arise when debts aren’t paid on time and in full

12. Cost of Credit • Using credit is more costly than paying with cash continued

13. Cost of Credit • Borrowers must pay principal plus finance charges • Finance charges reimburse creditors for • the costs of making credit available • taking the risk that borrowers may default continued

14. Cost of Credit • Creditors • may borrow money to make credit available; when they borrow, they must also pay interest • lose the chance to invest money • incur costs for opening and servicing credit accounts • absorb losses of unpaid accounts and cost of collecting overdue debts

15. Finance Charges • Are the dollar amounts paid for credit • Consist of two parts: interest and fees • Are expressed as percentages

16. In Your Opinion • Have you ever lent money to a friend? Based on your experience, do you think creditors deserve to be paid a finance charge?

17. Annual Percentage Rate (APR) • The higher the APR, the more you pay • Example: Interest for a $500 loan repaid in 12 monthly payments would cost • $50.08 at 18% • $58.72 at 21% • $67.36 at 24%

18. Amount of Credit Used • The more credit you use, the more you pay • Example: Interest on a loan repaid in 12 monthly payments at an APR of 18% would cost • $50.08 for a $500 loan • $110.01 for a $1,000 loan • $220.02 for a $2,000 loan

19. Length of Repayment Period • The longer you take to repay what you borrowed, the more you pay • Example: Interest on a $500 loan at 1.5% per month (18% APR) would cost • $50.08 if repaid in 12 monthly payments • $99.44 if repaid in 24 monthly payments • $150.88 if repaid in 36 monthly payments

20. Types of Credit • Closed-end credit must be repaid by a certain date • Open-end credit allows the borrower to use money for an indefinite period

21. Closed-End Credit • Most are installment loans that let you borrow a given amount of money and repay it with interest in regular installments • Examples: student loans, car loans, most home loans continued

22. Closed-End Credit • A secured loan requires collateral—finance charges may be lower because creditor can take property if loan is not repaid • An unsecured loan—finance charges are usually higher because no collateral; borrower must have strong credit rating or a cosigner

23. Open-End Credit • Borrower can continue to use credit if he or she makes scheduled payments, pays finance charges, and stays within borrowing limit • Regular charge accounts • Revolving credit accounts • Offered by retailers, merchants, banks, credit agencies continued

24. Open-End Credit • You must make at least the minimum payment each month • Total amount you may owe at any one time is limited

25. Establishing Credit • Start with a job • Open a savings account • Open a checking account • Apply for a credit card at a local department store or gas company

26. Your Credit Rating • Determines whether you can get credit and what you will pay for it • Is measured by the three Cs—character, capacity, and capital • A creditworthy applicant is judged to have the assets, income, and tendency to repay debt

27. The Credit Report • Three major national agencies sell credit reports to creditors • Each agency collects information about financial and credit transactions • The information on these reports often differs • Carefully review your credit reports and report errors to agencies continued

28. The Credit Report • The report lists • every credit account ever opened • outstanding balances • negative data, such as late payments, unpaid debts, bankruptcy

29. Credit Scores • A credit score is a numerical measure of a loan applicant’s creditworthiness • The higher the score, the greater a person’s creditworthiness • The lower the score, • the more trouble you will have getting credit • the more expensive credit will be continued

30. Credit Scores • Credit score factors: • Bill paying • Debt-to-credit-limit-ratio • Credit history length • Recent credit application • Different types of credit • You may have more than one credit score generated by different agencies

31. Getting a Credit Card • Common types of credit cards include • general-purpose • company or retail store • travel and entertainment

32. Shopping for a Credit Card • Understand possible fees, penalties, and consequences of failing to carry out the terms of the agreement • Be wary of acceleration clauses, balloon payments, and add-on clauses

33. The Contract • Read the contract (application) thoroughly before signing it

34. Disclosures • Annual percentage rates: • What is the APR? • How long will a lower introductory rate last? What is the regular rate? • Can the rate be raised for any reason? • Is the rate fixed or variable? continued

35. Disclosures • What is the grace period? • What method is used to calculate the interest rate? • Is there an annual fee? If so, how much? • What are fees for • late payments • exceeding credit limit • cash advances • balance transfers

36. Subprime Credit Cards • Easier to get; offered to those with poor credit histories • Often carry high interest rates, large annual fees, and other charges • Low credit limits • Often a bad deal for consumers

37. Managing Your Credit • Know your financial personality. • What are your money attitudes and habits? continued

38. Managing Your Credit • Keep track of spending • Create a budget • Don’t use more credit than you can pay off each month • Save your receipts and keep a log of credit charges

39. Remember Alternatives to Using Credit • Not to buy • Pay with savings • Postpone buying now and buy later with cash

40. Check Monthly Statements • Check statements against your own record of charges, payments, and credits

41. Check Your Credit Report Regularly • Find and correct errors immediately • Make sure no one has applied for credit in your name

42. Report Lost or Stolen Cards • Keep a list of your credit cards—issuers, account numbers, issuer phone numbers • Report lost or stolen cards right away • If your card is lost or stolen, you are responsible for • $50 per card that is charged by others • no charges made by others if you notify the issuer before the card is used

43. Handling Credit Problems • Poor credit use consequences: • Inability to get loans and credit cards • Paying higher interest rates for credit • Having fewer housing choices • Having fewer job prospects because many employers check credit reports • Paying higher insurance premiums continued

44. Handling Credit Problems • Blemishes on credit reports: • Accurate negative information, such as missed or late payments, may remain on your report for seven years • Bankruptcies may remain on your report for 10 years continued

45. In Your Opinion • Would you cosign a loan for your best friend or a family member if doing so would endanger your credit rating?

46. Handling Credit Problems • Actions taken to recover debts: • Collection agencies are hired to get payment • Repossession of property, including foreclosure • Liens against property • Wage garnishment

47. Bankruptcy • Desperate debtors last resort—file for personal bankruptcy • Court excuses debtor from repaying some or all debt • Debtor gives up certain assets and possessions • Two types—Chapter 7 and Chapter 13 • Consequences of bankruptcy are severe

48. The Easy-Access Credit Trap • Easy-access credit includes • payday loans • pawnshops • rent-to-own • title loans • A loan shark is someone who uses predatory lending tactics and easy-access credit

49. Inform Creditors • They may change payment dates and amounts if you have trouble paying bills

50. Get Credit Counseling • Use reputable nonprofit credit counseling services • Avoid credit counseling firms that • charge high fees • demand that the debtor pay them rather than their creditors