Understanding Consumer Credit: Benefits and Pitfalls

1. Chapter 5Introduction to Consumer Credit 5-1

2. 5-2 Learning Objectives - Chapter 5 • Define consumer credit and analyze its advantages and disadvantages. • Differentiate among various types of credit. • Assess your credit capacity and build your credit rating. • Describe the information creditors look for when you apply for credit. • Identify the steps you can take to avoid and correct credit mistakes.

3. 5-3 Learning Objective # 1Define consumer credit and analyze its advantages and disadvantages.

4. 5-4 What is Consumer Credit? • Credit is an arrangement to receive cash, goods or services now, and pay for them in the future • Consumer credit is the use of credit for personal needs, except a home mortgage • There are three ways consumers can finance current purchases • Take money from savings • Use present earnings • Borrow against future income • Trade-offs are involved in using credit

5. Consumer credit is the amount of credit used by consumers to purchase non-investment goods or services that are consumed and whose value depreciates quickly • Includes automobiles, recreational vehicles (RVs), education, boat and trailer loans • Excludes debts taken out to purchase real estate or margin on investment accounts

6. Common forms of consumer credit include • Credit cards • Store cards • Motor (auto) finance • Personal loans (installment loans) • Consumer lines of credit • Retail loans (retail installment loans) • Mortgages

7. The cost of credit is the additional amount, over and above the amount borrowed, that the borrower has to pay • Includes interest, arrangement fees and any other charges • Some costs are mandatory, required by the lender as a part of the credit agreement • Other costs may be optional. The borrower chooses whether or not they are included as part of the agreement

8. 5-5 Credit Considerations • Before you use credit for a major purchase, ask yourself some questions • Could I pay cash or make a down payment? • Do I want to use savings for this purchase? • Does purchase fit with my goals and 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?

9. 5-6 Advantages of Credit • Current use of goods and services • Permit purchase even when funds are low • Use for financial emergencies • Convenient when shopping • Safer than cash • Can take advantage of float time • May get rebates, airline miles or other bonuses • Demonstrates financial stability

10. 5-7 Disadvantages of Consumer Credit • Purchases are more expensive • Temptation to overspend • Ties up future income. • Possible financial difficulties • Damage to family relationships • Slows progress to future goals

11. 5-8 Learning Objective # 2Differentiate among various types of credit.

12. 5-9 Types of Credit • Closed-End Credit • For a specific purpose and amount. • Payments of equal amounts • Mortgage, automobile and installment loans • Open-End Credit • Use as needed until reaching line of credit. • You pay interest and finance charges if you do not pay the bill in full when due • Department store or bank credit card, overdraft protection, bank line of credit, home equity loan

13. 5-10 Open-End Credit • Credit Limit • The dollar amount which may or may not be borrowed that lender makes available to a borrower • Interest • A periodic charge for use of credit • Personal Line of Credit • A prearranged loan from a bank for a maximum specified amount

14. 5-11 Credit Cards MasterCard • Nearly 83% of Canadian households carry one or more credit cards. • One-third are convenience users. They pay their balance off in full each month. • The other two-thirds are borrowers. • Co-branding - linking a credit card with a business offering rebates on products and services. • Smart cards have an imbedded computer chip. • Debit cards are not credit cards.

15. Credit Card in Vietnam • According to Visa International, only 88,000 of 85mil people in Vietnam (1%) are using Visa credit cards with the transaction turnover of $115millions • Meanwhile, the percentages of populations using Visa cards are much higher in other countries • 68.5% in Singapore • 10.6% in Thailand • 20.3% in Malaysia

16. ANZ and HSBC are well known as banks that issue international credit cards • Both the banks have high technology and a lot of experience in international and domestic credit cards

17. Domestic banks also issue credit cards • For example, Vietcombank began issuing MasterCard in 1996 • After 10 years of development, the international card market now has 10 banks-issuers, including Vietcombank, ACB, ANZ, Eximbank, EAB and HSBC • There are three main brand name cards • Visa, MasterCard and American Express

18. 5-12 Protecting Yourself Against Credit Card Fraud • Sign new cards as soon as they arrive. • Treat the cards like money - keep them secure. • Shred anything with your account number on it. • Don’t give your number over the phone unless you initiate the call. • Get your card and a receipt after every transaction and compare them to your bills when they arrive.

19. 5-13 Protecting Yourself Against Credit Card Fraud • Immediately report if lost or stolen. • Notify issuer if you don’t get your billing statement • Check your credit report every few years • If you make purchases online; • use a secure browser • keep records of your online transactions

20. 5-14 Protecting Yourself Against Credit Card Fraud • If you make your purchases online; • review monthly statements for errors and unauthorized purchases • read the policies of sites you visit • keep your personal information private • give payment information only to businesses you know and trust • Never give your password to anyone online • Do not download files from strangers

21. 5-15 Personal Lines of Credit • Revolving line of credit • Interest rate linked to lender’s prime rate • Withdraw up to specified limit using debit card or cheques • Repay minimum stated or more • Secured with assets • GIC’s or home equity

22. Line of credit • Any credit source extended to a government, business or individual by a bank or other financial institution • A line of credit may take several forms • Overdraft protection • Demand loan • Special purpose • Export packing credit • Term loan • Discounting, purchase of commercial bills

25. The lender determines a line of credit based largely on the individual's credit worthiness and income potential • Most people encounter a line of credit when dealing with credit cards or home equity loans

26. 5-16 Home Equity Loans • A loan based on the current market value of your home less the amount still owing on your mortgage • Can borrow up to 85% of your equity • Interest on loan is tax deductible if proceeds are being used for an investment (outside of registered plans) • Usually set up as a revolving line of credit

27. Home Equity Loans vs. Second Mortgage • Similar to a 2nd mortgage, a home equity line of credit establishes a maximum amount of money a homeowner can borrow • In a second mortgage, the bank lends the entire amount of money and the borrower makes regular payments based on the balance due • A line of credit arrangement allows the homeowner to borrow smaller amounts of money to pay off contractors or bills without incurring a large debt up front

28. Closed End Credit • Mortgage and Mortgage Loans • Mortgage • A contract to buy a real estate, plan • A pledge of property to secure payment of a debt • Mortgage Loans • A debt • Loans to value is 80% at max • Ex: • Home Mortgage • Plant Mortgage

29. 5-17 Closed End Credit • CAR LOAN • Automobile is your second largest investment • Financing Sources • Financing at the Dealer • Affiliated with manufacturer or financial institution • Significantly lower interest rates on some models • Other incentives offered (no down payment, no late charge….)

30. Car Loan 2. Leasing • Closed-end lease • You can buy vehicle at lease end or return it to company • Open-end leas • You are responsible for residual value of vehicle at lease end • Vehicle owned by leasing company, you pay maintenance, repairs, insurance • May have mileage restrictions 5-15

33. 3. Paying Cash • Advantages: • Least expensive • Avoids interest charges • Used by people with limited/poor credit line • Disadvantages: • Investment returns higher than cost to borrow • Using saving money to buy or borrowing • Using saving money to buy or investing • Automobile depreciations • 15-20% on the first year • 50% after three years

34. 5-19 Learning Objective # 3Assess your credit capacity and building your credit rating.

35. 5-20 Measuring Your Credit Capacity • Before you take out a loan, ask yourself... • Can you afford the loan? • Ability to make principal and interest payments • Extra money after covering up the loan • What do you plan to give up in order to make the payment? • Saving or investing money

36. Credit Capacity • The maximum amount of debt a person or entity can be expected to assume and repay based on financial ability • Based on a formula that factors existing debt payments and net income to arrive at a percent of net income that is available for debt repayment

37. 5-21 Debt Payments-to-Income Ratio monthly payments* net monthly income should not exceed 20% Credit Capacity Indicators *Not including housing

38. Ex: • Monthly credit payments are $760 and net income is $3,800 • Debt-payments ratio • $760/$3,800 = 0.20 = 20%

39. 5-22 Credit Capacity Indicators Debt To Equity Ratio total liabilities = Should be < 1 net worth* *Excluding home value

40. Ex: • Long-term debt of $3,000 and owner’s equity of $12,000 • The debt/equity ratio • 3000 / 12000 = 0.25 • If the ratio is greater than 1, the majority of assets are financed through debt • If it is smaller than 1, assets are primarily financed through equity

41. 5-23 Co-Signing a Loan • You are considered as a co-debtor or co-owner of the loan • Guaranteeing a debt • If borrower doesn’t pay the debt you will have to • Including fees and collection costs • Statistics show that 3 out of 4 co-signors have to pay

42. If you do co-sign a loan • Be sure you can afford to pay • Cover the debt of others when they default • Liability can keep you from getting other credit • Credit line will be affected • Could lose the property you pledge as security • Lost of automobile or furniture • Understand provincial laws • Rights as a co-singer • Request copy of all over due notices

43. 5-24 Build and Maintain Your Credit Rating • Your credit experiences, or lack of, is a major consideration for the creditor • a good credit rating is a valuable asset • use credit with discretion • limit borrowing to your capacity to repay • abide by the terms of the lending contracts

46. Your Credit File The Credit Bureau is a reporting agency that collects credit and other information about consumers and sells the date to creditors to help in evaluating applications. Your Credit file includes; • Your employer and position • Former address and employer • Spouses name, social insurance number and employer • Public records and information • Cheques returned for insufficient funds 5-21

47. Credit Bureaus • Equifax Canada • www.equifax.ca • Trans Union Canada • www.tuc.ca • Experian • www.experiance.com • Others