5B Consumer Credit #2

1. 5B Consumer Credit #2 • Covered so far… • Advantages and disadvantages of credit • Types and sources of credit • Credit capacity (how much you can afford) • Credit reports and scores • Still to cover… • The cost of credit • Protecting your credit • Consumer credit protection laws • Debt problems and bankruptcy 5-1

2. Objective 4Determine the Cost of Credit by Calculating Interest Using Various Interest Formulas • Finance charge • Total dollar amount you pay to use credit • Includes interest costs and fees, such as service charges, credit-related insurance premiums, or appraisal fees • Annual Percentage Rate (APR) • Percentage cost of credit on a yearly basis • Key to comparing costs when shopping for rates It is important to shop around for credit 5-2

3. Tackling the Trade-Offs • Term (length of loan) versus interest cost • Longer loan: higher interest rate; total cost • Lender risk versus interest rate • Fixed rate: increases lender risk • To reduce the lender’s risk and thus the interest rate you can: • Accept a variable interest rate • Provide collateral to secure a loan • Provide up-front cash • Take a shorter term loan 5-3

4. Secured Credit Cards Secured Credit Card (or Collateralized Credit Card) – Backed by collateral in the form of a savings account opened at the financial institution that issues the card. Example: Deposit $1,000 with creditor to borrow $1,000

5. Calculating the Cost of Credit • Simple interest • Computed on principal only without compounding • The dollar cost of borrowing • Interest = Principal x Rate x Time • Simple interest on the declining balance • Interest is paid only on the amount of original principal not yet repaid • Add-on interest • Interest calculated on full amount of principal • Interest added to original principal • Payment = Total divided by number of payments to be made 5-5

6. Calculating the Cost of Credit • Avoid minimum monthly payment trap • The longer to pay bill, the more interest you pay • Avoid credit card fees • Annual Fee- fee charged each year just to have a credit card (many are increasing; why?) • Transaction Fee- fee charged to use a credit card, get cash advances, or make transfers • Late Fee- fee assessed for making a late payment • Bounced Check Fee- fee for NSF check payment • Over-the-Limit Fee- fee charged (with cardholder’s permission) to exceed credit card limit 5-6

7. Objective 5Develop a Plan to Protect Your Credit and Manage Your Debts Fair Credit Billing Act (FCBA, 1975) • Notify creditor of error in writing within 60 days • Pay the portion of the bill not in dispute • Creditor must respond within 30 days • Credit card company has two billing periods, but no longer than 90 days, to correct your account or tell you why they think the bill is correct 5-7

8. Protecting Your Credit Fair Credit Billing Act (FCBA, 1975) • Disputed item won’t affect your credit rating while in dispute • Can withhold payment on damaged or shoddy goods or poor services if purchased with a credit card • Must make sincere attempt to resolve problem with creditor • Contact merchant first and document it Has anybody ever used FCBA procedures? 5-8

9. Co-signing a Loan Co-signing meansguaranteeing a debt • Lender would not require a co-signer if borrower were a good risk • Can you afford it if the borrower defaults? • If borrower doesn’t pay, cosigner is liable for the full amount plus any late or collection fees • If payment is missed, creditor can collect from the cosigner first • Unpaid debts will appear on the cosigner’s credit report 5-9

10. Complaining About Consumer Credit • First: Try to solve the problem directly with the creditor • If that fails: Use formal complaint procedures • Federal government administers laws and assists with complaint procedures • Federal Reserve Board • Federal Trade Commission (FTC) 5-10

11. Consumer Credit Protection Laws • Truth in Lending and Consumer Leasing Acts • Requires disclosure of the cost of credit (APR) • Equal Credit Opportunity Act (ECOA) • Prohibits discrimination in credit-granting decisions • Fair Credit Billing Act • Provides rules for correcting billing errors • Fair Credit Reporting Act • Provides rules for accessing/correcting credit reports Your Rights Under Consumer Credit Laws • Complain to the creditor • File a complaint with the government • If all else fails, sue the creditor 5-11

12. Managing Your Debts Warning Signs of Debt Problems • Paying only the minimum balance each month • Trouble even paying the minimum balance • Total balance increases every month • Missing loan payments or paying late • Using savings to pay for necessities • Getting second or third payment notices • Borrowing money to pay old debts • Exceeding the credit limits on your credit cards • Denied credit due to a bad credit report 5-12

13. Managing Your Debts Debt Collection Practices The FTC enforces the Fair Debt Collection Practices Act (FDCPA) • Prohibits certain practices by debt collectors (e.g., early or late calls, calls at work, profane language) • Doesnot eliminate legitimate debts; just controls the way that debt collectors work • Does not apply to first-party debt collectors (original creditors); only to third-party collectors (independent companies) 5-13

14. Managing Your Debts Consumer Credit Counseling Services (CCCS) • Non-profit and supported by contributions from banks, merchants, etc. • Provides education about credit • Provides help with spending plan • Provides debt counseling services for those with serious financial problems • Can develop a debt repayment plan and negotiate reduced interest rates 5-14

15. Declaring Personal Bankruptcy U.S. Bankruptcy Act of 1978 Chapter 7 = straight bankruptcy Chapter 13 = wage earner plan Personal bankruptcy is a legal process to distribute some or all assets among a person’s creditors due to an inability to repay debts. Bankruptcy should be the last resort, because of the damage to your credit rating; stays in a person’s credit report 10 years vs. 7 years for other negative information 5-15

16. Chapter 7 Bankruptcy • Submit a petition to the court that lists assets and liabilities, and pay a filing fee • Many, but not all, debts are forgiven • Assets surrendered to pay creditors • Can keep some assets (home, vehicle,..), depending on state/federal exemptions • Intent = “A Fresh Start” • Most bankruptcies are this type 5-16

17. After Chapter 7 • You May No Longer Owe: • Retail store charges • Bank credit card charges • Unsecured loans • Unpaid hospital or physician bills • You Still May Owe... • Certain taxes and fines • Child support and alimony • Educational loans • Debts from willful or malicious acts 5-17

18. Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 • Makes it more difficult for consumers to file a Chapter 7 bankruptcy (means test) • Debtors must wait 8 years from their last bankruptcy to file again • Clamps down on “bankruptcy mills” that seek to game the system • Includes provisions for consumer education on debt management and financial planning 5-18

19. Chapter 13 Bankruptcy • Debtor with regular income proposes a plan to eliminate his debts over time • Debtor normally keeps most of property • Information provided to the court the same as under Chapter 7 • Plan may last up to five years • Debtor makes payments to a court-appointed trustee 5-19

20. Obtaining Credit after Bankruptcy • May be more difficult • But, creditors may consider the inability to file bankruptcy again for 8 years • Could be easier for Chapter 13 filers (who have repaid some debt) versus Chapter 7 filers who made no effort to repay • Likely to pay high interest rates (lower credit score) 5-20

21. CARD Act Regulations • 45 days’ notice before key changes in account terms (up from previous 15 days) • Minimum payment illustrations on credit card bills (payoff cost and payment to repay in 36 months) • “Universal default” practice was banned • Two-cycle balance billing was banned • “Teaser rates” must last at least 6 months • Consumers must “opt in” for over-the-limit fees • Bills must be mailed 21 days before due date • No more “late fee traps” (e.g., weekends, 8 am)

22. College Students and Credit Cards(CARD Act) • Credit card companies are prohibited from offering free merchandise in exchange for credit card applications (on campus, campus events) • No credit cards under age 21 unless cosigner or proof of income tomake payments • Maximum amount of credit < 21: greater of $500 or 20% of annual gross income in most recently completed calendar year • Aggregate limit for ALL credit cards held by someone <21: 30% of annual gross income in most recent completed calendar year

23. Alternatives to Credit Cards for College Students • “Authorized user” on parent’s credit cards and reimburse parents • Parents see everything you charge; may be fees • Does not boost students’ credit much; parent is user • Joint account with parents • Credit history reported to credit bureaus; builds credit • Secured credit cards • Still need to follow CARD Act cosigner/income rules • Prepaid debit cards • Not “credit”; use will not build credit history; high fees • Less protection than credit cards if lost or stolen

24. Wrap Up • Chapter Quiz • Concept Check 5-4- Two Key Concepts and Credit Terms • Concept 5-5- Correcting a Billing Error • Helpful Advice for Others