Unit 4 Credit and Debt

Unit 4 Credit and Debt • What is Credit? • Someone lends you money • 1. The original amount borrowed is called the ___ • Principal

Common Types of Credit • 2. Which type of credit has the highest interest rates? • Credit Card (Revolving Credit) • 3. Which type of credit has the lowest interest rates? • Student Loan / Mortgage • 4. Which type of credit has no “term”? • Credit Card

5. Which type of credit has the longest term? • Mortgage • 6. Which type of credit usually has a 10 year term? • Student • 7. Which type of credit usually offer tax breaks for the interest paid? • Student / Mortgage

Mortgage Details • Requires a credit check • Requires a down payment • Typically 15 or 30 year term • Interest rates may be fixed or variable (ARM) • Adjustable rate mortgage

The Cost of Using Credit • 8. If an advertisement states “Buy now and pay only $19 a month.” – What is the ad NOT telling you? • Interest rate, payoff time and payoff amount • 9. Know the bold terms on p. 44 and 45 • Annual Fee Credit Limit Finance Charge • Origination Fee Loan Term • Grace Period Over limit fee Late fee • Universal default

Credit: The Good and the Bad • 10. Understand the “risks” and “rewards” of credit • Risks: Interest, Overspending, Debt (legal claims against your future income), Identity Theft • Rewards: Convenience, Protection, Emergencies, Build Credit, Quicker Gratification, Special Offers, Bonuses

6 Questions to Ask When You Compare Credit (know them) • What is the interest rate (for purchases)? • How long is the loan for? • Minimum Monthly Payment? • Grace Period ? • Extra fees/penalties? • Which is best deal for me?

The 4 C’s of Credit • 11. An asset that lenders can take from you if you do not repay a loan is …. • Collateral • 12. If you put up a house or car as an asset to guarantee your loan, it is called a ……loan • Secured • 13. When assessing your credit worthiness, lenders want to know if you have ….. . That is, if you failed to pay the loan, they can sell your assets. • Capital

14. A pattern of rising income and steady employment help determine your ____ to repay your loan. • Capacity • 15. A history of paying bills on time helps demonstrate to lenders that you have good ___ and are worthy of getting a loan • Character

Keeping Score With Your Credit • 16. What is a FICO score? • A number that reflects your credit worthiness based on the 4 C’s. • Fair Isaac Corporation 1958 • use predictive analytics to help businesses automate, improve and connect decisions across organizational silos and customer lifecycles. • *there are several other credit scoring agencies

17. The average consumer has ___ on record at a credit bureau. • 13 • 18. Your credit score reflects your … • Credit worthiness

19. Credit scores range from ……..to…….. • 300-850 • 20. Building and maintain a good credit score is as simple as…… • Discipline • You have the right to receive one free credit report per year from each of the three credit bureaus.

"The very best rates go to people with scores above 770, but a score of 700 is considered good • (the average score is 725) • a score above 700 indicates relatively low credit risk, while scores below 600 indicate relatively high risk... " • Anything below about 550 is considered awful."

Your Credit Score is made up of….(Do not need for test) 1. 35% - payment history 2. 30% - “debt to credit limit ratio”: • Balances on all credit cards and loans ($5000) Compared to ….. • Available credit limits on all cards ($20000) • = 25% • Keep as low as possible • Good = < 30% ; Very Bad = > 50% 3. 15% - length of credit history

A simplified look at what Lenders look at…. They will look at a Borrower’s : Liability Payment history Income

4. 10% - # of recently opened accounts and credit inquiries - when you pay for a credit score or potential lenders look into your score • don’t want too many cards (3-4) ; don’t want to seek lots of credit in limited time 5. 10% - mix of credit : higher scores if you can manage 2-3 cards and other loans at same time

21. Be able to summarize the five ways to hurt your credit history and score. • Late payments • Bouncing checks • Too many credit cards/loans • High balances • Changing credit cards frequently These are not good ways to manage your credit

Getting Your Piece of the Credit Pie • 22. As a student, there are 5 ways to begin building your credit history. Identify them. • Co-sign on credit card • Credit card from “your” bank • Store credit card • Secured Credit Card (pre-pay) …like debit • Rent and/or Utility bills in your name • 23. Your first credit card will most likely have… • Low limit

Know for test “70-20-10 Rule” 10% Pay Debt 20% Save Invest 70% Living Expenses

Pitfalls and Warnings* = need to know • *Making ONLY THE MINIMUM payment raises the cost of Debt (credit card co’s make most of their profit off of interest charges) • *Too much available credit may look risky to other lenders…..why? • *Late Payments = Triple Threat • Fees • Increase interest rates • Lower credit score Previous Balance 1000 Paid the min - 50 New Balance ????? 950 But that 950 is charged interest. So….. New Balance 960 Pay the min - 48 912 But add interest = 922 So you paid $98 on $1000 balance Should owe $902 but owe $922

4. 7-10 year history 5. Make a Plan to Pay it Off • If Multiple Sources of Debt • *Pay off smallest balance first = easy to see progress • *Pay off largest interest first = paying less in the long run

Hounded by Creditors • Negotiate with Creditors • Seek help (credit counseling agencies) • Bankruptcy

Consequences of Failing to Manage Your Credit a. Bankruptcy • Unable to meet financial obligations b. Foreclosure • Inability to make mortgage payments; bank claims ownership c. Repossession -bank sends contractors to take your possessions back (cars, boats, etc..) d. Difficulty securing job …why? -especially in business or finance e. Hard to obtain future credit

Red Text = need to know • PRIME RATE • Prime Rate as an index or foundation rate for pricing various short-term loan products. • When newspapers, academics, investors and economists refer to the National, Fed, U.S. or WSJ Prime Rate, it is widely accepted that they are in fact referring to The United States Prime Rate as listed in the Eastern print edition of the Wall Street Journal® (WSJ).

Traditionally, the WSJ Prime Rate was determined by polling thirty (30) of America's largest banks. When twenty-three (23) of those 30 banks had changed their prime lending rate, The WSJ would respond by updating its published Prime Rate. • Effective December 16, 2008, however, the WSJ now determines the Prime Rate by polling the 10 largest banks in the United States. When at least 7 out of the top 10 banks have changed their Prime, the WSJ will update its published Prime Rate.

Providers of consumer and commercial loan products often use the U.S. Prime Rate as their base lending rate, • then add a margin (profit) based primarily on the amount of risk associated with a loan. • Moreover, some financial institutions use Prime as an index for pricing certain time-deposit products like variable-rate Certificates of Deposit.

The U.S. Prime Rate is invariably tied to America's cardinal, benchmark interest rate: the Federal Funds Target Rate (also known as The Fed Funds Rate.) • U.S. Prime Rate = (The Fed Funds Target Rate + 3) • Now: FFR = (targeted between 0 - .25) + 3 = • 3.25 • What you pay : 3.25 + (margin or spread for profit) = ……. • Credit Card ex: 3.25% + 12.74% = 15.99

This week Month ago Year ago • WSJ Prime Rate 3.25\\3.25\\ 3.25 • Federal Discount Rate 0.75\\ 0.75\\ 0.75 • Fed Funds Rate (Current target rate 0-0.25) 0.25\\ 0.25\\ 0.25 • 11th District Cost of Funds 1.452 1.469 1.859

The prime rate, as reported by the Wall Street Journal's bank survey, is among the most widely used benchmark in setting home equity lines of credit and credit card rates. It is in turn based on the fed funds rate, which is set by the Federal Reserve. The COFI (11th District cost of funds index) is a widely used benchmark for adjustable-rate mortgages.

Changes in the fed funds rate and the discount rate also dictate changes in the Wall Street Journal Prime Rate, which is of interest to borrowers. • The prime rate is the underlying index for most credit cards, home equity loans and lines of credit, auto loans, and personal loans. • Many small business loans are also indexed to the Prime rate. The 11th District Cost of Funds is often used as an index for adjustable-rate mortgages.

Ratings methodology • What's included? • The fed funds rate is the primary tool that the Federal Open Market Committee uses to influence interest rates and the economy. • Changes in the fed funds rate have far-reaching effects by influencing the borrowing cost of banks in the overnight lending market, and subsequently the returns offered on bank deposit products such as certificates of deposit, savings accounts, and money market accounts.

Sub-Prime • A type of loan that is offered at a rate above prime to individuals who do not qualify for prime rate loans. • Quite often, subprime borrowers are often turned away from traditional lenders because of their low credit ratings or other factors that suggest that they have a reasonable chance of defaulting on the debt repayment. • Good? / Bad? • Major role in housing collapse • Is the American Dream (house) your right? • Is it (should it) be guaranteed?

Unit 4 Credit and Debt