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Chapter 5

Chapter 5






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    Chapter 5 Chapter 5 Presentation Transcript

    • Chapter 5 Consumer Credit: Advantages, Disadvantages, Sources, and Costs Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin
    • Consumer Credit
      • Analyze advantages and disadvantages of using consumer credit
      • Assess the types and sources of consumer credit
      • Determine whether you can afford a loan and how to apply for credit
      • Determine the cost of credit by calculating interest using various interest formulas
      • Develop a plan to protect your credit and manage your debts
      Chapter Objectives 5-
    • Objective 1 Analyze Advantages and Disadvantages of Using Consumer Credit
      • Credit
        • An arrangement to receive cash, goods or services now, and pay for them in the future
        • Based on trust in people’s ability and willingness to pay bills when due
      • Consumer credit
        • Use of credit by individuals for personal needs, except a home mortgage
        • A major force in our economy
    • Uses and Misuses of Credit
      • Before you use credit for a major purchase, consider:
        • Do I have the cash for the down payment?
        • Do I want to use my savings for this purchase?
        • Does the purchase fit my 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?
    • Advantages of Credit
      • Current use of goods and services
      • Permits purchase even when funds are low
      • A cushion for financial emergencies
      • Advance notice of sales
      • Easier to return merchandise
      • Convenient when shopping
      • Provides a record of expenses
    • Advantages of Credit
      • One monthly payment
      • Safer than carrying cash
      • Needed for hotel reservations, car rentals, and shopping online
      • Take advantage of float time/grace period
      • Rebates, airline miles, or other bonuses
      • Credit indicates financial stability
    • Disadvantages of Consumer Credit
      • Temptation to overspend
      • Can create long-term financial problems and slow progress toward financial goals
      • Potential loss of merchandise due to late or non-payment
      • Ties up future income
      • Credit costs money - more costly than paying with cash
    • Objective 2 Assess the Types & Sources of Consumer Credit
      • Two Basic Types of Consumer Credit
      • Closed-End Credit
        • One-time loans for a specific purpose paid back in a specified period of time
      • Open-End Credit
        • Use as needed until line of credit max reached
    • Closed-End Credit
      • One-time loans for a specific purpose that you pay back in a specified period of time, and in payments of equal amounts
      • Mortgage, automobile, and installment loans for furniture, appliances and electronics
      • 3 most common types of closed-end credit
          • Installment sales credit
          • Installment cash credit
          • Single-lump credit
    • Open-End Credit
      • Use as needed until line of credit max reached
        • Credit cards
        • Department store cards
        • Home equity loans
      • You pay interest and finance charges if you do not pay the bill in full when due
      • Revolving check credit
      • Bank line of credit
    • Sources of Consumer Credit
      • Loans
        • Borrowing money with an agreement to repay along with interest within a certain amount of time
      • Inexpensive loans
        • Parents or family members
      • Medium-priced loans
        • Commercial banks, savings and loan associations, and credit unions
      • Expensive loans
        • Finance and check cashing companies
        • Retailers such as car or appliance dealers
        • Bank credit cards and cash advances
    • Sources of Consumer Credit
      • Home Equity Loans
        • Loan based on your home equity
          • Current market value of your home minus the amount you still owe on the mortgage
        • Interest is tax deductible
        • Should only be used for major purchases
      • Credit Cards
        • Average cardholder has > 9 credit cards
        • Convenience users vs. Borrowers
        • Finance charge = total amount paid to use credit
    • Sources of Consumer Credit
      • Debit Cards
        • Debit cards electronically subtract money from your savings or checking accounts
        • Most commonly used at ATMs
      • Stored Value Cards
        • Gift cards
        • Prepaid cards
    • Sources of Consumer Credit
      • Smart Cards
        • Plastic card equipped with a computer chip that can store 500 times as much data as a normal credit card
      • Travel and Entertainment (T&E) cards
        • Not really “credit cards”; balance is due in full each month
        • Diners Club; American Express
        • You don’t pay for services or goods at the time you purchase them
    • Objective 3 Determine Whether You Can Afford a Loan and How to Apply for Credit
      • Before you take out a loan, ask yourself...
      • Can you meet all your essential expenses and still afford the monthly loan payments ?
        • What do you plan to give up in order to make the payment?
    • General Rules of Credit Capacity * Not including house payment which is a long-term liability Debt Payments-to-Income Ratio Monthly Debt Payments* Net Monthly Income Consumer credit payments should not exceed a maximum of 20% of your net income . 5-
    • General Rules of Credit Capacity Debt To Equity Ratio Total Liabilities Net Worth* = Should be < 1 *Excluding home value 5-
    • The Five C’s of Credit
      • Character - Do you pay bills on time?
      • Capacity - Can you repay the loan?
      • Capital - What are your assets and net worth?
      • Collateral - What assets do you have to secure the loan?
      • Conditions- Lenders will review how general economic conditions will affect your ability to repay your loan
    • FICO & VantageScore
      • FICO Credit Score
        • 350 to 850
        • Higher score = less risk
        • Available from http://www.myfico.com for a fee
      • VantageScore
        • New scoring technique
        • Developed collaboratively by 3 credit agencies
        • Range = 501 to 990
    • Factors of Creditworthiness
      • ECOA (Equal Credit Opportunity Act)
        • Gives all applicants the same rights.
        • Credit providers may not discriminate based on:
          • Age
          • Social Security or public assistance
          • Housing loans ( redlining )
        • If you are denied credit, you have the right to know the reasons
          • You can request a copy of your credit report within 60 days if you are denied credit based on what is in your files
    • Your Credit Report
      • Credit Reports
        • Record of your complete credit history
      • Credit Bureaus
        • Agencies that collect information on how promptly people and businesses pay their bills
        • Experian , Trans Union and Equifax are the 3 major credit bureaus
        • Credit Bureaus obtain information from banks, finance companies stores, credit card companies and other lenders
    • Your Credit Report
      • Credit Files
        • Typically contain detailed credit data along with considerable personal information:
          • Name, address, SSN, DOB (self & spouse)
          • Employer, position and income (current & previous, self and spouse)
          • Home owner or renter
      • Fair Credit Reporting Act (1971)
        • Law allows out-of-date information to be deleted, as well as the right to correct misinformation
    • Your Credit Report
      • Who can obtain a credit report?
        • Only authorized persons have access to your report for approved legitimate business purposes
      • Time Limits on Unfavorable Data
        • Adverse data can be reported for 7 years
        • Bankruptcy can be reported for 10 years
    • Your Credit Report
      • Incorrect Information in Your File
        • You may request a copy of your credit
        • information within 60 days of being denied
        • credit
        • You may request a free copy of your credit
        • report annually
        • What are Your Legal Rights?
        • You have the legal right to sue the credit bureau or the creditor that has caused you harm
    • Objective 4 Determine 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 for credit
    • Tackling the Trade-Offs
      • Term (length of loan) versus interest cost
      • Lender risk versus interest rate
      • 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
    • 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
    • Calculating the Cost of Credit
      • Cost of Open-End Credit
        • Truth in Lending Act requires that open-end creditors inform consumers as to how the finance charge and APR will affect their costs
      • Cost of Credit and Expected Inflation
        • Lenders incorporate the expected rate of inflation when deciding how much interest to charge
      • Avoid the Minimum Monthly Payment Trap
        • The longer you take to pay off the bill, the more interest you pay
    • Objective 5 Develop 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
    • P rotecting Your Credit
      • 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
      Fair Credit Billing Act (FCBA, 1975) 5-
    • What to Do If Your Identity is Stolen?
      • Contact the three major credit bureaus
        • Ask the fraud department to institute a fraud alert
        • Request that creditors call you for permission before opening any new accounts in your name
      • Contact creditors
        • Check for any accounts that have been tampered with or opened fraudulently
      • File a police report
        • Keep a copy
    • Protecting Your Credit From Theft or Loss
      • Shred any papers that contain personal information
      • Close your accounts immediately if you suspect an identity thief has accessed the account
      • Be sure your credit card is returned after a purchase
      • Keep a record of credit card numbers
      • Notify your credit card company immediately if your card is lost or stolen
    • Protecting Your Credit Information on The Internet
      • Use a secure browser
      • Keep records of online transactions
      • Review monthly bank and credit card statements
      • Read the privacy and security policies of websites you visit
      • Keep personal information private
      • Never give your password to anyone
      • Don’t download files sent by strangers
    • Co-signing a Loan
      • Co-signing means guaranteeing the 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
    • Complaining About Consumer Credit
      • First: Try to solve the problem directly with the creditor
      • If that fails: Use formal complaint procedures
      • A variety of Consumer Credit Protection Laws and Federal Agencies administer and assist with complaint procedures
    • Consumer Credit Protection Laws
      • Truth in Lending and Consumer Leasing Acts
      • Equal Credit Opportunity Act (ECOA)
      • Fair Credit Billing Act
      • Fair Credit Reporting Act
      • Consumer Credit Reporting Reform Act (1977)
      • Electronic Funds Transfer Act
      • Your Rights Under Consumer Credit Laws
        • Complain to the creditor
        • File a complaint with the government
        • If all else fails, sue the creditor
    • 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
    • Managing Your Debts
      • Debt Collection Practices
      • The Federal Trade Commission enforces the Fair Debt Collection Practices Act (FDCPA)
        • Prohibits certain practices by debt collectors
        • Does not eliminate legitimate debts
    • 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 consolidation plan and negotiate reduced interest rates
    • Other Counseling Services
      • Universities, local county extension agents, credit unions, military bases, and state and federal housing authorities provide nonprofit counseling services
      • Check with your financial institution or consumer protection office for a list of reputable, low-cost financial counseling services
    • Declaring Personal Bankruptcy
      • U.S. Bankruptcy Act of 1978
      • Chapter 7 = straight bankruptcy
      • Chapter 13 = wage earner plan
      Bankruptcy should be the last resort , because of the damage to your credit rating Personal bankruptcy is a procedure to distribute some or all of your assets among creditors 5-
    • 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 sold to pay creditors
      • Can keep some assets (home, vehicle,..)
      • Intent = a fresh start
      • Most filed are this type
    • 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 act
    • Bankruptcy Abuse Prevention and Consumer Protection Act of 2005
      • Makes it more difficult for consumers to file a Chapter 7 bankruptcy
        • Forces a Chapter 13 repayment plan
        • 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
    • Chapter 13 Bankruptcy
      • Debtor with regular income proposes a plan to eliminate his debts over time
      • 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
    • 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