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 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