Personal Finance: An Integrated Planning Approach Winger & Frasca Chapter 6 Short-term Credit Management http://www.prenha...
Major Topics <ul><li>Arranging and Using Credit </li></ul><ul><li>Sales Credit </li></ul><ul><li>Cash Credit </li></ul><ul...
Reasons for Using Credit <ul><li>As a Shopping Convenience </li></ul><ul><li>To Increase Total Consumption </li></ul><ul><...
Disadvantages of Using Credit <ul><li>Temptation to overspend </li></ul><ul><li>Credit costs </li></ul><ul><li>Less flexib...
How to Get Credit <ul><li>Consider what the lender looks for. </li></ul><ul><li>Begin a credit record. </li></ul><ul><li>R...
What Lenders Look For <ul><li>The Three C’s of Credit </li></ul><ul><li>Character </li></ul><ul><ul><li>Have you met your ...
Begin a Credit Record <ul><li>Open savings and checking accounts. </li></ul><ul><li>Open a retail charge account. </li></u...
Special Concerns for Spouses Establishing Credit <ul><li>Make sure your credit history is in your name. </li></ul><ul><li>...
Credit Accounts <ul><li>Joint Credit Account </li></ul><ul><ul><li>Both spouses responsible for debt. </li></ul></ul><ul><...
The Role of the Credit Bureau <ul><li>Does not decide who receives credit. </li></ul><ul><li>Stores information on past us...
Contents of a Credit Report <ul><li>Existing credit accounts </li></ul><ul><li>Information on each credit account includes...
Credit Report You must have an Internet connection for the above link to work. View a Credit Report
If You are Denied Credit <ul><li>Obtain a copy of your report. </li></ul><ul><li>Correct any mistakes. </li></ul><ul><li>S...
Sales Credit <ul><li>Kinds of Accounts </li></ul><ul><li>Major Issuers of Credit Cards </li></ul><ul><li>Selecting a Credi...
Sales Credit Accounts <ul><li>Regular charge account </li></ul><ul><ul><li>billed for purchases at end of month </li></ul>...
Revolving Charge Account <ul><li>Credit limit determined by credit record and net worth. </li></ul><ul><li>Partial payment...
Required Information on  Revolving Charge Account Truth in Lending Act <ul><li>Annual percentage rate (APR) applied to bal...
Interest Computation Methods <ul><li>Previous balance method </li></ul><ul><li>Adjusted balance method </li></ul><ul><li>A...
Previous Balance Method <ul><li>Rate applied to balance at end of previous month.  </li></ul>Example Previous balance = $2...
<ul><li>Equal to the previous balance less any payments or returns made during the current billing cycle </li></ul><ul><li...
Average Daily Balance Method (including current purchases)
Average Daily Balance Method (including current purchases) Interest charged =  $261.83 x 1.65% = $4.32 Average Daily Balan...
Average Daily Balance Method (excluding current purchases)
Average Daily Balance Method (excluding current purchases) Interest charged = $201.45 x 1.65% = $3.32 Average Daily Balanc...
Interest Charges on Balances Text Illustration <ul><li>Previous Balance Method $3.55 </li></ul><ul><li>Adjusted Balance Me...
Two-cycle  Average Daily Balance Method <ul><li>Eliminates a grace period in the previous month when you fail to completel...
Major Issuers of Credit Cards <ul><li>Bank Credit Cards </li></ul><ul><ul><li>Discover MasterCard Visa </li></ul></ul><ul>...
Credit Card Cost Comparison <ul><li>Annual membership fee </li></ul><ul><li>Variable rate information </li></ul><ul><li>Ba...
Credit Card Benefit Comparison <ul><li>Credit limit </li></ul><ul><li>Disability insurance </li></ul><ul><li>Accident insu...
Payback Period $3,000 Credit Balance @ 19% APR $2,991 1,790 1,102 804 100 64 42 31 $60 75 100 125 Total Interest Months Mo...
Protect Against Credit Card Fraud <ul><li>Record card numbers, expiration dates and phone number for card company. </li></...
Correcting Credit Mistakes <ul><li>Notify the creditor in writing within 60 days after bill was mailed. </li></ul><ul><li>...
Correcting Credit Mistakes <ul><li>If no error is found, you must pay or you will be reported as delinquent. </li></ul><ul...
Other Credit Terms <ul><li>Chargeback </li></ul><ul><ul><li>a disputed amount charged back to the merchant by the credit c...
Debit Cards <ul><li>Bank deposit is immediately reduced </li></ul><ul><li>You do not have the protections afforded credit ...
Debit Cards <ul><li>Lost or stolen credit cards are covered by the Electronic Funds Transfer Act </li></ul><ul><ul><li>you...
Cash Credit <ul><li>Credit extended in the form of cash. </li></ul><ul><li>Elements of a retail installment contract </li>...
Methods for Charging Interest <ul><li>Simple Interest Method </li></ul><ul><ul><li>percentage rate applied to outstanding ...
Figure 6.6 A 12-month installment loan with annual simple interest of 12 percent
Discount Method Total payments on discount loan amount financed 1 - (discount rate x  t  ) = $1,000 1 - (0.12 x  t  ) $1,1...
Add-on Method Total payments on add-on loan amount financed x [1 + (add-on rate x  t  ) ] = $1,000 x [1 + (0.12 x  t  ) ] ...
Figure 6.7 Comparative interest on credit of $1,000 to be repaid in 12 equal monthly installments Simple  Discount  Add-on...
Annual Percentage Rate (APR) <ul><li>Same as annual simple interest. </li></ul><ul><li>In the absence of other loan fees i...
Rule of 78 <ul><li>Rule for determining how interest accrues on a loan. </li></ul><ul><li>Pushes interest earned by credit...
Consumer Loan Clauses <ul><li>Acceleration clause </li></ul><ul><ul><li>Late payment entitles the lender to demand that th...
Consumer Loan Clauses <ul><li>Balloon payment </li></ul><ul><ul><li>Lump-sum payment at end of loan. </li></ul></ul>
Sources of Credit <ul><li>Banking Institutions </li></ul><ul><ul><li>Overdraft protection credit line </li></ul></ul><ul><...
Sources of Credit <ul><li>Other </li></ul><ul><ul><li>Life insurance policies </li></ul></ul><ul><ul><li>Margin accounts o...
A Credit Management Strategy <ul><li>Use the grace period. </li></ul><ul><li>Avoid expensive credit on revolving charge ac...
Bankruptcy <ul><li>Straight Bankruptcy </li></ul><ul><li>Wage Earner Plan </li></ul>
Straight Bankruptcy <ul><li>Primary form of bankruptcy. </li></ul><ul><li>Discharges all debts and provides a fresh start....
Wage Earner Plan <ul><li>Repayment schedule established by court. </li></ul><ul><li>Debtor may retain property. </li></ul>...
Appendix Rule of 78
Calculating Loan Prepayment Under Rule of 78 <ul><li>Determine monthly interest factor for each month. </li></ul><ul><li>M...
Calculating Loan Prepayment Under Rule of 78 <ul><li>Add interest earned by lender to original principal. </li></ul><ul><l...
Elements of Rule of 78 Sum of Digits (SD) =  N N  + 1 2 (  Monthly interest factor =  Month in reverse order Sum of Digits
Figure 4.6 A 12 month installment loan  with annual add-on interest of 12 percent, Total Interest = $120 1 2 3 $  93.33 93...
Next Chapter 7 Consumer Durables
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Chapter 6

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Chapter 6

  1. 1. Personal Finance: An Integrated Planning Approach Winger & Frasca Chapter 6 Short-term Credit Management http://www.prenhall.com/winger/
  2. 2. Major Topics <ul><li>Arranging and Using Credit </li></ul><ul><li>Sales Credit </li></ul><ul><li>Cash Credit </li></ul><ul><li>Obtaining Credit and Resolving Credit Problems </li></ul>
  3. 3. Reasons for Using Credit <ul><li>As a Shopping Convenience </li></ul><ul><li>To Increase Total Consumption </li></ul><ul><li>As an Inflation Hedge </li></ul><ul><li>As a Source of Emergency Funds </li></ul>
  4. 4. Disadvantages of Using Credit <ul><li>Temptation to overspend </li></ul><ul><li>Credit costs </li></ul><ul><li>Less flexibility with future budgets </li></ul>
  5. 5. How to Get Credit <ul><li>Consider what the lender looks for. </li></ul><ul><li>Begin a credit record. </li></ul><ul><li>Review your credit report. </li></ul><ul><li>Repair a bad credit record. </li></ul>
  6. 6. What Lenders Look For <ul><li>The Three C’s of Credit </li></ul><ul><li>Character </li></ul><ul><ul><li>Have you met your previous obligations? </li></ul></ul><ul><li>Capital </li></ul><ul><ul><li>Have you sufficient financial assets? </li></ul></ul><ul><li>Capacity </li></ul><ul><ul><li>Can you meet your future obligations? </li></ul></ul>
  7. 7. Begin a Credit Record <ul><li>Open savings and checking accounts. </li></ul><ul><li>Open a retail charge account. </li></ul><ul><li>Qualify for a small installment loan. </li></ul><ul><li>Make sure your credit records follow you. </li></ul><ul><li>Have a telephone installed. </li></ul>
  8. 8. Special Concerns for Spouses Establishing Credit <ul><li>Make sure your credit history is in your name. </li></ul><ul><li>Don’t use a social title </li></ul><ul><ul><li>ex., Mrs... Edward Hall </li></ul></ul><ul><li>Inform creditors that you wish to maintain your own credit history. </li></ul><ul><li>Know the difference between a joint and individual credit account. </li></ul>
  9. 9. Credit Accounts <ul><li>Joint Credit Account </li></ul><ul><ul><li>Both spouses responsible for debt. </li></ul></ul><ul><ul><li>Divorced or separated spouses should cancel joint accounts. </li></ul></ul><ul><li>Individual Credit Account </li></ul><ul><ul><li>Only you are responsible for debt. </li></ul></ul><ul><ul><li>Account will appear only on you credit report. </li></ul></ul>
  10. 10. The Role of the Credit Bureau <ul><li>Does not decide who receives credit. </li></ul><ul><li>Stores information on past use of credit </li></ul><ul><li>Stores information on legal actions against you. </li></ul><ul><li>Sells credit reports to lenders. </li></ul>
  11. 11. Contents of a Credit Report <ul><li>Existing credit accounts </li></ul><ul><li>Information on each credit account includes </li></ul><ul><ul><li>credit limit, loan amount and account balance </li></ul></ul><ul><ul><li>who is responsible for paying the account </li></ul></ul><ul><li>Public record information </li></ul><ul><ul><li>bankruptcies, tax liens and monetary judgments </li></ul></ul><ul><li>Who has obtained a copy </li></ul>
  12. 12. Credit Report You must have an Internet connection for the above link to work. View a Credit Report
  13. 13. If You are Denied Credit <ul><li>Obtain a copy of your report. </li></ul><ul><li>Correct any mistakes. </li></ul><ul><li>Submit your own statement on disputed claims. </li></ul><ul><li>Have adverse information that is old removed from report. </li></ul><ul><li>Have those who received report notified of any incorrect entries. </li></ul>
  14. 14. Sales Credit <ul><li>Kinds of Accounts </li></ul><ul><li>Major Issuers of Credit Cards </li></ul><ul><li>Selecting a Credit Card </li></ul>
  15. 15. Sales Credit Accounts <ul><li>Regular charge account </li></ul><ul><ul><li>billed for purchases at end of month </li></ul></ul><ul><li>Open-end account </li></ul><ul><ul><li>revolving credit account </li></ul></ul><ul><ul><li>agreement continues as long as account is open </li></ul></ul><ul><li>Closed-end account </li></ul><ul><ul><li>separate installment contract for each purchase </li></ul></ul>
  16. 16. Revolving Charge Account <ul><li>Credit limit determined by credit record and net worth. </li></ul><ul><li>Partial payment must be made each month. </li></ul><ul><li>Interest charged on unpaid balance. </li></ul><ul><li>Account may never actually be paid off. </li></ul>
  17. 17. Required Information on Revolving Charge Account Truth in Lending Act <ul><li>Annual percentage rate (APR) applied to balance. </li></ul><ul><li>Method for calculating interest. </li></ul><ul><li>Grace period, if any. </li></ul><ul><li>Minimum monthly payment, and penalties for late payment. </li></ul><ul><li>Permission to investigate credit history. </li></ul>
  18. 18. Interest Computation Methods <ul><li>Previous balance method </li></ul><ul><li>Adjusted balance method </li></ul><ul><li>Average daily balance method </li></ul><ul><ul><li>including current purchases </li></ul></ul><ul><ul><li>excluding current purchases </li></ul></ul><ul><li>Two-cycle average daily balance method </li></ul>
  19. 19. Previous Balance Method <ul><li>Rate applied to balance at end of previous month. </li></ul>Example Previous balance = $215 Monthly interest rate = 1.65% Interest charge: 1.65% x $215 = $3.55
  20. 20. <ul><li>Equal to the previous balance less any payments or returns made during the current billing cycle </li></ul><ul><li>Example </li></ul><ul><li>Previous balance $215 </li></ul><ul><li>Less current payment 20 </li></ul><ul><li>Interest charge = $190 x 1.65% = $3.22 </li></ul>Adjusted Balance Method
  21. 21. Average Daily Balance Method (including current purchases)
  22. 22. Average Daily Balance Method (including current purchases) Interest charged = $261.83 x 1.65% = $4.32 Average Daily Balance = Weighted sum Days $8,116.73 = $261.83 31
  23. 23. Average Daily Balance Method (excluding current purchases)
  24. 24. Average Daily Balance Method (excluding current purchases) Interest charged = $201.45 x 1.65% = $3.32 Average Daily Balance = Weighted sum Days $6,245 = $201.45 31
  25. 25. Interest Charges on Balances Text Illustration <ul><li>Previous Balance Method $3.55 </li></ul><ul><li>Adjusted Balance Method $3.22 </li></ul><ul><li>Average Daily Balance Method </li></ul><ul><ul><li>including current purchases $4.32 </li></ul></ul><ul><ul><li>excluding current purchases $3.32 </li></ul></ul>
  26. 26. Two-cycle Average Daily Balance Method <ul><li>Eliminates a grace period in the previous month when you fail to completely pay off the balance in the present month. </li></ul><ul><li>Can go back two periods to collect interest on unpaid balance. </li></ul>
  27. 27. Major Issuers of Credit Cards <ul><li>Bank Credit Cards </li></ul><ul><ul><li>Discover MasterCard Visa </li></ul></ul><ul><li>Travel & Entertainment Cards </li></ul><ul><ul><li>American Express </li></ul></ul><ul><li>Other Cards </li></ul><ul><ul><li>Department store chains </li></ul></ul><ul><ul><li>Major gasoline retailers </li></ul></ul>
  28. 28. Credit Card Cost Comparison <ul><li>Annual membership fee </li></ul><ul><li>Variable rate information </li></ul><ul><li>Balance computation method </li></ul><ul><li>Late payment fee </li></ul><ul><li>Return check charge </li></ul><ul><li>Copy charge </li></ul><ul><li>Annual percentage rate </li></ul><ul><li>Grace period </li></ul><ul><li>Cash advance fee </li></ul><ul><li>Over-the-limit penalty </li></ul><ul><li>Replacement fee </li></ul><ul><li>Fees for optional services </li></ul>
  29. 29. Credit Card Benefit Comparison <ul><li>Credit limit </li></ul><ul><li>Disability insurance </li></ul><ul><li>Accident insurance </li></ul><ul><li>Rental car collision insurance </li></ul><ul><li>Warranty protection </li></ul><ul><li>Merchandise loss protection </li></ul><ul><li>Credit life </li></ul><ul><li>Rebates & discounts </li></ul><ul><li>Frequent flyer miles </li></ul><ul><li>Credit card registry </li></ul><ul><li>Purchase price protection </li></ul>
  30. 30. Payback Period $3,000 Credit Balance @ 19% APR $2,991 1,790 1,102 804 100 64 42 31 $60 75 100 125 Total Interest Months Monthly Payment
  31. 31. Protect Against Credit Card Fraud <ul><li>Record card numbers, expiration dates and phone number for card company. </li></ul><ul><li>Destroy old bills, receipts and credit cards. </li></ul><ul><li>Check sales receipt and compare with credit card statement. </li></ul><ul><li>Be careful giving out your card number. </li></ul><ul><li>Report lost and stolen cards immediately. </li></ul>
  32. 32. Correcting Credit Mistakes <ul><li>Notify the creditor in writing within 60 days after bill was mailed. </li></ul><ul><li>Pay parts of the bill that are not in dispute. </li></ul><ul><li>Creditor will notify you within 30 days of its decision. </li></ul>
  33. 33. Correcting Credit Mistakes <ul><li>If no error is found, you must pay or you will be reported as delinquent. </li></ul><ul><li>If you still challenge in writing the creditor must report that information. </li></ul><ul><li>Provide credit bureau with your explanation of the dispute. </li></ul>
  34. 34. Other Credit Terms <ul><li>Chargeback </li></ul><ul><ul><li>a disputed amount charged back to the merchant by the credit card company. </li></ul></ul><ul><li>Credit blocking </li></ul><ul><ul><li>a reduced credit limit based upon an expected purchase </li></ul></ul>
  35. 35. Debit Cards <ul><li>Bank deposit is immediately reduced </li></ul><ul><li>You do not have the protections afforded credit card purchases </li></ul>
  36. 36. Debit Cards <ul><li>Lost or stolen credit cards are covered by the Electronic Funds Transfer Act </li></ul><ul><ul><li>you can lose up to $500 if you fail to notify issuer within two days after learning of theft </li></ul></ul><ul><ul><li>if you wait 60 days your losses may be unlimited </li></ul></ul>
  37. 37. Cash Credit <ul><li>Credit extended in the form of cash. </li></ul><ul><li>Elements of a retail installment contract </li></ul><ul><ul><li>Promissory note </li></ul></ul><ul><ul><ul><li>A contract binding a borrower to future repayment of the amount borrowed. </li></ul></ul></ul><ul><ul><li>Security agreement </li></ul></ul><ul><ul><ul><li>Establishes the creditor’s security interest in the good for which the credit was extended </li></ul></ul></ul>
  38. 38. Methods for Charging Interest <ul><li>Simple Interest Method </li></ul><ul><ul><li>percentage rate applied to outstanding loan balance </li></ul></ul><ul><li>Discount Method </li></ul><ul><ul><li>interest deducted from credit extended you </li></ul></ul><ul><li>Add-on Method </li></ul><ul><ul><li>interest added to amount borrowed at beginning of loan </li></ul></ul>
  39. 39. Figure 6.6 A 12-month installment loan with annual simple interest of 12 percent
  40. 40. Discount Method Total payments on discount loan amount financed 1 - (discount rate x t ) = $1,000 1 - (0.12 x t ) $1,136.36 =
  41. 41. Add-on Method Total payments on add-on loan amount financed x [1 + (add-on rate x t ) ] = $1,000 x [1 + (0.12 x t ) ] $1,120 =
  42. 42. Figure 6.7 Comparative interest on credit of $1,000 to be repaid in 12 equal monthly installments Simple Discount Add-on 12% 12% 12% Interest Method Contract Rate APR 12.00% 24.28% 21.46% Monthly Payment $88.85 94.72 93.33 Total Interest Paid $ 66.19 136.36 120.00
  43. 43. Annual Percentage Rate (APR) <ul><li>Same as annual simple interest. </li></ul><ul><li>In the absence of other loan fees it is the rate charged on the outstanding loan balance. </li></ul><ul><li>The ratio of the finance charge to the average amount of credit over the term of the loan expressed as a percentage rate. </li></ul>
  44. 44. Rule of 78 <ul><li>Rule for determining how interest accrues on a loan. </li></ul><ul><li>Pushes interest earned by creditor to front of loan. </li></ul><ul><li>Pushes your repayment of principal to back of loan. </li></ul><ul><li>Early loan prepayment may be costly. </li></ul>
  45. 45. Consumer Loan Clauses <ul><li>Acceleration clause </li></ul><ul><ul><li>Late payment entitles the lender to demand that the entire unpaid balance be paid immediately. </li></ul></ul><ul><li>Add-on clause </li></ul><ul><ul><li>Lender can repossess all goods financed under the agreement in the event of a missed payment. </li></ul></ul>
  46. 46. Consumer Loan Clauses <ul><li>Balloon payment </li></ul><ul><ul><li>Lump-sum payment at end of loan. </li></ul></ul>
  47. 47. Sources of Credit <ul><li>Banking Institutions </li></ul><ul><ul><li>Overdraft protection credit line </li></ul></ul><ul><ul><li>Unsecured personal credit line </li></ul></ul><ul><ul><li>Home equity loan </li></ul></ul><ul><li>Consumer Finance Companies </li></ul>
  48. 48. Sources of Credit <ul><li>Other </li></ul><ul><ul><li>Life insurance policies </li></ul></ul><ul><ul><li>Margin accounts on stocks and bonds </li></ul></ul><ul><ul><li>Pawnbroker </li></ul></ul>
  49. 49. A Credit Management Strategy <ul><li>Use the grace period. </li></ul><ul><li>Avoid expensive credit on revolving charge accounts. </li></ul><ul><li>Take a broad view of credit sources. </li></ul><ul><li>Carefully consider the use of variable rate loans. </li></ul>
  50. 50. Bankruptcy <ul><li>Straight Bankruptcy </li></ul><ul><li>Wage Earner Plan </li></ul>
  51. 51. Straight Bankruptcy <ul><li>Primary form of bankruptcy. </li></ul><ul><li>Discharges all debts and provides a fresh start. </li></ul><ul><li>Homeowner’s equity and some personal assets may be partially protected. </li></ul><ul><li>Cannot file again for 6 years. </li></ul><ul><li>Record remains on credit report for 10 years. </li></ul>
  52. 52. Wage Earner Plan <ul><li>Repayment schedule established by court. </li></ul><ul><li>Debtor may retain property. </li></ul><ul><li>Lenders receive partial or total repayment over 3-5 year period. </li></ul><ul><li>Remains on credit report for 7 years. </li></ul>
  53. 53. Appendix Rule of 78
  54. 54. Calculating Loan Prepayment Under Rule of 78 <ul><li>Determine monthly interest factor for each month. </li></ul><ul><li>Multiply each month’s interest factor by total interest due on loan. </li></ul><ul><li>Result is amount earned by lender each month. </li></ul>
  55. 55. Calculating Loan Prepayment Under Rule of 78 <ul><li>Add interest earned by lender to original principal. </li></ul><ul><li>Subtract previous monthly payments to determine loan payoff. </li></ul>
  56. 56. Elements of Rule of 78 Sum of Digits (SD) = N N + 1 2 (  Monthly interest factor = Month in reverse order Sum of Digits
  57. 57. Figure 4.6 A 12 month installment loan with annual add-on interest of 12 percent, Total Interest = $120 1 2 3 $ 93.33 93.33 93.33 Month Payment Monthly Interest Factor 12/78 11/78 10/78 Monthly Interest Earned $18.46 16.92 15.38 Total Interest Earned $18.46 35.38 50.77 Interest Refund $101.54 84.62 69.23
  58. 58. Next Chapter 7 Consumer Durables
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