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  1. 1. Credit Management GENERAL ISSUES
  2. 2. Introduction <ul><li>Many of you have probably received credit card offers (either on campus or through the mail) if you are a college student </li></ul><ul><li>About 90% of college sophomores have credit cards </li></ul><ul><li>Proper use of a credit card can help establish a solid credit history </li></ul><ul><li>Improper use can take years to heal </li></ul>
  3. 3. What is Credit? <ul><li>Receiving money, goods, or services on the basis of an agreement that the borrower will repay the lender with a specified time period at a specified rate of interest </li></ul><ul><li>Today, total consumer credit is about $2 trillion (excludes home mortgages and home equity loans) </li></ul><ul><li>Americans carry over one billion credit cards </li></ul><ul><li>Over one million Americans file for personal bankruptcy each year (twice as many as ten years ago) </li></ul>
  4. 4. Types of Consumer Credit <ul><li>Revolving credit </li></ul><ul><ul><li>Consumer can make a number of different purchases, up to a certain credit limit </li></ul></ul><ul><ul><li>A minimum payment is due each month and interest is charged on the unpaid balance (average is 14%/year) </li></ul></ul><ul><li>Installment loans </li></ul><ul><ul><li>Consumer borrows a fixed amount and repays the principal plus interest at regular intervals (usually monthly) </li></ul></ul><ul><ul><ul><li>Lender usually holds title to asset until final payment is made </li></ul></ul></ul><ul><li>Mortgage loans and home equity loans </li></ul><ul><ul><li>Mortgage is an installment loan secured by real estate </li></ul></ul><ul><ul><ul><li>Typically have a term of 15 or 30 years </li></ul></ul></ul>
  5. 5. Deciding How Much to Borrow <ul><li>Failure to set debt limits is one reason why people get in trouble with credit cards </li></ul><ul><ul><li>Guideline: No more than 10 to 20% of your take-home pay should go toward repayment of installment or revolving credit (exclude mortgage payment) </li></ul></ul><ul><ul><ul><li>National average is about 14% </li></ul></ul></ul>
  6. 6. The Right Reasons for Borrowing <ul><li>Purchasing large, important goods and services </li></ul><ul><ul><li>House </li></ul></ul><ul><ul><li>Car </li></ul></ul><ul><ul><li>College education </li></ul></ul><ul><li>Dealing with emergencies </li></ul><ul><ul><li>Loss of job </li></ul></ul><ul><ul><li>Death of relative (plane tickets on short notice are expensive) </li></ul></ul>
  7. 7. The Right Reasons for Borrowing <ul><li>Taking advantage of opportunities </li></ul><ul><ul><li>Good sale on computer (you are saving for one anyway) </li></ul></ul><ul><li>Convenience </li></ul><ul><ul><li>Easy to pay with a credit card (pay off your balance every month) when doing day-to-day shopping </li></ul></ul><ul><li>Establishing or improving your credit rating </li></ul><ul><ul><li>Good way for a college student to establish a credit rating </li></ul></ul>
  8. 8. The Wrong Reasons for Borrowing <ul><li>Living beyond your means </li></ul><ul><ul><li>Do you have to use your credit card to pay your basic living expenses (because you can’t afford not to)? </li></ul></ul><ul><ul><ul><li>Buy groceries </li></ul></ul></ul><ul><ul><ul><li>Buy clothes </li></ul></ul></ul><ul><ul><ul><li>Buy gasoline </li></ul></ul></ul><ul><ul><ul><li>Pay your taxes </li></ul></ul></ul>
  9. 9. Sources of Consumer Credit <ul><li>Financial institutions </li></ul><ul><ul><li>Commercial banks, savings banks, credit unions </li></ul></ul><ul><li>National credit cards </li></ul><ul><ul><li>University alumni associations, sports franchises, etc., are issuing credit cards with their logo (can be used anywhere a regular bank-issued card is accepted) </li></ul></ul><ul><ul><ul><li>These organizations receive a fee from the issuing bank </li></ul></ul></ul><ul><ul><li>Retailer-specific credit cards (such as Sears and JCPenney) </li></ul></ul><ul><ul><ul><li>Can only be used at a specific store </li></ul></ul></ul>
  10. 10. Sources of Consumer Credit <ul><li>Consumer Finance Companies </li></ul><ul><ul><li>Company specializing in consumer loans </li></ul></ul><ul><ul><ul><li>Example: Household Finance </li></ul></ul></ul><ul><ul><ul><li>Make relatively short-term loans </li></ul></ul></ul><ul><ul><ul><li>Charge high interest rates </li></ul></ul></ul><ul><ul><ul><li>Generally unsecured </li></ul></ul></ul><ul><ul><ul><li>Application forms are easier to fill out than a bank’s </li></ul></ul></ul><ul><ul><ul><li>Takes a short period of time to receive approval </li></ul></ul></ul>
  11. 11. Sources of Consumer Credit <ul><li>Life insurance companies and investment companies </li></ul><ul><ul><li>Policyholders may be able to borrow against their life insurance policy (up to the amount they have paid in premiums) </li></ul></ul><ul><li>May be able to borrow money from your investment firm via your brokerage account </li></ul>
  12. 12. Sources of Consumer Credit <ul><li>Personal loan from family and friends </li></ul><ul><ul><li>Always treat these in a businesslike manner </li></ul></ul><ul><ul><ul><li>Lots of potential for interpersonal conflict </li></ul></ul></ul><ul><li>Pawnbrokers </li></ul><ul><ul><li>Issues loans for a very low percentage of an item’s face value </li></ul></ul><ul><ul><li>Item is held as security until the loan is repaid in full </li></ul></ul><ul><ul><li>Should be viewed as a lender of last resort </li></ul></ul>
  13. 13. Applying for Credit <ul><li>How creditors evaluate loan applications </li></ul><ul><ul><li>1. Capacity (Cash Flow) </li></ul></ul><ul><ul><ul><li>Can you afford to repay the debt? </li></ul></ul></ul><ul><ul><ul><li>Examines current income (and expected future earning potential) vs. current expenses </li></ul></ul></ul><ul><ul><ul><li>Are you a good credit risk? </li></ul></ul></ul><ul><ul><li>2. Character (Integrity </li></ul></ul><ul><ul><ul><li>Do you live within your means or above it? </li></ul></ul></ul><ul><ul><ul><li>Do you pay your bills on time? </li></ul></ul></ul><ul><ul><ul><li>Do you demonstrate stability? </li></ul></ul></ul><ul><ul><li>3. Collateral (assets) </li></ul></ul><ul><ul><ul><li>Property to secure a loan </li></ul></ul></ul>4. Capital 5. Conditions
  14. 14. The Role of Credit Bureaus <ul><li>Credit bureau – a clearinghouse for consumer credit information </li></ul><ul><ul><li>What’s in your credit file? </li></ul></ul><ul><ul><ul><li>Identifying information </li></ul></ul></ul><ul><ul><ul><li>Your credit history </li></ul></ul></ul><ul><ul><ul><ul><li>Including whether or not you pay your bills on time </li></ul></ul></ul></ul><ul><ul><ul><li>Information of public record </li></ul></ul></ul><ul><ul><ul><ul><li>Bankruptcies, lawsuits, criminal convictions </li></ul></ul></ul></ul><ul><ul><li>You may request a copy of your credit record at any time </li></ul></ul><ul><ul><ul><li>If you’ve recently been denied credit, the credit reporting service must provide you a copy free of charge </li></ul></ul></ul>
  15. 15. What to Do If You’re Denied Credit <ul><li>The lender must provide you with a written explanation </li></ul><ul><ul><li>Try negotiating with the lender </li></ul></ul><ul><ul><ul><li>Ask for a lower loan amount </li></ul></ul></ul><ul><ul><li>Try another lender </li></ul></ul><ul><ul><ul><li>Different lenders have different lending policies </li></ul></ul></ul><ul><ul><ul><ul><li>Some are more lenient than others </li></ul></ul></ul></ul>
  16. 16. Calculating Total Finance Charges <ul><li>Lenders are required to clearly state the finance charge and annual percentage rate (APR) </li></ul><ul><ul><li>Finance charge – total dollar amount charged for credit </li></ul></ul><ul><ul><ul><li>Function of </li></ul></ul></ul><ul><ul><ul><ul><li>Amount you borrow </li></ul></ul></ul></ul><ul><ul><ul><ul><li>APR </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Term of loan </li></ul></ul></ul></ul><ul><ul><li>Annual percentage rate – interest rate paid per dollar per year for credit </li></ul></ul><ul><ul><li>Principal – the amount borrowed </li></ul></ul>
  17. 17. Choosing the Lowest-Cost Credit Card <ul><li>Four main areas to consider </li></ul><ul><ul><li>Annual fee </li></ul></ul><ul><ul><ul><li>Ranges from $0 to $50 annually </li></ul></ul></ul><ul><ul><li>Late payment and other fees </li></ul></ul><ul><ul><li>Annual percentage rate </li></ul></ul><ul><ul><li>Grace period – how long you have to pay for new purchases without having to pay interest charges </li></ul></ul><ul><ul><ul><li>Ranges from 0 days to 30 days </li></ul></ul></ul><ul><ul><ul><ul><li>If you pay your bill in full every month, get a card with no annual fee and a grace period of at least 25 days </li></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>This way you won’t pay interest charges </li></ul></ul></ul></ul></ul>
  18. 18. Choosing the Lowest-Cost Credit Card <ul><li>Many credit card companies offer a low interest rate for a short time period (to lure you in—called a teaser rate), and then raise the interest rate substantially </li></ul><ul><li>Or the company may offer a great rate unless one payment is late and then the rate rises substantially </li></ul><ul><ul><li>Read the fine print </li></ul></ul>
  19. 19. Credit Abuse <ul><li>If you abuse your credit, it can have lasting repercussions </li></ul><ul><ul><li>Repossession – collection of collateral by the lender </li></ul></ul><ul><ul><ul><li>May not settle the debt if market value of asset doesn’t cover amount of loan still outstanding </li></ul></ul></ul><ul><ul><ul><ul><li>Remaining debt is called deficiency judgment </li></ul></ul></ul></ul><ul><ul><li>Wage garnishment – a portion of borrower’s wages is paid directly to lender by the employer </li></ul></ul><ul><ul><ul><li>Requires a court order </li></ul></ul></ul>
  20. 20. Credit Abuse <ul><li>Bankruptcy – borrower is relieved of debts, court divides assets/income among creditors </li></ul><ul><ul><li>Action of last resort </li></ul></ul><ul><ul><li>Virtually eliminates chances of securing future credit </li></ul></ul><ul><ul><li>Over one million Americans file for bankruptcy each year </li></ul></ul><ul><ul><ul><li>Most are voluntary filings </li></ul></ul></ul><ul><ul><ul><ul><li>Chapter 7: assets are seized by court and sold, funds are prorated among creditors (after court costs/legal fees)—70% of bankruptcies </li></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Creditors usually receive only small percentage of what’s owed </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><li>Chapter 13: individuals establish a three-year plan of debt repayment </li></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Debtor retains possession of property </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Creditors usually receive 60–70% of what’s owed </li></ul></ul></ul></ul></ul>
  21. 21. Credit Abuse <ul><li>Bankruptcy doesn’t eliminate all forms of debt </li></ul><ul><ul><li>Student loans </li></ul></ul><ul><ul><li>Back taxes </li></ul></ul><ul><ul><li>Child support </li></ul></ul><ul><ul><li>Alimony </li></ul></ul><ul><li>Bankruptcy shouldn’t be considered a ‘quick fix’ </li></ul><ul><ul><li>Remains on your credit record for ten years </li></ul></ul><ul><ul><li>Won’t get reasonable credit terms during that time </li></ul></ul><ul><ul><li>May be difficult to rent an apartment, obtain car insurance, etc. </li></ul></ul>
  22. 22. Credit Counseling and Credit Repair Services <ul><li>A credit counselor is a trained professional who helps you develop a budget and arrange a program of debt repayment </li></ul><ul><ul><li>Nonprofit Consumer Credit Counseling Service </li></ul></ul><ul><ul><ul><li>Funded by lenders and credit card companies (vested interest in repayment) </li></ul></ul></ul><ul><li>Credit repair doctors often claim they can ‘erase your bad credit’ </li></ul><ul><ul><li>Can’t deliver on their promises—don’t use them </li></ul></ul>