GoodheartWillcox Co Inc 1 9 Credit GoodheartWillcox Co

© Goodheart-Willcox Co. , Inc. 1

9 Credit © Goodheart-Willcox Co. , Inc. 2

Chapter Objectives • Explain the advantages and disadvantages of using credit. • Identify the different types of consumer credit. • Describe how to establish a sound credit rating. • Define the key terms in credit contracts and agreements. © Goodheart-Willcox Co. , Inc. 3 continued

Chapter Objectives • Compare credit terms and charges. • Outline the steps involved in managing credit. • Identify steps to take in resolving credit problems. • Summarize the laws that govern the use of credit. © Goodheart-Willcox Co. , Inc. 4

Understanding Consumer Credit • Credit plays an important role in the economy • Provides extra buying power that supports mass production and distribution – Helps make more goods and services available to consumers at lower prices © Goodheart-Willcox Co. , Inc. 5 continued

Understanding Consumer Credit • Credit is a medium of exchange • It is an agreement between two parties – Creditor supplies money, goods, or services to the borrower – Borrower agrees to make future payment by a particular date or according to an agreed-upon schedule © Goodheart-Willcox Co. , Inc. 6 continued

Understanding Consumer Credit • There is a risk that the borrower cannot repay what is owed • Creditors minimize risk by – having borrowers sign a contract – taking a borrower who defaults to court and even taking back property © Goodheart-Willcox Co. , Inc. 7

Reasons to Use Credit • Gives you the opportunity to buy costly items that you may not be able to buy with cash © Goodheart-Willcox Co. , Inc. 8 continued

Reasons to Use Credit • You can use goods and services as you pay for them • Credit can be used as a source of cash for emergencies and unexpected expenses • You can take advantage of sale prices when you don’t have cash © Goodheart-Willcox Co. , Inc. 9 continued

Reasons to Use Credit • Convenience – eliminates the need to carry a lot of cash – provides a purchase record – simplifies shopping by phone, mail, and Internet • You can make purchases that are part of a long-range financial plan: education, furniture, vacation © Goodheart-Willcox Co. , Inc. 10

Drawbacks of Credit Use • Using credit reduces future income • Expense—using credit costs money (finance charges) • Temptation—using credit makes it easy to spend money you don’t have • Risk of serious consequences—financial problems arise when debts aren’t paid on time and in full © Goodheart-Willcox Co. , Inc. 11

Cost of Credit • Using credit is more costly than paying with cash © Goodheart-Willcox Co. , Inc. 12 continued

Cost of Credit • Borrowers must pay principal plus finance charges • Finance charges reimburse creditors for – the costs of making credit available – taking the risk that borrowers may default © Goodheart-Willcox Co. , Inc. 13 continued

Cost of Credit • Creditors – may borrow money to make credit available; when they borrow, they must also pay interest – lose the chance to invest money – incur costs for opening and servicing credit accounts – absorb losses of unpaid accounts and cost of collecting overdue debts © Goodheart-Willcox Co. , Inc. 14

Finance Charges • Are the dollar amounts paid for credit • Consist of two parts: interest and fees • Are expressed as percentages © Goodheart-Willcox Co. , Inc. 15

In Your Opinion • Have you ever lent money to a friend? Based on your experience, do you think creditors deserve to be paid a finance charge? © Goodheart-Willcox Co. , Inc. 16

Annual Percentage Rate (APR) • The higher the APR, the more you pay • Example: Interest for a $500 loan repaid in 12 monthly payments would cost – $50. 08 at 18% – $58. 72 at 21% – $67. 36 at 24% © Goodheart-Willcox Co. , Inc. 17

Amount of Credit Used • The more credit you use, the more you pay • Example: Interest on a loan repaid in 12 monthly payments at an APR of 18% would cost – $50. 08 for a $500 loan – $110. 01 for a $1, 000 loan – $220. 02 for a $2, 000 loan © Goodheart-Willcox Co. , Inc. 18

Length of Repayment Period • The longer you take to repay what you borrowed, the more you pay • Example: Interest on a $500 loan at 1. 5% per month (18% APR) would cost – $50. 08 if repaid in 12 monthly payments – $99. 44 if repaid in 24 monthly payments – $150. 88 if repaid in 36 monthly payments © Goodheart-Willcox Co. , Inc. 19

Types of Credit • Closed-end credit must be repaid by a certain date • Open-end credit allows the borrower to use money for an indefinite period © Goodheart-Willcox Co. , Inc. 20

Closed-End Credit • Most are installment loans that let you borrow a given amount of money and repay it with interest in regular installments • Examples: student loans, car loans, most home loans © Goodheart-Willcox Co. , Inc. 21 continued

Closed-End Credit • A secured loan requires collateral— finance charges may be lower because creditor can take property if loan is not repaid • An unsecured loan—finance charges are usually higher because no collateral; borrower must have strong credit rating or a cosigner © Goodheart-Willcox Co. , Inc. 22

Open-End Credit • Borrower can continue to use credit if he or she makes scheduled payments, pays finance charges, and stays within borrowing limit – Regular charge accounts – Revolving credit accounts • Offered by retailers, merchants, banks, credit agencies © Goodheart-Willcox Co. , Inc. 23 continued

Open-End Credit • You must make at least the minimum payment each month • Total amount you may owe at any one time is limited © Goodheart-Willcox Co. , Inc. 24

Establishing Credit • • Start with a job Open a savings account Open a checking account Apply for a credit card at a local department store or gas company © Goodheart-Willcox Co. , Inc. 25

Your Credit Rating • Determines whether you can get credit and what you will pay for it • Is measured by the three Cs—character, capacity, and capital • A creditworthy applicant is judged to have the assets, income, and tendency to repay debt © Goodheart-Willcox Co. , Inc. 26

The Credit Report • Three major national agencies sell credit reports to creditors • Each agency collects information about financial and credit transactions • The information on these reports often differs • Carefully review your credit reports and report errors to agencies © Goodheart-Willcox Co. , Inc. 27 continued

The Credit Report • The report lists – every credit account ever opened – outstanding balances – negative data, such as late payments, unpaid debts, bankruptcy © Goodheart-Willcox Co. , Inc. 28

Credit Scores • A credit score is a numerical measure of a loan applicant’s creditworthiness • The higher the score, the greater a person’s creditworthiness • The lower the score, – the more trouble you will have getting credit – the more expensive credit will be © Goodheart-Willcox Co. , Inc. 29 continued

Credit Scores • Credit score factors: – Bill paying – Debt-to-credit-limit-ratio – Credit history length – Recent credit application – Different types of credit • You may have more than one credit score generated by different agencies © Goodheart-Willcox Co. , Inc. 30

Getting a Credit Card • Common types of credit cards include – general-purpose – company or retail store – travel and entertainment © Goodheart-Willcox Co. , Inc. 31

Shopping for a Credit Card • Understand possible fees, penalties, and consequences of failing to carry out the terms of the agreement • Be wary of acceleration clauses, balloon payments, and add-on clauses © Goodheart-Willcox Co. , Inc. 32

The Contract • Read the contract (application) thoroughly before signing it © Goodheart-Willcox Co. , Inc. 33

Disclosures • Annual percentage rates: – What is the APR? – How long will a lower introductory rate last? What is the regular rate? – Can the rate be raised for any reason? – Is the rate fixed or variable? © Goodheart-Willcox Co. , Inc. 34 continued

Disclosures • What is the grace period? • What method is used to calculate the interest rate? • Is there an annual fee? If so, how much? • What are fees for – late payments – exceeding credit limit – cash advances – balance transfers © Goodheart-Willcox Co. , Inc. 35

Subprime Credit Cards • Easier to get; offered to those with poor credit histories • Often carry high interest rates, large annual fees, and other charges • Low credit limits • Often a bad deal for consumers © Goodheart-Willcox Co. , Inc. 36

Managing Your Credit • Know your financial personality. • What are your money attitudes and habits? © Goodheart-Willcox Co. , Inc. 37 continued

Managing Your Credit • Keep track of spending – Create a budget – Don’t use more credit than you can pay off each month – Save your receipts and keep a log of credit charges © Goodheart-Willcox Co. , Inc. 38

Remember Alternatives to Using Credit • Not to buy • Pay with savings • Postpone buying now and buy later with cash © Goodheart-Willcox Co. , Inc. 39

Check Monthly Statements • Check statements against your own record of charges, payments, and credits © Goodheart-Willcox Co. , Inc. 40

Check Your Credit Report Regularly • Find and correct errors immediately • Make sure no one has applied for credit in your name © Goodheart-Willcox Co. , Inc. 41

Report Lost or Stolen Cards • Keep a list of your credit cards—issuers, account numbers, issuer phone numbers • Report lost or stolen cards right away • If your card is lost or stolen, you are responsible for – $50 per card that is charged by others – no charges made by others if you notify the issuer before the card is used © Goodheart-Willcox Co. , Inc. 42

Handling Credit Problems • Poor credit use consequences: – Inability to get loans and credit cards – Paying higher interest rates for credit – Having fewer housing choices – Having fewer job prospects because many employers check credit reports – Paying higher insurance premiums © Goodheart-Willcox Co. , Inc. 43 continued

Handling Credit Problems • Blemishes on credit reports: – Accurate negative information, such as missed or late payments, may remain on your report for seven years – Bankruptcies may remain on your report for 10 years © Goodheart-Willcox Co. , Inc. 44 continued

In Your Opinion • Would you cosign a loan for your best friend or a family member if doing so would endanger your credit rating? © Goodheart-Willcox Co. , Inc. 45

Handling Credit Problems • Actions taken to recover debts: – Collection agencies are hired to get payment – Repossession of property, including foreclosure – Liens against property – Wage garnishment © Goodheart-Willcox Co. , Inc. 46

Bankruptcy • Desperate debtors last resort—file for personal bankruptcy – Court excuses debtor from repaying some or all debt – Debtor gives up certain assets and possessions • Two types—Chapter 7 and Chapter 13 • Consequences of bankruptcy are severe © Goodheart-Willcox Co. , Inc. 47

The Easy-Access Credit Trap • Easy-access credit includes – payday loans – pawnshops – rent-to-own – title loans • A loan shark is someone who uses predatory lending tactics and easyaccess credit © Goodheart-Willcox Co. , Inc. 48

Inform Creditors • They may change payment dates and amounts if you have trouble paying bills © Goodheart-Willcox Co. , Inc. 49

Get Credit Counseling • Use reputable nonprofit credit counseling services • Avoid credit counseling firms that – charge high fees – demand that the debtor pay them rather than their creditors © Goodheart-Willcox Co. , Inc. 50

Consumer Credit Legislation • Truth in Lending Law requires creditors to tell consumers what credit will cost • Equal Credit Opportunity Act prohibits creditors from discriminating against consumers • Fair Credit Reporting Act requires accuracy and privacy of credit report information © Goodheart-Willcox Co. , Inc. 51 continued

Consumer Credit Legislation • Fair Credit Billing Act protects consumers from unfair billing practices • Electronic Funds Transfer Act protects consumers in EFT transactions • Fair Debt Collection Practices Act protects consumers against unfair methods of collecting debts © Goodheart-Willcox Co. , Inc. 52 continued

Consumer Credit Legislation • Preservation of Consumers’ Claims and Defenses Ruling protects debtors who have a legitimate dispute with a seller • Bankruptcy Abuse Prevention and Consumer Protection Act – was meant to increase fairness of the bankruptcy system – makes filing for bankruptcy more difficult © Goodheart-Willcox Co. , Inc. 53

Central Ideas of the Chapter • Credit is a powerful financial management tool. • Serious financial problems result from the misuse of credit. © Goodheart-Willcox Co. , Inc. 54

Glossary of Key Terms Back • annual percentage rate (APR). The annual cost of credit a lender charges. • bankruptcy. A legal state in which the courts excuse a debtor from repaying some or all debt. In return, the debtor must give up certain assets and possessions. • closed-end credit. A loan that must be repaid with finance charges by a certain date. © Goodheart-Willcox Co. , Inc. 55

Glossary of Key Terms Back • collateral. Property that a borrower promises to give up in case of default. • contract. A legally binding agreement between a borrower and a creditor. • cosigner. A responsible person who signs a loan along with a borrower thereby agreeing to pay the obligation if the borrower fails to do so. © Goodheart-Willcox Co. , Inc. 56

Glossary of Key Terms Back • credit. An arrangement that allows consumers to buy goods or services and pay for them later. • credit card. Allows consumers to make purchases or borrow money on a timepayment plan. • creditor. The party that supplies money, goods, or services in a credit agreement. © Goodheart-Willcox Co. , Inc. 57

Glossary of Key Terms Back • credit report. A record of a person’s credit history and financial behavior. • creditworthy. A credit applicant judged to have the assets, income, and tendency to repay debt. • default. When a borrower fails to pay the debt owed. © Goodheart-Willcox Co. , Inc. 58

Glossary of Key Terms Back • easy-access credit. A short-term, high-interest loan granted to borrowers regardless of credit history. • foreclosure. The forced sale of a property. • garnishment. A legal procedure requiring a portion of a debtor’s pay to be set aside by the person’s employer to pay creditors. © Goodheart-Willcox Co. , Inc. 59

Glossary of Key Terms Back • grace period. The time between the billing date and the start of interest charges. • lien. A legal claim on a borrower’s property by a creditor who is owed money. • loan shark. Someone who loans money at excessive rates of interest. • open-end credit. Allows the borrower to use a certain amount of money for an indefinite period of time. © Goodheart-Willcox Co. , Inc. 60

Glossary of Key Terms Back • pawnshop. A business that gives customers high-interest loans with personal property, such as jewelry, held as collateral. • payday loan. A short-term, high interest loan that must usually be repaid on the borrower’s next payday. • principal. The amount borrowed on a loan. © Goodheart-Willcox Co. , Inc. 61

Glossary of Key Terms Back • rent-to-own. A credit arrangement in which a consumer pays rent for the use of a product and eventually owns it. • repossession. A lender takes back collateral when a borrower fails to repay a loan. • secured loan. A loan that requires collateral. • title loan. A loan made using the borrower’s car as collateral. © Goodheart-Willcox Co. , Inc. 62