© Goodheart-Willcox Co., Inc. Credit. © Goodheart-Willcox Co., Inc. Chapter Objectives Explain the advantages and disadvantages of using credit. Identify

© Goodheart-Willcox Co., Inc.

Credit


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.

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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.


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

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• 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

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• 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


Reasons to Use Credit

• Gives you the opportunity to buy costly items that you may not be able to buy with cash

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• 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

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• 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

• It’s a safe way to shop on the internet.


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


Cost of Credit

• Using credit is more costly than paying with cash

• 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

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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


Finance Charges

• Consist of fees:– The dollar amounts paid for having a

credit card

• Consist of interest:– Expressed as percentages– Charged to your credit card account

after a balance is left unpaid


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?


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%


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


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


Types of Credit• Closed-end credit

must be repaid by a certain date– Example: Loan

• Open-end credit allows the borrower to use money for an indefinite period– Example: Credit

Card


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

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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


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

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Open-End Credit

• You must make at least the minimum payment each month

• Total amount you may owe at any one time is limited


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


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


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

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The Credit Report

• The report lists– every credit

account ever opened

– outstanding balances

– negative data, such as late payments, unpaid debts, bankruptcy


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

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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


Getting a Credit Card

• Common types of credit cards include– general-purpose – company or

retail store – travel and

entertainment


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


The Contract

• Read the contract (application) thoroughly before signing it


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?

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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


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


Managing Your Credit

• Know your financial personality.

• What are your money attitudes and habits?

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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


Remember Alternatives to Using Credit

• Not to buy• Pay with savings• Postpone buying now and buy

later with cash


Check Monthly Statements

• Check statements against your own record of charges, payments, and credits


Check Your Credit Report Regularly

• Find and correct errors immediately

• Make sure no one has applied for credit in your name

• You should check your credit report at least once a year.


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


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

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• 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

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In Your Opinion

• Would you cosign a loan for your best friend or a family member if doing so would endanger your credit rating?



• Actions taken to recover debts: – Collection agencies are hired to get

payment– Repossession of property, including

foreclosure– Liens against property– Wage garnishment


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


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 easy-access credit


Inform Creditors

• They may change payment dates and amounts if you have trouble paying bills


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


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

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• 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

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• 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


Central Ideas of the Chapter

• Credit is a powerful financial management tool.

• Serious financial problems result from the misuse of credit.


Glossary of Key Terms

• 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.

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• 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.

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• 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 time-payment plan.

• creditor. The party that supplies money, goods, or services in a credit agreement.

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• 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.

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• 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.

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• 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.

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• 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.

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• 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.

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Documents

© Goodheart-Willcox Co., Inc. Credit. © Goodheart-Willcox Co., Inc. Chapter Objectives Explain the advantages and disadvantages of using credit. Identify