© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Personal Finance:An Integrated Planning Approach
Winger & Frasca
Chapter 6Short-term Credit Management
http://www.prenhall.com/winger/
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Major TopicsMajor Topics
Arranging and Using Credit Sales Credit Cash Credit Obtaining Credit and Resolving Credit
Problems
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Reasons for Using CreditReasons for Using Credit
As a Shopping Convenience To Increase Total Consumption As an Inflation Hedge As a Source of Emergency Funds
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Disadvantages of Using CreditDisadvantages of Using Credit
Temptation to overspend Credit costs Less flexibility with future budgets
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How to Get CreditHow to Get Credit
Consider what the lender looks for. Begin a credit record. Review your credit report. Repair a bad credit record.
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
What Lenders Look ForWhat Lenders Look For
The Three C’s of Credit Character
– Have you met your previous obligations? Capital
– Have you sufficient financial assets? Capacity
– Can you meet your future obligations?
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Begin a Credit RecordBegin a Credit Record
Open savings and checking accounts. Open a retail charge account. Qualify for a small installment loan. Make sure your credit records follow you. Have a telephone installed.
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Special Concerns for SpousesSpecial Concerns for SpousesEstablishing CreditEstablishing Credit
Make sure your credit history is in your name. Don’t use a social title
– ex., Mrs... Edward Hall Inform creditors that you wish to maintain
your own credit history. Know the difference between a joint and
individual credit account.
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Credit AccountsCredit Accounts
Joint Credit Account– Both spouses responsible for debt.– Divorced or separated spouses should cancel
joint accounts. Individual Credit Account
– Only you are responsible for debt.– Account will appear only on you credit report.
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
The Role of the Credit BureauThe Role of the Credit Bureau
Does not decide who receives credit. Stores information on past use of credit Stores information on legal actions against
you. Sells credit reports to lenders.
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Contents of a Credit ReportContents of a Credit Report
Existing credit accounts Information on each credit account includes
– credit limit, loan amount and account balance– who is responsible for paying the account
Public record information– bankruptcies, tax liens and monetary judgments
Who has obtained a copy
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Credit ReportCredit Report
View a Credit Report
You must have an Internet connection for the above link to work.
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
If You are Denied CreditIf You are Denied Credit
Obtain a copy of your report. Correct any mistakes. Submit your own statement on disputed
claims. Have adverse information that is old removed
from report. Have those who received report notified of
any incorrect entries.
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Sales CreditSales Credit
Kinds of Accounts Major Issuers of Credit Cards Selecting a Credit Card
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Sales Credit AccountsSales Credit Accounts
Regular charge account– billed for purchases at end of month
Open-end account– revolving credit account– agreement continues as long as account is open
Closed-end account– separate installment contract for each purchase
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Revolving Charge AccountRevolving Charge Account
Credit limit determined by credit record and net worth.
Partial payment must be made each month. Interest charged on unpaid balance. Account may never actually be paid off.
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Required Information on Required Information on Revolving Charge AccountRevolving Charge Account
Truth in Lending ActTruth in Lending Act Annual percentage rate (APR) applied to
balance. Method for calculating interest. Grace period, if any. Minimum monthly payment, and penalties
for late payment. Permission to investigate credit history.
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Interest Computation MethodsInterest Computation Methods
Previous balance method Adjusted balance method Average daily balance method
– including current purchases– excluding current purchases
Two-cycle average daily balance method
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Previous Balance MethodPrevious Balance Method
Rate applied to balance at end of previous month. Example
Previous balance = $215
Monthly interest rate = 1.65%
Interest charge:
1.65% x $215 = $3.55
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Equal to the previous balance less any payments or returns made during the current billing cycle
Example
Previous balance $215
Less current payment 20
Interest charge = $190 x 1.65% = $3.22
Adjusted Balance MethodAdjusted Balance Method
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Average Daily Balance MethodAverage Daily Balance Method(including current purchases)(including current purchases)
Period Daysa
Balanceb a x b
7/1-7/4 4 215.00 $ 860.007/5-7/9 5 253.15 1,265.757/10-7/11 2 233.15 payment 466.307/12/-7/19 8 265.65 2,125.207/20-7/31 12 283.29 3,399.48
31 Weighted sum = $8,116.73
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Average Daily Balance Method(including current purchases)
Average Daily Balance = Weighted sum Days
$8,116.73 = $261.83 31
Interest charged = $261.83 x 1.65% = $4.32
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Average Daily Balance Method(excluding current purchases)
Period Daysa
Balanceb a x b
7/1-7/9 10 215.00 $2,150.007/10-7/31 21 215 - 20 = 195 4,095.00
(payment)31 Weighted sum = $6,245.00
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Average Daily Balance Method(excluding current purchases)
Average Daily Balance = Weighted sum Days
$6,245 = $201.45 31
Interest charged = $201.45 x 1.65% = $3.32
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Interest Charges on BalancesInterest Charges on Balances
Text IllustrationText IllustrationPrevious Balance Method $3.55
Adjusted Balance Method $3.22
Average Daily Balance Method
– including current purchases $4.32
– excluding current purchases $3.32
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Two-cycle Two-cycle Average Daily Balance MethodAverage Daily Balance Method
Eliminates a grace period in the previous month when you fail to completely pay off the balance in the present month.
Can go back two periods to collect interest on unpaid balance.
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Major Issuers of Credit CardsMajor Issuers of Credit Cards
Bank Credit CardsDiscover MasterCard Visa
Travel & Entertainment Cards– American Express
Other Cards– Department store chains– Major gasoline retailers
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Credit Card Cost ComparisonCredit Card Cost Comparison
Annual membership fee
Variable rate information
Balance computation method
Late payment fee Return check charge Copy charge
Annual percentage rate
Grace period Cash advance fee Over-the-limit penalty Replacement fee Fees for optional
services
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Credit Card Benefit ComparisonCredit Card Benefit Comparison
Credit limit Disability insurance Accident insurance Rental car collision
insurance Warranty protection Merchandise loss
protection
Credit life Rebates & discounts Frequent flyer miles Credit card registry Purchase price
protection
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Payback PeriodPayback Period$3,000 Credit Balance @ 19% APR$3,000 Credit Balance @ 19% APR
Monthly Payment
Months Total Interest
$6075100125
100644231
$2,9911,7901,102804
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Protect Against Credit Card FraudProtect Against Credit Card Fraud
Record card numbers, expiration dates and phone number for card company.
Destroy old bills, receipts and credit cards. Check sales receipt and compare with credit
card statement. Be careful giving out your card number. Report lost and stolen cards immediately.
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Correcting Credit MistakesCorrecting Credit Mistakes
Notify the creditor in writing within 60 days after bill was mailed.
Pay parts of the bill that are not in dispute. Creditor will notify you within 30 days of its
decision.
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Correcting Credit MistakesCorrecting Credit Mistakes
If no error is found, you must pay or you will be reported as delinquent.
If you still challenge in writing the creditor must report that information.
Provide credit bureau with your explanation of the dispute.
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Other Credit TermsOther Credit Terms
Chargeback– a disputed amount charged back to the
merchant by the credit card company. Credit blocking
– a reduced credit limit based upon an expected purchase
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Debit CardsDebit Cards
Bank deposit is immediately reduced
You do not have the protections afforded credit card purchases
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Debit CardsDebit Cards
Lost or stolen credit cards are covered by the Electronic Funds Transfer Act– you can lose up to $500 if you fail to notify
issuer within two days after learning of theft– if you wait 60 days your losses may be
unlimited
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Cash CreditCash Credit
Credit extended in the form of cash. Elements of a retail installment contract
– Promissory note• A contract binding a borrower to future
repayment of the amount borrowed.
– Security agreement• Establishes the creditor’s security interest in the
good for which the credit was extended
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Simple Interest Method– percentage rate applied to outstanding loan
balance Discount Method
– interest deducted from credit extended you Add-on Method
– interest added to amount borrowed at beginning of loan
Methods for Charging InterestMethods for Charging Interest
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Figure 6.6 A 12-month installment loan with Figure 6.6 A 12-month installment loan with annual simple interest of 12 percentannual simple interest of 12 percent
Monthly OutstandingBalance
MonthlyPayment
FinanceCharge
LoanRepayment
1 $1,000.00 $88.85 $10.00 $78.85
2 921.15 88.85 9.21 79.85.... ... ... ... ...
11 175.07 88.85 1.75 87.10
12 87.97 88.85 0.88 87.97
Total $1,066.19 $66.19 $1,000
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Discount MethodDiscount Method
Total paymentson discount loan
amount financed
1 - (discount rate x t )
=
$1,000
1 - (0.12 x t )$1,136.36 =
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Add-on MethodAdd-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 =
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Figure 6.7 Comparative interest on credit of $1,000 Figure 6.7 Comparative interest on credit of $1,000 to be repaid in 12 equal monthly installmentsto be repaid in 12 equal monthly installments
Simple Discount Add-on
12%12%12%
InterestMethod
ContractRate
APR
12.00%24.28%21.46%
MonthlyPayment
$88.8594.7293.33
Total Interest
Paid
$ 66.19136.36120.00
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Annual Percentage Rate (APR)Annual Percentage Rate (APR)
Same as annual simple interest. In the absence of other loan fees it is the
rate charged on the outstanding loan balance.
The ratio of the finance charge to the average amount of credit over the term of the loan expressed as a percentage rate.
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Rule of 78Rule of 78
Rule for determining how interest accrues on a loan.
Pushes interest earned by creditor to front of loan.
Pushes your repayment of principal to back of loan.
Early loan prepayment may be costly.
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Consumer Loan ClausesConsumer Loan Clauses
Acceleration clause– Late payment entitles the lender to demand that
the entire unpaid balance be paid immediately. Add-on clause
– Lender can repossess all goods financed under the agreement in the event of a missed payment.
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Consumer Loan ClausesConsumer Loan Clauses
Balloon payment– Lump-sum payment at end of loan.
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Sources of CreditSources of Credit
Banking Institutions– Overdraft protection credit line– Unsecured personal credit line– Home equity loan
Consumer Finance Companies
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Sources of CreditSources of Credit
Other– Life insurance policies– Margin accounts on stocks and bonds– Pawnbroker
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
A Credit Management StrategyA Credit Management Strategy
Use the grace period. Avoid expensive credit on revolving charge
accounts. Take a broad view of credit sources. Carefully consider the use of variable rate
loans.
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
BankruptcyBankruptcy
Straight Bankruptcy Wage Earner Plan
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Straight BankruptcyStraight Bankruptcy
Primary form of bankruptcy. Discharges all debts and provides a fresh
start. Homeowner’s equity and some personal
assets may be partially protected. Cannot file again for 6 years. Record remains on credit report for 10 years.
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Wage Earner PlanWage Earner Plan
Repayment schedule established by court. Debtor may retain property. Lenders receive partial or total repayment
over 3-5 year period. Remains on credit report for 7 years.
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
AppendixAppendix
Rule of 78
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Calculating Loan Prepayment Under Calculating Loan Prepayment Under Rule of 78Rule of 78
Determine monthly interest factor for each month.
Multiply each month’s interest factor by total interest due on loan.
Result is amount earned by lender each month.
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Calculating Loan Prepayment Under Calculating Loan Prepayment Under Rule of 78Rule of 78
Add interest earned by lender to original principal.
Subtract previous monthly payments to determine loan payoff.
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Elements of Rule of 78Elements of Rule of 78
Sum of Digits (SD) = N
N + 1
2( Monthly interest factor = Month in reverse order
Sum of Digits
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Figure 4.6 A 12 month installment loan Figure 4.6 A 12 month installment loan with annual add-on interest of 12 percent,with annual add-on interest of 12 percent,
Total Interest = $120Total Interest = $120
123
$ 93.3393.3393.33
Month Payment MonthlyInterestFactor
12/7811/7810/78
MonthlyInterestEarned
$18.4616.9215.38
Total InterestEarned
$18.4635.3850.77
InterestRefund
$101.5484.6269.23
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
NextNextChapter 7Chapter 7
Consumer Durables Consumer Durables