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Chapter 11

Consumer Credit

Chapter 11.1Understanding Credit

ObjectivesExplain basic principles of credit; Describe types of credit; and Analyze the benefits, costs, and

drawbacks of using credit.

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The Meaning of Credit

 Credit – is the supplying of money, goods, or

services at present in exchange for the promise of future payment

 Creditor – business or organization that extends the credit Principal – the original amount borrowed 

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 Credit Benefits All:

•Buyer – buys the item•Seller – sells the item•Bank – makes a profit from interest

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Types of Credit

•Cash Credit – take out a loan and receive cash

•Sales Credit – buy now pay later

•Secured Credit – backed by a pledge of property, something of value as

assurance that the loan will be repaidSecurity Interest – when the lender can take property if the loan is not repaidCollateral – the property that is pledged to guarantee repayment

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Types of Credit Continued

•Closed-ended Credit – a one-time extension of credit for a specific amount and time period

•Open-end Credit (Line of Credit) – can be used repeatedly

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Types of Credit Continued

•Single- Payment – the entire amount due in a single payment

•Installments – a set portion of the loan amount that the borrower must pay

at regularly scheduled intervalsPayment Schedule – specifies the dates on which installment payments are due and the amount of each installment

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Pros and Cons of Credit 

Pros of Using Credit

•Temporary Expansion of Income – allows you to use goods and services before you’ve paid for them.•Convenience – making large purchases without carrying cash, also refunds on returned items are usually easier•Financial Responsibility – creating good credit provides proof to others of your financial responsibility

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Pros and Cons of Credit Continued

Costs of Using Credit

•Finance Charges – total cost of using credit (interest and fees)•Increased Cost of Merchandise – because retailers must pay banks to collect on their credit sales therefore, must offset that cost.•Opportunity Cost – are needs and wants that they must give up because of the expense of paying back borrowed money + interests + fees.

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Pros and Cons of Credit Continued

Cons of Using Credit

•Security Concerns – taking precautions against stolen cards

•Impulse Buying – more likely to buy items on the spur of the moment without careful consideration•Overspending – spending more than you can afford•Reclaimed Merchandise – the merchant

could take items that you fail to pay for back

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Deciding When to Use Credit

Alternatives to Using Credit

•Paying by cash or check•Use a prepaid card or debit

Chapter 11.2Qualifying for Credit

ObjectivesAnalyze factors that affect the

ability to get credit;Explain the significance of credit

reports; and Describe how to establish and

maintain a good credit history.

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What Lenders to Consider

 The Three C’s of Credit

•Character – a person’s reputations•Capacity – a person’s earning power and ability to pay debts from regular income•Capital – items owned, or assets

 

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 Credit History

– pattern of past behavior in regard to repaying debt.

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The Credit Application

•Employment •Residence •Home Ownership – Rent / own a home. Home owner may be more permanent•Monthly Housing Cost – if there enough

money left to pay bills•Credit References – checking if you have a good credit history with other businesses•Collateral – property that you could use to secure the loan•Bank References – checking how much you have in accounts

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Equal Credit Opportunity Act

– a federal law ensuring that all consumers are given an equal chance to obtain credit.

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Credit Reporting and Rating

Credit Bureau (Credit Reporting Agency) – a firm that collects information about the

creditworthiness of consumers Credit Report – a record of particular consumer’s transactions and payment patterns Credit Rating – an evaluation of a consumers

credit history

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Credit Reporting and Rating Continued

Credit Score – a numerical rating, based on credit report information that represents a person’s level of creditworthiness

Fair Credit Reporting Act – assures a consumer’s right to access his or her credit file and dispute incorrect information

•You should check your credit report once a year

•Information from your credit file may be given only to those who have a

legitimate need for it

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Establishing and Maintaining Credit

Step 1 Opening a checking and savings account

Step 2 Put a utility bill in your name and pay it regularly

Step 3 Apply for a credit card from a local store and pay bills on time

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Establishing and Maintaining Credit

Cosigner – a person with a strong established credit history who signs the credit

application and contract along with the borrower Secured Credit Card – one that requires you to keep a savings account as security

A disadvantage is that your money is tied up and can’t be used for other purposes

Chapter 11.3Managing Credit Cards

ObjectivesIdentify sources and types of credit

cards;Evaluate credit card terms and

conditions;Give guidelines for using credit cards

wisely; andExplain how to resolve credit card billing

problems.

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Types of Credit Cards

•Private Label Cards – can be used only at a single retailer

•General Purpose Cards (bank card or major credit card) – can be used at millions of different business across the country and around the world

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Types of Credit Cards Continued

•Revolving Credit Cards – has payment options: pay in full, only a minimum payment, any amount in between

•Charge Card – charge must be paid in full each month

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Credit Card Variations

•Prestige / Status Cards – generally have higher annual fee, highly promoted to consumers with established credit

•Co-branded Cards – carry the name of not only a card network and possibly a bank but also another company

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Credit Card Variations Continued

•Affinity Cards – carries the name of a non-profit or charitable organization

•Smart Card – has a computer chip used for online shopping

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Comparing Credit Cards Terms

•Annual Fee

•Annual Percentage Rate (APR) – is the annual rate of interest that is charged for using credit

•Whether the APR may change •Variable Rate – means the APR can go up or down depending on economic factors•Teaser Rate – a low introductory rate that is in effect for only a limited time.

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Comparing Credit Cards Terms Continued

•Computation Method – agreement specifies how finance charges are computed

•Minimum Payment

•Grace Period – period of time during which the balance may be paid in full to avoid finance charges

•Minimum Finance Charge

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Comparing Credit Cards Terms Continued

•Other Fees – Late payments, cash advances, credit limit, & returned checks

•Credit Limit – is the maximum amount of credit that the creditor will extend to the

borrower

•Special Features and Services – discounts, frequent flyer miles, insurance, etc…

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Finance Charge Computation Methods (pg. 274)

•Previous Balance•Adjusted Balance•Average Daily Balance (excluding new purchases)•Average Daily Balance (including new purchases)•Two-Cycle Average Daily Balance

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Truth in Lending Act – requires creditors to adequately inform consumers about

credit terms and costs. •Lenders must disclose specific information

such as APR, variable rates, & fees. •They should be clear and easy to read.

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Using Credit Cards Wisely

•Remember that your credit limit is a maximum, not a goal.•Save credit card receipts.•Set your own limit for how much you want to

charge each month.•Try to pay the full balance each month to avoid finance charges.•If you can’t pay full amount the pay your largest amount that you can.•Pay bills on time.

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Safeguarding Your Card 

Credit Card Fraud – Unauthorized use of credit cards or account numbers.•Put in safe place•Keep it in your sight•Don’t leave without it•Keep records private Consumer Credit Protection Act – says the

maximum amount for which you may be held liable if someone uses the card illegally is $50

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Reviewing the Monthly Statements

•Monthly•Online access•Check the list of transactions •Verify personal information•Pay attention to fees

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Resolving Billing Problems 

Fair Credit Billing Act – outlines procedures for settling credit card billing disputes.

•Must write a letter, sent within 60 days•Name, account number, description, copies•Use certified mail and get receipt•They should respond in 30 days and resolve it in 90 days•They will investigate•Can withhold payment for disputed amount but are required to pay all other expenses.•If error is confirmed, creditor pays full disputed amount plus all additional fees

Chapter 11.4Taking Out a Loan

ObjectivesDiscuss sources and types of

loans;Explain provisions that may be

found in loan contracts; andDescribe the loan process from

application to payment.

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Sources & Types of Loans

•Loans from Financial Institutions Offer a variety of loans; interest rate & other terms depend on type of loan

oHome Loans – Closed-end installment loans; home serves as security for loan; term is usually 15, 20, 30 years

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Loans from Financial Institutions Continued

oHome Equity Loan – closed or open-end loans, used for a variety of purposes; available whenever homeowner needs/wants to use it after building equity

oHome Improvement Loan – repair or improve home; increase it’s value; closed-end loan; secured by home; five-year term usually

oVehicle Loan – purchase a new or used vehicle; closed-end; three to five

years

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Loans from Financial Institutions Continued

oPersonal line of Credit – open-end unsecured loan; consumer can draw upon it when needed up to a preset limit

oEducation or Student Loans – pay for higher education, low interest rates, flexible repayment schedule

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Loans from Consumer Finance Companies

-businesses that specialize in making small or personal loans

Give credit to those who can not get credit elsewhere

•negative credit history•low income•minimal assets

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Loans from Consumer Finance Companies Continued

Higher interest rate

They borrow the money and pay interest

Costs include: credit investigation, record keeping, small loans so they can not

absorb costs like banks

Greater credit risk – higher collection costs & bad debts

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“Payday” Loans

-cash advance loans

•Write a personal check for amount you want to borrow•Gives the borrower the amount minus fees

until borrower’s next pay day•Fees = a percentage or fee for every $50 or $100 loaned•APR extremely high•Creates a cycle of debt difficult to break

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Insurance Policy Loans

•Borrow against the amount paid in premiums

•No credit investigation

•Policy is the security

•Interest rate lower than bank rates

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Insurance Policy Loans Continued

•Drawbacks

Pays a benefit to survivors in event of a death, if an outstanding loan exists, then company will deduct any amount still owed

before paying benefit

Pay back loan, you might only be charged for interest

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Private Loans

– borrow from family or friend

•Guidelines to help pay backKeep loan smallInterest rate?Payment planSpecific about terms-get in writingPay promptlyGet a signed receipt

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Loans from Other sources

•Credit card

•Pawnbroker – trade a valuable item for cash; holds item for 30 days; then you buy back your item at higher price then amount

borrowed

•Loan sharks – avoid dealing with unlicensed lenders who operate illegally and charge excessive interest

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Loan Contract Provisions

– shop around; look at APR, payment due dates, charged for penalty if you pay back the loan ahead of schedule; down payment

•Balloon Payment Clause – final payment that is much larger than the other installments•Acceleration Clause – gives the seller the right to declare the whole balance due if the

buyer misses even one installment payment•Add-On Clause – allows additional purchases to be added to an installment contract

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Getting the Loan

•Apply by phone, online, or in person•Provide info about income, employment history, residence, and credit history•Run a credit check•Sign the loan contract•Credit life insurance – optional

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Getting the Loan Continued

•Right of rescission – right to cancel the loan within 3 business days if you are using your home as security; must give notice in writing•Loan contract outlines payment schedule-pay

installments, online, automatic deductions from bank account; use payment booklet

Chapter 11.5Handling Debt Problems

ObjectivesAnalyze the consequences of

excess debt;Identify warning signs of excess

debt; and Describe assistance and remedies

for debt problems.

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 Dangers of Excess Debt

1. Inability to keep up with normal expenses from one paycheck to the next.

2. Getting caught in a cycle of taking on new debt to pay off old debt.

3. Stress over constant financial worries.4. Serious damage to one’s credit history.5. Inability to save or invest sufficiently to

reach financial goals.

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Debt Collection Methods

Delinquent – payments are overdue. 

Defaults – failure to fulfill the obligations of the loan, and a warning that the creditor is taking more aggressive actions toward collecting the debt.

Repossession – taking away property due to failure to make loan or credit payments (car)

Shut-offs – discontinue providing the service (electricity)

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Debt Collection Methods Continued

Collection Agencies – a business that collects unpaid debt for others. • This will result in seriously lowering your

credit rating.• Agencies get a high incentive for being

relentless and aggressive in their collection tactics.

• Fair Debt collection Practices Act – protects consumers against

abusive practices of debt collectors.

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Debt Collection Methods Continued

Judgments – a court ruling that says the debt must be paid

Liens – a claim upon property to satisfy a debt. Put on public record Appear on the debtor’s credit history Lower credit rating

Garnishment – the legal withholding of a specified sum from a person’s wages in order to collect a debt

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Avoiding Excess Debt

Set reasonable limits on debt

Stay within those limits

Set aside money for emergencies

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Warning Signs

• Reaching a credit limit on most credit cards• Skipping payments on some bills in order to

pay others• Using cash advances on one credit card to

pay off another• Using credit cards for day-to-day purchases

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Climbing Out of Debt

• Workings with Creditors – letting them know that you’re struggling and arranging mutual solutions

• Self-help Measures – making paying off debt your top priority

• Credit Counseling – guidance provided by trained people who help consumers

learn to live within their means• Debt Consolidation Loans – combines all

existing debt into a new loan to pay off all previous creditors

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Bankruptcy: A Last Resort

Bankruptcy – legal relief from repaying certain debt, most negative information possible on a credit report, and last 7-10 years.

 Types:

• Chapter 7 – sale of all the debtor’s property except that related to continuing employment.

• Chapter 13 – debtor proposes a plan which must be approved and supervised by the court

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Rebuilding Credit

Takes time Starting new credit habits Avoid high balances on credit