CHAPTER:7 CHOOSING A SOURCE OF CREDIT: THE COSTS OF CREDIT ALTERNATIVES

SOURCES OF CONSUMER CREDIT “CREDIT COSTS MONEY”

• Always weigh the benefits of buying an item on credit now versus waiting until you have saved enough money.

• Financial and other institutes provides all kinds of credits.

• Evaluate all the credit options available in the market so that you can reduce the charges.

Before deciding whether to borrow or not-Do I need a loan?Can I afford a loan?Can I qualify for a loan? Avoid credit in two situation-You not need or want a product that require

financing.You can afford to pay cash.

Kind of loan available- Inexpensive loans:

Parents and relatives are source of least expensive loans. They may only charge the interest they would have earned had they not made the loan- deposit account interest.

Money borrowed on financial assets held by

the lending institutions. Eg. Cash value of life insurance policy, FD OD.

Medium priced loans

All commercial banks and credit unions provide these loans on percentage varies from 8 to 12%. Eg. Home loans, auto loans.

Credit unions are good source for availing credits as its terms repayments are easy.

Expensive loans Convenient to obtain Available from finance companies, retailers and

banks. Interest rates are high. Consider APR(Annual Percentage Return)

Sources of consumer credit1) Commercial banks:Provides-Single Payment loansPersonal installment loansCredit card loansMortgage loansPolicies-Customers having good creditRequire collateral and securityPrefer to deal in large amt loans

Determine the repayment schedule As per loan vary credit ratesTake some days for processing application.

2) Consumer finance companiesProvides-Personal finance loansMortgage loansPolicies-Lend without credit historyVary interest as size of loans

Variety of payment schedulesProcess application quickly

3) Credit unionsProvides-Personal installment loansMortgage loansPolicies-Lend to members onlyMake secured and unsecured loansRequire collateral and cosignerLarge loans through Committee members

approvalVariety of payment schedules.

4) Life insurance companiesProvides-Single payment or partial paymentPolicies-Lend on cash value of policyDeduct the amount owed from the value of

benefits

COST OF CREDIT Whenever a person think of borrowing

consider whether he afford it and how much it will cost.

Two things- Finance charges Annual percentage rate If the borrower knows both things he can

compare the credit that includes interest costs, service charges.

TACKLING THE TRADE OFFS When you choose finance trade offs between

the features you prefer and cost of your plan. Terms versus interest rate People who want to have smaller monthly

payments choose longer term finances so greater amt of interest payment.

Lender risk versus interest rate If you want to minimize borrowing cost, you

need to accept conditions that reduce lender’s risk.

Variable Interest Rate: based on the fluctuating rate in the banking system.

Secured loan: pledge property or other asset as collateral

Up front cash: If you have stake in repaying a loan then lender gives easy terms for remaining amt.

Shorter term: shorter the period of time for which you borrow, the smaller the chance of default.

CALCULATING COST OF CREDITSimple interest- Interest computed on principal only, it is the

cost of borrowing money.

Simple interest on the declining balance- When more than one payment is made on

simple Interest loan.

Add on method- Interest calculated on full amount of the

original principal and added to principal amt and divide that with no of installments.

Cost of open end credit:

This includes the credit cards, departmental store cards, OD accounts. Till you don’t repay the previous balance you cant enjoy further credit.

Credit companies use adjusted balance method or average daily balance method for finance charge calculation.

Credit card companies also priorly inform what is the grace period available.

Cost of credit and expected inflation Each percentage increase in inflation means a

decrease of that percentage in the quantity of goods and services that a person purchase.

So lenders require protection against the inflation rates. So interest charges need consideration of inflation part.

Cost of credit and tax consideration Don't get deduction on consumer loans but on

home loans deductions are available.

Avoid the minimum monthly payment trap The monthly minimum payment is the

smallest amount you can pay still be a card holder in good standing. This is also called rollover facility but end of the year the interest charges are very high.

MANAGING YOUR DEBTS• A sudden illness or loss of your job may

make it impossible for you to pay your bills on time.

• If a person can’t make your payments on time then contact creditor and try out some settlement.

• Auto loan repayment if person fails, repossess and sell car, still owe the difference between the selling price unpaid debt plus other charges.

DEBT COLLECTION PRACTICES Banks have been advised by the Reserve Bank of

India to use the forum of Lok Adalat for the recovery of personal loans, credit card loans or housing loan. Some banks have hit headlines recently for harassing customers for nonpayment of loan installments. The draft guidelines issued by the RBI say that .Banks, as principals, are responsible for the actions of their agents. Hence, they should ensure that their agents engaged for recovery of their dues should strictly adhere to the guidelines and instructions, including the BCSBI (Banking Codes and Standards Board of India)Code.

Frequent reasons of indebtedness-Emotional problemsUse of money to punishExpectation of instant comfortOverspending for childrenLack of communicationFinance charges

Warning Signs of Debt Problems:

Paying only the minimum balance each month.Increasing the total balance due each month.Missing or alternating payments or paying late.Intentionally using overdraft protection or

taking frequent cash advances.Using savings to pay routine bills such as food.Getting second or third payment notices.Not talking to your partner about money or

talking only about money.Depending on overtime to meet routine

expenses.

Using up your savings.Borrowing money to pay old debts.Not knowing how much you owe.Going over your credit limit on credit cards.Having little or no savings for the unexpected.Being denied credit due to a credit report.Getting a credit card revoked by the issuer.Putting off medical or dental visits because you

can’t afford them now.

CONSUMER CREDIT COUNSELING SERVICECredit counseling in India is not such a big

business, though it is increasingly gaining a foot-hold in the common man’s consciousness.

Sudden loss of jobs, stop on increments, over-spending on credit cards multiple loans- a few or any of these combinations can bring you to a dead-end called the debt trap.

When you approach a consumer credit counselor, they will try and convince the lender to decrease the rate of interest on the loan taken. That doesn’t help you decrease the loan.

Based on a credit counseling agency’s relationship with a particular bank, the negotiation between the debtor and the creditors could be mediated to get reasonably favourable outcomes.

The credit counselor also ensures that you get ample time in hand to stabilise your finances and also to pay off your debt in small installments.

They can help create awareness about the costs of misusing credit. This helps improve the customer’s financial management and develop sound spending plans.

These agencies help the distressed people gain access to the structured financial system, including banking.

What do you need to check?How much does the credit counseling agency

charge for its servicesDoes the agency have due credentialsWhat are the services that the company can

offerHave you read the testimonials and reviews

of agencies previous or current clients as well as checked their official website

DECLARING PERSONAL BANKRUPTCYA debtor is required to draw up a petition

listing all assets and liabilities to district court.The Provincial Insolvency Act, 1920Subject to the provisions of this Act, the Court

shall have full power to decide all questions whether of title or priority, or of any nature whatsoever, and whether involving matters of law or of fact, Court may decide for the purpose of doing complete justice or making a complete distribution of property in any such case.

As per the provisions of this Act and any other law for the time being in force, every such decision shall be final and binding for all debtors as well as creditors.