Using Credit

SSEPF4.a, SSEPF4.b, SSEPF4.c

Loans and Credit Cards: Buy Now, Pay Later The U.S. economy runs on credit.

Credit – The ability to obtain goods now, based on an agreement to pay for them later.

Loans and Credit Cards: Buy Now, Pay Later Credit includes Bank loans to pay for major

expenses such as Cars Houses higher education

As well as credit card debt incurred for smaller expenses such as Food Clothing gasoline

Loans and Credit Cards: Buy Now, Pay Later Using credit is convenient It allows us to enjoy goods before we actually

pay for them Increases the total cost of the things we buy. Can lead to spiraling debt that can destroy

financial health now and in the future.

Loans and Credit Cards: Buy Now, Pay Later An important part of being a successful adult

in the U.S. is learning how to build a good credit history How to obtain credit at the lowest possible cost, or

interest rate. How to use credit wisely.

Becoming Creditworthy

Are you able to pay the money back? Are you likely to pay the money back?

Creditworthy In order to determine whether individuals are

creditworthy, banks ask: Where your work How much you earn How much money you have saved What are your current expenses How many people depend on you for their basic

needs How much you already owe in debts What property you own that can be used as

collateral

Collateral

Something the bank could take away from you if you do not repay the loan.

Credit history – How well you have managed your bills and credit in the past.

To obtain your credit history, they rely on powerful companies called credit bureaus.

Credit Bureaus – Collect financial information on every bill-paying adult in the nation.

Credit History

It shows how reliable you are It shows every bill you have paid and whether

you paid it on time It shows whether you have received loans

before and how responsible you were at paying them back.

Credit History

Based on the information collected by credit bureaus, the credit bureau gives you a credit score.

The higher your credit score the more likely you are to receive a loan.

Credit History

Follows you for your whole life. It affects whether you get a loan and how

much interest you pay for the loan. Can even determine how high your car

insurance premiums are Whether you are able to get certain job.

Building Good Credit

You need to establish a steady work history, rather than leaving a series of jobs after working only a few months.

You need to pay all your bills on time To establish Credit:

Open a checking account (and don’t “bounce” any checks!) Open a savings account Can buy something from a local department store on an

installment plan – you agree to pay a fixed amount per month for a specified number of months (making all payments on time – to show creditworthiness)

Making Wise Credit Decisions To decide whether you can afford a loan or

other form of credit Add up your monthly income Minus deductions for taxes, Social Security, and

health insurance Then determine your fixed expenses (the amount

you must pay every month for rent, utilities, transportation, etc.

And determine your variable expenses (the amount you usually spend on food, entertainment, new clothes, etc.

Deduct these expenses from your income. Do you have enough money left over to make

a new loan payment or to pay for credit purchases?

If not, you may be able to deduce your variable expenses, but probably not my much.

If you can’t increase your current income or reduce your current expenses, then you can’t afford the loan.

Interest Rates: the Cost of Borrowing Money Interest – the cost of using credit often

expressed as an interest rate. Interest rate – a percentage of the total

amount owed.

Interest Rates: the Cost of Borrowing Money To compare the cost of different credit

options, you need to know the following: Is the interest rate quoted an annual rate, in other

words, the amount of interest charged per year, rather than per month?

Is the interest rate fixed or variable? Fixed rate – never changes throughout the length of the

loan. Variable interest rate – Interest rate can go up at any

time. Is the interest calculated as simple interest or compound

interest?

Interest Rates: the Cost of Borrowing Money When obtain loan from bank, bank will

usually charge you a fixed annual rate of simple interest.

Simple interest – you are charged interest ONLY on the original amount of the loan

Interest Rates: the Cost of Borrowing Money For example, if you receive a one-year bank

loan for $1,000 at 10%, you will end up repaying the bank the following:

$1,000 + (.10 X 1,000) = $1,000 + $100 = $1,100 If you take two years to repay the loan, you would pay the

following:

$1,000 + (.10 X $1,000) + (.10 X $1,000) = $1,000 + $200 = $1,200

Credit Card Interest

Much trickier Credit cared interest rates usually higher The rates are variable Even if you received a low introductory rate,

can go up at any time. Annual Fee – a yearly charge just for having

the card, whether you use it or not.

Credit Card Interest

Biggest problem with credit cards: They charge Compound Interest if you do not pay

off the full amount every month.

Credit Card Interest

When you pay compound interest, the interest is charged not only on the original amount you borrowed, but on the existing amount your owe.

You are ultimately paying interest that was previously added to your bill.

Credit Card Interest

If 10% interest on a $1,000 loan is compounded annually, you would owe the following amount after two years:

1st Year: $1,000 + (.10 X 1,000) = $1,000 + $100 = $1,100

2nd Year: $1,100 + (.10 X 1,100) = $1,100 + 110 + $1,210

However, credit card interest is usually compounded monthly.

Credit Card Interest

Finance Charge – A fraction of the annual interest rate, on your monthly balance, the amount of your debt remaining unpaid each month, including previous finance charges.

If it took you two years to pay off a credit card purchase of $1,000, you would actually pay $388 in interest!

(This is assuming you didn’t make additional charges on your credit card in those two years)

Credit Card Interest

In August 2012, the average American owed over $7,150 in credit card debt.

Of those who actually carry debt, the average credit card debt is $15,328 (46.7% households carry credit card debt)

Average student loan debt: $34,703

Question #1

Which of the following might lower your credit score?

A. Having worked at the same job for three year

B. Having paid all your bills on time

C. Never having applied for credit before

D. Never having “bounced” a check before

Answer: C Having never applied for credit.

Question #2

Darrell wants to buy a used car for $3,000. If he doesn’t have $3,000 in savings, which would be his least expensive credit option for purchasing the car?

A. A 3-year bank loan with a fixed simple interest rate

B. A variable-rate cash advance from his credit card

C. Two variable-rate cash advances from two different credit cards

D. A 3-year loan with a fixed compound interest rate from a finance company

Answer: A A 3-year bank loan with a fixed simple interest

rate

Question #3 Mr. and Mrs. Jacobs obtained a $20,000 bank loan

to make improvements on their house. Which of the following was the bank’s MOST important consideration in giving them the loan?

A. The type of improvements they were planning to make

B. The reliability of the company they hired to make the improvements

C. The estimate of how much the improvements would cost

D. The total value of their house and other assets they own.

Answer: D The total value of their house and other assets

they own.