5a consumer credit 1
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5A Consumer Credit #1. Credit – An arrangement to receive cash, goods, or services now and pay for them in the future. Types of credit ???. Objective 1 Analyze Advantages and Disadvantages of Using Consumer Credit. Credit

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5A Consumer Credit #1

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5a consumer credit 1

5A Consumer Credit #1

Credit– An arrangement to receive cash, goods, or services now and pay for them in the future.

Types of credit ???


Objective 1 analyze advantages and disadvantages of using consumer credit

Objective 1Analyze Advantages and Disadvantages of Using Consumer Credit

  • Credit

    • Based on trust in people’s ability and willingness to pay bills when due

  • Consumer Credit

    • Use of credit by individuals for personal needs, except a home mortgage

    • Dates back to colonial times; exploded after invention of cars (installment loans; traveling)

    • A major force in our economy

5-2


Uses and misuses of credit

Uses and Misuses of Credit

Before you use credit for a major purchase, ask:

  • Do I have the cash for the down payment?

  • Do I want to use my savings for this purchase?

  • Does the purchase fit my budget?

  • Could I use the credit I’ll need in some better way?

  • Can I postpone this purchase?

  • What are the opportunity costs of postponing this purchase?

  • What are the dollar and psychological costs of using credit for this purchase?

5-3


Advantages of credit

Advantages of Credit

  • Current use of goods and services

  • Permits purchase even when funds are low

  • A cushion for financial emergencies

  • Advance notice of sales

  • Easier to return merchandise

  • Convenient when shopping

  • Provides a record of expenses

5-4


More advantages of credit

More Advantages of Credit

  • One monthly payment

  • Safer than carrying cash

  • Needed for hotel reservations, car rentals, and shopping online

  • Take advantage of “float” time/grace period

  • Rebates, airline miles, cash-back rewards, or other “perks”

  • Credit indicates financial stability

5-5


Disadvantages of consumer credit

Disadvantages of Consumer Credit

  • Temptation to overspend

  • Can create long-term financial problems and slow progress toward financial goals

  • Potential loss of merchandisedue to late or non-payment

  • Ties up future income

  • Credit costs money - more costly than paying with cash

5-6


Objective 2 assess the types sources of consumer credit

Objective 2Assess the Types & Sources of Consumer Credit

Two Basic Types of Consumer Credit

  • Closed-End Credit

    • One-time loans for a specific purpose paid back in a specified period of time

  • Open-End Credit

    • Use as needed until line of credit max reached

Examples of each?

5-7


Closed end credit

Closed-End Credit

  • One-time loans for a specific purpose that you pay back in a specified period of time, and in payments of equal amounts

  • Mortgage, automobile, and installment loans for furniture, appliances and electronics

  • 3 most common types of closed-end credit

    • Installment sales credit- loan for high-priced items

    • Installment cash credit- loan of cash for personal use

    • Single-lump credit- loan repaid on a specific day

5-8


Open end credit

Open-End Credit

  • Use as needed until line of credit max reached

    • Credit cards

    • Department store cards

    • Home equity loans

  • You pay interest and finance charges if you do not pay the bill in full when due

  • Revolving Check Credit (Bank Line of Credit)- pre-arranged loan for a specified amount; can be accessed with special checks

5-9


Sources of consumer credit

Sources of Consumer Credit

Loans

  • Borrowing money with an agreement to repay, along with interest, within a certain amount of time (e.g., 3 years)

  • Inexpensive loans

    • Parents or family members

  • Medium-priced loans

    • Commercial banks, savings and loan associations, and credit unions

  • Expensive loans

    • Finance and check cashing companies

    • Retailers (e.g., department store credit cards)

    • Bank credit cards and cash advances

  • 5-10


    Sources of consumer credit1

    Sources of Consumer Credit

    • Home Equity Loans

      • Loan based on home equity

        • Current market value of your home minus the amount you still owe on the mortgage

      • Interest is tax-deductible

      • Should only be used for major purchases

    • Credit Cards

      • Average cardholder has > 9 credit cards

      • Convenience users vs. borrowers

      • Finance charge = total amount paid to use credit

    5-11


    Sources of consumer credit2

    Sources of Consumer Credit

    • Debit Cards

      • Debit cards electronically subtract money from savings or checking accounts

      • Most commonly used at ATMs

      • Widely accepted at stores also

    • Stored Value Cards

      • Gift cards

      • Prepaid cards

    5-12


    Sources of consumer credit3

    Sources of Consumer Credit

    • Smart Cards

      • Plastic card equipped with a computer chip that can store 500 times as much data as a normal credit card (e.g., health info)

    • Travel and Entertainment (T&E) cards

      • Not really “credit cards”; balance is due in full each month

      • Diners Club; American Express

      • You don’t pay for goods or services at the time of purchase

    5-13


    Objective 3 determine whether you can afford a loan and how to apply for credit

    Objective 3Determine Whether You Can Afford a Loan and How to Apply for Credit

    Before you take out a loan, ask yourself...

    Can you meet all your essential expenses and still afford the monthly loan payments?

    • Add up basic monthly expenses and subtract from take-home pay; will the difference cover the monthly payment? (NO? Can’t afford it!)

    • What do you plan to give up in order to make the payment?

    5-14


    General rules of credit capacity

    General Rules of Credit Capacity

    Debt Payments-to-Income Ratio

    Monthly Debt Payments*

    Net Monthly Income

    Consumer credit payments should not exceed a maximum of 20% of your net income.

    *Not including a house payment, which is a long-term liability

    5-15


    General rules of credit capacity1

    General Rules of Credit Capacity

    Debt To Equity Ratio

    Total Liabilities

    =

    Should be < 1

    Net Worth*

    *Excluding home value

    The lower the ratio, the better; e.g., 0.5 or 0.25

    5-16


    The five c s of credit

    The Five C’s of Credit

    • Character - Do you pay bills on time?

    • Capacity - Can you repay the loan?

    • Capital - What are your assets and net worth?

    • Collateral - What assets do you have to secure the loan?

    • Conditions- Lenders will review how general economic conditions will affect your ability to repay your loan

    5-17


    Fico vantagescore

    FICO & VantageScore

    • FICO Credit Score

      • 350 to 850

      • Higher score = less risk

      • Available from http://www.myfico.com for a fee; can sometimes get for free from lenders

    • VantageScore

      • New scoring technique

      • Developed collaboratively by 3 credit agencies

      • Range = 501 to 990

    5-18


    Credit scoring factors

    Credit Scoring Factors

    • Bill payment history, weighted to emphasize past 12 months (35%)

    • Proportion of outstanding debt to available credit limits (30%)

    • Length of credit history (15%)

    • Number of recent credit inquiries (10%)

    • Mix of types of credit used (10%)


    Factors of creditworthiness

    Factors of Creditworthiness

    ECOA (Equal Credit Opportunity Act)

    • Gives all applicants the same rights.

    • Credit providers may not discriminate based on:

      • Age

      • Social Security or public assistance

      • Housing loans (redlining)

    • If you are denied credit, you have the right to know the reasons

      • You can request a copy of your credit report within 60 days if you are denied credit based on what is in your files

    5-20


    Your credit report

    Your Credit Report

    • Credit Reports

      • Record of your complete credit history

    • Credit Bureaus

      • Agencies that collect information on how promptly people and businesses pay their bills

      • Experian, Trans Union and Equifax are the 3 major credit bureaus

      • Credit Bureaus obtain information from banks, finance companies stores, credit card companies and other lenders

    5-21


    Four main parts to a credit report

    Four Main Parts to a Credit Report

    • Identifying Information: name, SS Number, current/previous addresses, birthdate, employer

    • Public Record Information from Local Courthouse: liens, foreclosures, bankruptcy

    • Other Credit History Information: list of loans and credit cards, timeliness of payments, defaults and negative information (7 years)

    • Inquiries: Usually 2 years; self-initiated and promotional (for marketing purposes)


    Your credit report1

    Your Credit Report

    • Who can obtain a credit report?

      • Only authorized persons have access to your report for approved legitimate business purposes

      • Examples???

    • Time Limits on Unfavorable Data

      • Adverse data can be reported for 7 years

      • Bankruptcy can be reported for 10 years

    5-23


    Wrap up

    Wrap Up

    • Concept Check 5-1- Reasons to Borrow and Advantages/Disadvantages

    • Concept Check 5-2- Definition of Terms; Difference Between Credit and Debit Cards

    • Concept Check 5-3- Definition of Terms


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