Chapter 6
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Chapter 6. Building and Maintaining Good Credit. Learning Objectives. Explain reasons for and against using credit. Establish your own debt limit. Achieve a good credit reputation. Describe common sources of consumer credit.

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Chapter 6

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Chapter 6

Building andMaintaining Good Credit


Learning Objectives

  • Explain reasons for and against using credit.

  • Establish your own debt limit.

  • Achieve a good credit reputation.

  • Describecommon sources of consumer credit.

  • Identify signs of over-indebtedness and describe options available for debt relief.


Reasons For andAgainst Using Credit

  • Credit is any arrangement in which goods, services or money is received in exchange for a promise to repay at a later date.

  • Good uses of credit include emergencies, reservations, convenience, owning expensive items sooner, earning a college education, etc.


Reasons For andAgainst Using Credit

  • The downside of credit:

    • Use of credit reduces financial flexibility

    • It is tempting to overspend

    • It can be difficult to get out of debt

    • Interest is costly

      • Interest, Finance Charge, Annual Percentage Rate (or APR)


Debt Payments-to-Disposable Income

  • Maximum 14% limit of monthly debt payment as percent of disposable income

  • A Monthly payment (mortgage not included) of 15% to 18% as percent of

  • disposable income is precariously over-indebted and should NOT aquire more

  • debt.


Setting Debt Limits

Ratio of debt-to-equity method uses your Debt-to-Equity Ratio: Ratio of your consumer debt to your assets.

Equity: Amount by which the value of a person’s assets exceeds debts.

Example: Assume a household has $9,120 monetary assets, $20,500 tangible assets and $167,000 investment assets for total assets of $196,620. If total household debt is $9,365, the equity is $187,255 ($196,620 - $9,365) and the debt-to-equity ratio is 5% ($9,365/$187,255)

A ratio of 33% or higher is excessive.


Managing Student Loan Debt

  • When possible, choose grants, scholarships first

  • Choose the most advantageous repayment pattern allowed.

  • Pay electronically.

  • Make your repayments on time, every time.

  • Consolidate your student loans.

  • If necessary, sign up for the Federal government’s income-based repayment plan.

  • Go to http://studentaid.edu.gov/ and select “Repay Your Loans” then “Repayment Plans”


Credit Approval Process

  • You apply for credit.

    • Credit Application – ability to pay debt

    • Credit History – record of credit usage

  • The lender conducts a credit investigation.

    • Credit Rating – evaluation of credit worthy

    • Credit Report – Info about payment history

    • Credit Bureau – Firm that collects history

    • Credit Scoring (or Risk Scoring) System – rates credit worthiness & likelihood of repayment


Credit Approval Process

  • The lender decides whether to accept the application.

    • Credit Agreement – loan on credit card

    • Promissory Note

    • Tiered Pricing

      - Interest rate charged

      based upon level

      of risk


Making Sense of YourFICO Credit Scores

  • Percent indicates weight of characteristic used when determining credit score


Your Credit Reputation

  • Building credit history: Ways to establish Credit:

    • Establish both a checking account and a savings account.

    • Have your telephone and other utilities billed in your name.

    • Request, acquire, and use an oil-company credit card.

    • Apply for a bank credit card.

    • Ask a bank for a small short-term cash loan.

    • Pay off student loans.


Your Credit Reputation

  • Managing your credit bureau file for free

  • Fair Credit Reporting Act (FCRA) – Requires that credit reports contain accurate, relevant, and recent information and access is restricted for approved purposes.


Sources of Consumer Loans

  • Depository institutions such as commercial banks, mutual savings banks, savings banks and credit unions loan money to their banking customers. – Wells Fargo, First National Bank, Centris Federal, etc.

  • Sales finance companies loan money to buy consumer products. GMAC Financial Services, Ford Motor Credit

  • Consumer finance companies make small cash loans. CitiFinancial, Beneficial Finance Corp, HSBC, Household Finance, etc.

  • Stockbrokers loan money to their clients. Charles Schwab, Fidelity Investments, A.G. Edwards, etc.

  • Insurance companies loan money to their policyholders. Allstate, State Farm, Farmers Insurance


What it Costs to Borrow Money

  • Above payment schedule based upon $1,000 Loan over two and five year periods


10 Signs of Overindebtedness

  • Exceeding debt limits and credit limits

  • Not knowing how much you owe

  • Running out of money

  • Paying only the minimum amount due

  • Requesting new credit cards and increasesin credit limits

  • Paying late or skipping credit payments

  • Using debt-consolidation loans

  • Taking add-on loans

  • Experiencing garnishment

  • Experiencing repossession or foreclosure


Debt Collection

  • Federal law regulates debt collection practices.

  • Federal Fair Debt Collection Practices Act (FDCPA)

    • Prohibits third-party debt collection agencies from using abusive, deceptive and unfair practices to collect past due debts.

  • Debt collection agencies

    • Specialize in making collections that could not be obtained by the original lender for a fee.

    • Prohibited from calling at unusual hours, numerous calls, false claims, contacting employer and abusive tactics


Steps to Take toGet Out from Under Excessive Debt

  • Determine your account balances and the payments required.

  • Focus your budget on debt reduction.

  • Contact your creditors.

  • Do not take on new credit.

  • Refinance.

  • Find good help.


Bankruptcy

  • Bankruptcy is a last resort.

  • Discharged debts

  • Chapter 13 of the Bankruptcy Act:Wage earner or regular income plan – Reorganization plan to repay debts in 3-5 years

    • Stay – prevents creditors from recovering claims temporarily before court proceedings

  • Chapter 7 of the Bankruptcy Act:Straight bankruptcy – liquidation (sale) of assets to repay creditors and remains on record for 10 years

    • May result in future problems when credit requested for home or car purchase


TheTop 3 Financial Challengesin Building and Maintaining Good Credit

People experience difficulty in building and maintaining good credit when they do the following:

  • Make late payments on credit cards.

  • Pay more than 14 percent of disposable income toward nonmortgage debt payments.

  • Fail to regularly check the accuracy of credit bureau files.


Good Money Habits in Buildingand Maintaining Good Credit

  • Protect your credit reputation just as you would guard your personal reputation.

  • Calculate your own debt limits before taking on any credit.

  • Obtain copies of your credit bureau reports regularly, and challenge all errors or omissions on them.

  • Never cosign a loan for anyone, including relatives.

  • Always repay your debts in a timely manner.


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