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Chapter 6

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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  1. Chapter 6 Building andMaintaining Good Credit

  2. 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.

  3. 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.

  4. 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)

  5. 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.

  6. 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.

  7. 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”

  8. 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

  9. 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

  10. Making Sense of YourFICO Credit Scores • Percent indicates weight of characteristic used when determining credit score

  11. 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.

  12. 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.

  13. 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

  14. What it Costs to Borrow Money • Above payment schedule based upon $1,000 Loan over two and five year periods

  15. 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

  16. 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

  17. 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.

  18. 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

  19. 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.

  20. 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.

  21. Questions ?

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