What is Credit?

1. What is Credit? Is it Good or Bad?

2. What is Credit? Means “I believe” When goods or services or money is received in exchange for a promise to pay a definite sum of money at t future date?

3. 5 C’s of Credit • Character – person’s honesty and reliability determined by their history of repaying bills on time. • Capital – an evaluation of a person’s net worth. • Capacity – the income a person has available to repay the loan determined by job longevity and having few other loans.

4. 5 c’s continued….. 4.Collateral- Property which can be seized if a person does not repay the loan • Conditions – the general state of the economy If a person has these qualities, he/she is more likely to be perceived as having the ability and willingness to pay back a loan.

5. Opening a credit account Applicant completes a credit application Lender conducts a credit investigation Applicant is given a credit rating Lender accepts or denies the credit request If accepted

6. Types of Credit • Installment credit – closed end credit • A one time loan which the borrower must repay the amount in a specified number of equal payments. • Usually has an agreement (contract) • Must be signed • Outlines the repayment terms • Mortgages, auto loans, education loans

7. Types of Credit Non-installment Credit – open ended Credit extended in advance Can continue to borrow up to line of credit Bank credit cards and department store credit cards.

8. What is a lender? The person or organization who has the resources to provide the individual with a loan.

9. What is a borrower? The person or organization that is receiving the money from the lender.

10. What is a credit card? • A plastic card that holds pre-approved credit which can be used for the purchase of items now, and then the pay for them later. • Can assist people with money management • Can cost large amounts of money • Can cause debt

11. Credit card terminology Credit – when a bank or other financial institution lends an individual money and trusts he or she will pay it back. Interest – a fee for borrowed money Credit line – The maximum amount of money that can be charged to a credit card. Due date – The date that the payment is due.

12. What are the……….. Advantages of credit Disadvantages of Credit Have to pay interest Additional fees are common Tempting to overspend Responsible for lost or stolen cards Identity theft possible Can cause large amounts of dect • Convenient • Useful for emergencies • Often required to hold a reservation. • Able to purchase expensive items earlier • Eliminate the need to carry large amounts of cash

13. Using a card properly Only use a card when there is no doubt about ability to pay off the charges at the end of the billing cycle. Record all expenses and keep receipts Check credit statement for errors Always pay off balance completely and on time.

14. Safety tips Tear up any credit card offers or credit cards that you receive in the mail. Check your credit card statements Sign the back “ please see ID” Don’t leave cards lying around Close unused accounts in writing and by phone; then cut up the card

15. More Safety tips…….. Don’t give out credit card numbers Keep a separate list of your card numbers and contact numbers in a safe place Immediately report a lost or stolen card

16. Some Statistics 92% of college students have a credit card by their sophomore year 1 our of every 5 college students owes between $3,000 and $7,000 in credit card debt. Almost half (47%) of all college students carry four or more credit cards.

17. Types of credit cards • Bank credit cards • Flexible account • Accepted everywhere • Available from a financial institution (Master card and visa) • Retail Credit cards • Purchases only allowed at that particular retail store.

18. More……… • Usually higher interest rates • Sometimes gives you rewards for using them • Travel and entertainment cards • Similar to bank credit cards • Entire balance must be repaid in 30 days • Prestige cards • High status accounts • Higher qualifications • Special benefits (travelers checks, higher credit lines

19. More……… • Affinity cards • Accounts through a financial institution • Logo of sponsoring organization – (MADD) • Financial institution donates a percentage of charges to organization

20. The effect of Interest Rates on Borrowing Costs • You borrow $1,000 at 9%, What is your interest? What is the total amount you will pay back? • $1,000 X .09 = $246 • You pay back $1,246 • You borrow $1,000 at 12%, What is your interest? • What is the amount you will pay back? • $1,000 X .12 = $334 • You pay back $1,334 • A difference of $88 at a lower interest rate

21. You bought stuff • In fact you bought $500 worth of “stuff” • Your APR is 18% • You are going to pay the minimum payment of $15 a month • Charged $500 • Interest you will pay 180 • Final cost $680 • At $15 a month it will take you almost 4 years to pay it off.

22. How long could it take? APR=18% Minimum Pay 2% or $20 Balance Time to Finance Total pay off Charge Pay $2,000 18 yrs + $3500 $5,500 When you make the last payment will the things you purchased be long gone?

23. 10 things to ask before Signing Do I really need this item right now or can I wait? Can I qualify for credit? What is the interest rate (APR) Are there additional fees? How much is the monthly payment and when is it due?

24. More…… Can I afford to pay the monthly payments? What will happen if I don’t make the payments on time? What will be the extra cost of using credit? What will I have to give up to pay for it? All things considered, is using credit worth it?

25. Schumer Box • Fair Truth in Lending Act • Information required by law to inform consumer of all costs associated with use of a credit card

26. Annual Percentage Rate • Annual Percentage Rate (APR) – Interest rate charged for amount borrowed in terms of per dollar per year

27. Grace Period • Grace Period – Amount of time allowed before finance charges are applied

28. Minimum Finance Charges • Minimum Finance Charge – Minimum amount charged for card use

29. Balance Calculation Method • Balance Calculation Method – Method used to determine balance for finance charges

30. Balance Calculation Method cont. • Balance Calculation Method • Average daily balance excluding new purchases – Interest is only paid on the previous balance, not on purchases made since the last payment • Average daily balance including new purchases with a grace period – If the balance is not zero, interest is applied to new purchases when they are made, if the balance is zero, a grace period is allowed before interest is charged

31. Balance Calculation Method cont. • Balance Calculation Method • Average daily balance including new purchases with no grace period – Regardless of the previous month’s balance, interest is applied to new purchases as they are made • Two-cycle average daily balance including new purchases – This method should be avoided by consumers, as it is the least-beneficial. The average daily balance is determined on 60 days, rather than 30 days, so finance charges are doubled. A zero balance must be held for two months in order to avoid charges

32. Annual Fees • Annual Fees – Yearly charge for credit card ownership

33. Cash Advances • Cash Advance Transaction Fees – Cash withdrawal fees

34. Payday Lending A short term loan providing immediate cash, typically secured by a borrower’s bank account. People using them usually have poor credit To use you must write a post dated check for the amount of the loan along with the loan company’s fee.. APR is usually 391% -443%

35. Obtaining a payday loan • Personal check • Individual writes a check to the lender for the amount borrowed and the lending company fee • Payday loans are issued for amounts between $50 and $1000 • Payday loan fees are between $10 and $30 per $100 borrowed3 • Fees translate to an APR of 391% - 443%4 • Example: If James needs $100, he will be charged $15 in fees. He will write a check for $115 and receive $100. • Lender will hold the check until the agreed upon date (usually the borrower’s payday) before cashing it

36. Obtaining a payday loan • Automatic withdrawal • Borrower gives lender permission to automatically withdraw the funds from their financial institution account

37. Payday Lending Options • Payday loans are difficult to pay back • Payday lending companies require borrowers to pay back the entire loan in one lump sum rather than installments • For example: if Max saves $25 each pay period, he cannot apply that money to a payday loan until it equals the total cost of the loan • Other credit options, such as a credit card or loan do allow installment payments • For example: if Max saves $25 each pay period, he can apply that money to a credit card balance • 91% of all payday loans are made to borrowers with five or more payday loans per year4

38. Payday Lending Options • If lenders cannot pay back their payday loan in full on pay day, there are three options 1. Rollovers or extensions • Pay another fee for the original loan • Example: If James does not have enough money to pay back his $100 loan, he may pay $15 to extend the loan until his next payday • Cost of the loan after one payday • Original loan = $100 + $15 = $115 • Rollover fees = $15 • Total cost of the payday loan = $130

39. Payday Lending Options 2. Back-to-back • Pay back the original loan, but immediately take out a new loan to cover expenses • Example: If James can pay back the original loan on his payday, but then needs money to pay other bills, he can take out another loan. • Cost of the loan after one payday • Original loan = $100 + $15 = $115 • Payback $100 on payday • New loan = $100 + $15 = $115 • Total cost of the both payday loans = $130

40. Payday Lending Options 3. Default • If an individual does not have enough money in his checking account, the borrower will default on the loan • Insufficient funds (NSF) fees are charged by the lender and financial institution • NSF fees may be charged multiple times if insufficient funds remain in the account • Example: James wrote a check for a payday loan. He does not have enough money in his checking account for the loan amount on payday. • Cost of the loan after one payday • Original loan = $100 + $15 = $115 • Payday lender NSF fees = $20 • Financial institution NSF fees = $20 • Total cost of the payday loan = $155

41. Amount Paid after Pay Period 1 Amount Paid after Pay Period 2 Amount Due: Credit Card $ 50 $ 50 $72.50 Payday Loan Saved $50, but can’t make installment payments, so she pays $30 to rollover the loan ($20 left from amount saved) Saved $70 ($50 + $20), but can’t make installment payments, so she pays $30 to rollover the loan ($40 left from amount saved) $230.00 Comparing the Total Cost Fran purchases new clothes with $150 credit. She saves $50 each pay period to apply to the total credit cost. • Example 1 – credit card with a 15% APR • Total cost after 2 pay periods = $150 * .15 = $172.50 • Example 2 – payday loan with a $20 fee and a rollover fee of $30 • Total cost after 2 pay periods = $150 + $20 + $30 + $30 = $230

42. Risks of payday lending • Borrowers can get “trapped” in a cycle of borrowing • Lead to long term debt and legal problems • Payday loan customers are 4 times more likely than all adults to file for bankruptcy5

43. Alternatives to payday lending • Family or friends • May charge much lower finance fees • Paycheck advance • Ask employers to issue a paycheck earlier if bills are due • Overdraft protection • May be less costly than paying payday lending fees • Ask creditors for more time to pay bills • Make arrangements to pay bills after receiving a paycheck • Financial institution loan for large amounts • Interest rates may range from 10% to 18%3 • Credit card • Higher interest rate of 16% to 21%3 • Is still lower than the ~400% interest rate of a pay day loan

44. Alternatives to payday lending • Create a spending plan • Track income and expenses • Open a savings account • Set aside money from each paycheck • Emergencies • Unexpected expenses

45. Government Regulation • Some states have small loan laws making payday lending illegal or regulating the number of times a rollover can occur • The Truth in Lending Act • Requires payday loan companies to advertise the finance charges and annual percentage rate • All terms must be in writing for customers