Presentation Transcript

1. CHAPTER 6: BORROWING ONOPEN ACCOUNT

2. The Basic Concepts of Credit Why Borrow? Avoid paying cash for large purchases (like a car) Meet financial emergencies Convenience Investment purposes
3. Improper Uses of Credit Meet basic living expenses Make impulse purchases Purchase non-durable goods (like restaurant meals) College Student
4. Rule of Thumb! THE PRODUCT PURCHASED SHOULD OUTLIVE THE CREDIT PAYMENTS Don’t let credit squash you!
5. Minimum Payments means Maximum Years Calculations here are based on a minimum 3 percent payment and 15.0 percent annual interest rate.
6. Some Credit Danger Signs
7. Establishing Credit Open checking and savings accounts. Get one card and make small purchases. Build a good credit history by: Not getting overextended. Fulfilling all terms of credit obligations. Consistently paying on time. Immediately notifying creditors if unable to pay. Being truthful when applying.
8. What is the toughest part of the consumer credit process? Servicing the loan (I.e.,making payments) in a prompt and timely fashion. In many respects, this is the most important element.
9. How much credit can you stand? DEBT SAFETY RATIO = Total monthly consumer credit payments Monthly take-home pay Monthly consumer credit payments (excluding mortgage) should not exceed 20% of your monthly net income.
10. Example: Consider someone who takes home $2,500 a month. $2,500 x 20% = $500 This is the maximum amount this individual should have to use to pay off personal loans and consumer credit.
11. Open Account Credit Credit extended to a consumer in advanceof any transaction. Consumer can buy/borrow up to a specified amount--the credit limit. Usually, interest can be avoided by paying balance in full. Sources of open account credit: Financial institutions Retail Stores/merchants Biggest types of open account credit Bank credit cards Retail charge cards
12. Bank Credit Cards: Issued by financial institutions Features include: Line of credit dependent upon applicant’s financial status and ability to pay Cash advances and balance transfers Other services or rebates—in the end, the cardholder pays for these “free” services Interest rates and fees
13. Credit Card Fees Interest Generally high Prime rate + a percentage Annual fee – assessed for the “privilege” of using the card Transaction fees “not using our credit card” fee Late-payment fees Over-the-limit fees Balance transfer fees Foreign transaction fees World’s Worst Credit Card MyBank MyStore
14. Reward (Co-branded) Credit Cards Features of traditional bank credit card with an incentive Frequent flyer programs Automobile rebate program Other merchandise rebates—cruises lines, major oil companies, phone companies Most carry higher interest rates than regular bank cards.
15. Interest Rates on Bank Card Charges Most bankcards have one rate for purchases and a different one for cash advances Interest on merchandise/service purchases may have grace period Interest on cash advance begins the day the advance is taken out Watch our for those special low introductory rates that many banks offer Interest rates on credit cards are higher than any other form of consumer credit
16. Affinity Cards Visa or MasterCard issued in conjunction with a sponsoring group Sponsoring groups receive share of the profits (usually ½ to 1 % of retail purchases) Cardholder usually pays higher fees or interest
17. Secured Credit Card You have to put up collateral to get the card—deposit money Line of credit is equal to the amount of deposit Targeted at people with no credit or bad credit histories Issued as Visa or MasterCard
18. Student Credit Cards Often come packaged with special promotional programs (free music CDs, movie tickets, etc.) Most require that you be enrolled in a 2- or 4- year college and have some sort of income
19. Credit Card Offers
20. Retail Charge Cards Second largest category of credit cards Usually more expensive than bank credit cards Build loyalty
21. Debit Card: Looks like a credit card but works like writing a check—accesses your checking account. Does not provide line of credit. Greater liability exposure in event of fraud ($50-$500) Prepaid card is a debit card with fixed amount available—does not access your checking account.
22. Revolving Credit Lines: Open account credit offered by banks and other financial institutions. Usually offer higher credit linesand lower interest ratesthan credit cards! Money accessed by writing checks.
23. Forms of revolving credit: Overdraft protection lines – line of credit linked to checking account that enables depositor to overdraw Unsecured personal credit lines Available on an as-needed basis Home equity credit lines Secured by the equity in owner’s home Interest tax deductible (if you itemize deductions)
24. Obtaining and Managing Open Account Credit Steps in opening an account: 1. Complete and submit application. 2. Lender investigates creditworthiness. 3. Lender obtains credit bureau report. 4. Lender makes credit decision; may use credit scoring.
25. The Credit Application Applicant submits information on income, marital status, employment history, existing accounts, etc.
26. The Credit Application Applicant submits information on income, marital status, employment history, existing accounts, etc. The Lender Verifies application; turns it over to the Credit Bureau.
27. The Credit Application Applicant submits information on income, marital status, employment history, existing accounts, etc. The Lender Verifies application; turns it over to the Credit Bureau. The Credit Bureau Reporting agency that gathers and sells info about people. Gets information from: subscribing creditors creditors you use as reference public documents
28. The Credit Application Applicant submits information on income, marital status, employment history, existing accounts, etc. The Lender Verifies application; turns it over to the Credit Bureau. Credit Bureau submits report back to lender; lender then makes The Credit Bureau Reporting agency that gathers and sells info about people. Gets information from: subscribing creditors creditors you use as reference public documents The Credit Decision
29. The Credit Decision Credit scoring scheme will be used Values are assigned to such factors as your age, annual income, number of years on your present job, rent or own and how long, age of cars, number and type of credit cards you hold, level of your existing debts, savings accounts, phone, and general credit references
30. Credit Report
31. Fair Isaac & Co. Scores (FICO Scores) Uses only credit information in its calculations Payment history 35% Amounts owed 30% Length of credit history 15% New credit 10% Types of credit used 10%
32. FICO Scores Range from a low of 300 points to a maximum of 850 points The higher the score, the lower the risk to the lender Distribution of FICO scores in 2005:
33. Computing Finance Charges Lenders must disclose Annual percentage rate (APR), the true rate of interest paid over life of loan. Method used in computing finance charges. Balance to which interest rate applied generally determined using one of four variations of the Average Daily Balance (ADB) method.
34. ADB including new purchases—for each day in the billing cycle, add the outstanding balance, including new purchases, and subtract payments and credits, then divide by the number of days in the billing cycle; most frequently used—no grace period on new purchases if you carry a balance. ADB excluding new purchases—same as first method, excluding new purchases; the most consumer friendly! Two-cycle ADB including new purchases—calculated like the first method, but using the average daily balance for both the current and previous billing cycles; least consumer friendly method! Two-cycle ADB excluding new purchases—same as the two-cycle method, but excluding new purchases
35. Example: Calculate the finance charges on a credit card account which has an annual interest rate of 18% (or 1.5% per month) and uses the average daily balance method including new purchases.
36. ADB Including New Purchases: # of Days Balance Weighted (1) (2) Balance (1x2) 5 $582 $ 2,910 7 932 6,524 15 986 14,790 4 961 3,844 Total: 31 $28,068 ADB = $28,068  31 = $905.42 Monthly APR = .18  12 = .015 Finance charge = $905.42 x .015 = $13.58
37. Refer to Exhibit 6.6 in text— What a difference the balance method makes! Examples shown below all have: Same stated rate of 19.8% Same account activity Method Finance Charges ADB including new purchases $132.00 ADB excluding new purchases 66.00 Two-cycle ADB including new purchases 196.20 Two-cycle ADB excluding new purchases 131.20
38. Managing Your Credit Cards Review statements promptly each month and verify each entry. Pay at least the minimum monthly payment by due date. Returned merchandise credited to your account.
39. Using Credit Wisely Shop around, comparing: Annual fees & other fees APR Length of grace period Balance method
40. Advantages of Credit Cards Short, interest-free loan Simplified record keeping Easier resolution to unsatisfactory purchases Convenience and emergencies Disadvantages of Credit Cards Easy to overspend High interest costs
41. Avoid credit problems by: Using discipline when purchasing. Reducing the number of cards you carry. Being selective in accepting preapproved credit offers. Not making new charges. Paying more than the minimum. Paying off cards with highest finance charges first. Transferring balances to card with low introductory rate and paying off quickly.
42. Important Consumer Credit Legislation Key legislation deals with Credit discrimination. Disclosure of credit information. Billing procedures, errors, complaints, and recourse on unsatisfactory purchases. Disclosure of finance charges, other fees, credit terms, and loss of credit card. Protection against collector harassment New Credit Card Rules
43. H.R. 627:Credit Card Accountability Responsibility and Disclosure Act of 2009 4.6 – average number of credit cards owned by college students $3,173 - 2008 national average for undergraduate credit card debt 21% of undergrads have balances between $3,000 and $7,000 February 22, 2010 - effective date of new credit card legislation
44. Credit Card Fraud Never give account number to someone who calls you—you must initiate the call. Use only secure Internet sites. Never put credit card info on checks or personal info on charge slips. Keep your eye on your card! Draw line through blank spaces on slip. Destroy old cards and shred old statements and slips. Report lost or stolen cards immediately!
45. Options if you’re getting into trouble... Try credit counselors Help you prepare a budget and repayment schedule. Deal with creditors to possibly reduce some interest & fees. File Bankruptcy Chapter 13—debt restructuring. Chapter 7—wipe the slate clean. Other bankruptcy options.
46. THE END!