Going Into Debt

1. Going Into Debt Chapter 4

2. Americans and Credit Debt = Principal + Interest • Credit • Receiving money either directly or indirectly to buy goods and services TODAYwith the promise to PAY BACK LATER Principal: amount originally borrowed Interest: amount to be paid for using someone else’s money

3. CREDIT REALITY EVERYTIME you use credit, you are going into DEBT (this includes taking out a loan)

4. Installment Loans Definition CONSUMER DURABLES MORTGAGE • Installment debt owed on real estate property (houses, buildings, land) • Repay this type of loan over a period of time in equal installments (payments). • Examples: mortgage or car loan • Length of loan determines the amount of the payment & interest • Longer time period = higher interest, lower payment Manufactured items people use for a long time before replacing them Commonly purchased with installment loans

5. WHY USE CREDIT??? Immediate need (gratification) Spread payments over “life” of the item

6. BUYING ON CREDIT- ASK YOURSELF THIS: • Do I really need this item? • Can I wait for this item? • If I pay cash, what am I giving up? (opportunity cost) • Will the satisfaction I get from an item be greater than the interest I have to pay? • Have I done comparison shopping? • % rates • Loan rates • Prices • Can I afford to borrow or use credit now? • Will I be over my limit?

7. HOME MORTGAGE • Use the real estate flyers to select three properties of varying prices. • Calculate thetotal interest (I=principal x interest x years)&total payout (total interest + principal) for the following conditions on EACH property. Example: I = 100,000 x .0375 x 15 Example: TP = 56,250 + 100,000 • 30 year, 5.25% • 20 year, 4.25% • 15 year, 3.75% • Calculate the MONTHLY payment for each loan set. (monthly payment = total payout / total months of loan) Example: MP=156,250/180 4. Using the “Buying on Credit” analysis, which property would you purchase at which term rate and WHY?

8. Types of Financial Institutions Match institutions to the main functions: Commercial Bank Charge Accounts Consumer Finance Companies Savings Banks Credit Unions Savings & Loans (S&L) accept deposits, loan $, transfer funds from one bank, individual, or business to another mortgage loans (single and multifamily), commercial mortgage, auto loans, accepts deposits savings accts., home loans, checking accts. at lower interest rates, “small savers” owned & operated by its members, provide checking & savings accts. at higher interest, loans at lower interest takes over installment debts & adds a collection fee, higher interest fees, loan to “high risk” allows customer to buy goods or services from a particular company & pay them later

9. Types of Financial Institutions Match institutions to the main functions: Commercial Bank Charge Accounts Consumer Finance Companies Savings Banks Credit Unions Savings & Loans (S&L) accept deposits, loan $, transfer funds from one bank, individual, or business to another mortgage loans (single and multifamily), commercial mortgage, auto loans, accepts deposits savings accts., home loans, checking accts. at lower interest rates, “small savers” owned & operated by its members, provide checking & savings accts. at higher interest, loans at lower interest takes over installment debts & adds a collection fee, higher interest fees, loan to “high risk” allows customer to buy goods or services from a particular company & pay them later

10. CHARGE ACCOUNTS REGULAR CHARGE ACCT. “30 day charge” with a credit limit Credit limit: max amount of goods or services a person or business can buy on the promise to pay in the future (usually $500-$1000) Process: bill sent at end of 30 days; 0% interest charged if paid in full before interest is charged at the end of the month (billing cycle)

11. Revolving Charge Account Allows you to make additional purchases from the same store even if previous month’s bill is not paid in full Terms: usually must pay 1/5th of balance interest; has a credit limit No “common lender” symbol in corner

12. Like a charge card only can be used at many random stores, resturants, businesses, etc. • Terms: • Varying credit limits • Higher interest rates (10%-30% range based on credit score) • Special rates to reliable customers Credit Card COMMONLY HAVE THESE LOGOS

13. “Check Card” – works like a check from your checking or savings account at a banking institution • Transfers funds electronically • Only funds IN your account are accessible for use through the card • Can be used for ATM withdrawal of cash • No interest charge, but fees!!! Rules are decided at each bank. Debit Card

14. Finance Charges and Percentage Rates • Finance Charge • Cost of credit expressed in $ and includes interest costs plus other charges connected to credit (annual membership fee) • Computing finance charge (4 ways): • Previous balance • Average daily balance • Adjusted balance • Past due balance • Creditors must inform you which method is being used. • Annual Percentage Rate (APR) • Cost of credit expressed as a yearly percentage See Page 93

15. How do I apply for credit? • Know who is watching: Credit Bureau • A private business hired to do a credit check. Credit Check • An investigation to reveal current income, debts, details of personal life, repayment history • Completed prior to MOST financial transactions or even prior to obtaining employment

16. 3 Credit Check Factors CAPACITY TO PAY CHARACTER COLLATERAL • Capital (personal wealth) • Past ability to save & accumulate • Personal ability to pay (able to sell items of value) Related to income & debt Spotty employment = questionable record Factor in current amount of debt If debt is high, reluctant to loan Reputation of being trustworthy & reliable Educational background Trouble with law or criminal background = reluctant to loan

17. Credit Rating Information is supplied by the credit bureau which determines rating or risk – good, average, or poor. This determines if a creditor will lend money to you and at what price = “CREDITWORTHINESS” Factors to “poor” credit rating: not paying bills on time, inconsistent employment, debt delinquency, criminal record, high debt/low income

18. TYPES OF LOANS SECURED LOANS UNSECURED LOANS A loan that is backed up with collateral Signed legal agreement Example: Auto loan / title of car or repossession When a loan is granted without collateral Based on reputation alone Co-signer – person who signs the loan contract along with borrower & promises to repay the loan if the borrower does not

19. Responsibility as a Borrower • Paying on time! • Past due notices – received if you are late in paying • Collection agency – extensive late payment leads to “aggressive” collection • Late or non-payment = increase in cost for ALL customers • Keeping records!! • Track credit purchases and KNOW what you have borrowed! • Notify immediately if credit cards or ID are lost or stolen Thieves are not all as obvious as him!

20. Government Regulation on Credit • Usury Law • Law restricting the amount of interest charged for credit • Recently changed to help consumers • Higher ratescan be charged on loans of higher risk • Personal Bankruptcy • The inability to pay debts based on the income received or the condition in which debtorsgive up most of what they own for distribution to creditors • Should be a last resort • Stays on credit history for 10 years • Offers a fresh start but is difficult to get future credit!