Tools

1
Tools Techniques of Financial
PlanningLeimberg, Satinsky, Doyle Jackson

• Chapter 17 Credit and Debt Management
• Slides designed by Rosilyn H. Overton, MS, CFP,
  CRPS, LTCP
• New Jersey City University

2
What This Chapter Will Cover

• What is credit?
• Characteristics creditors look for when granting
  credit
• Debt ratios and their use
• Debt problems and over-borrowing
• Credit reports, the FICO credit score
• How to improve ones credit
• How to deal with identity theft
• Major consumer protection laws

3

What is Credit?

• Credit is borrowing money so that one can pay in
  the future for goods and services that are
  enjoyed now.
• Credit costs in the form of interest rates.
  Interest is the rent on using other peoples
  money.
• Maintaining creditworthinessis important to
  financial freedom in todays world.

4
What Creditors Look For The Three Cs

• Capacity
• Does the debtor have the resources to pay the
  debt?
• Are those sources secure?
• Character
• What is this persons history when it comes to
  paying off debt?
• Collateral
• Is there fungible property that could be used to
  secure this debt?

5
Debt Ratios

• Key indicator of their true financial picture
• Less than 10 (not counting mortgage) is good.
• Greater than 20 is danger signal.
• Types of Debt Ratios
• Front-End Ratio housing expense (PITI)
  /monthly income.
• Back-End Ratio (PITI Other monthly
  debt)/monthly gross income.
• Collateral and Secured Loans
• Loans secured by pledged assets such as
  securities or tangible assets.

6
Steps to Take Dealing with Debt Problems

• These are for dealing with progressively more
  severe situations
• Developing a Budget figure out where you are.
• Contacting Your Creditors see if you can work
  out a modified payment plan.
• Dealing with Debt Collectors Federal laws
  restrict what collectors can do.
• Credit Counseling
• Credit counselor takes a certain percent of your
  income and allots it to creditors (with whom they
  have worked out deals).
• Some are not-for-profit Others charge hefty
  fees.
• ---More on next slide

7
Steps to Take Dealing with Debt Problems (cont.)

• Debt Consolidation
• Often uses a home equity line of credit or a
  refinance.
• Interest rates are often less and are
  tax-deductible (to a point).
• Remember that these are now secured by your
  house, and non-paymentcould mean that you lose
  your home.

8
Bankruptcy

• The last resort in dealing with excess debt. It
  affects your credit for a minimum of seven (and
  maybe 10) years.
• Also makes it difficult to get life insurance.
• Can prevent you from buying a home.
• Can cause you to not be hired for a job.
• Two types of personal bankruptcy Chapter 13 and
  Chapter 7.
• There are some new restrictions on bankruptcy
  that take effect in October 2005.

9
Chapter 13

• Allows the filers, if they have a regular income
  and limited debt, to keep property, such as a
  mortgaged house or car that they otherwise might
  lose.
• The court approves a repayment plan that allows
  the filer to pay off a default during a period of
  three to five years, rather than surrender any
  property.

10
Chapter 7 Straight Bankruptcy

• Liquidates all assets that are not exempt.
• Exempt property may include cars, work-related
  tools, and basic household furnishings.
• Some property may be sold by a court-appointed
  official a trustee or turned over to
  creditors.
• A person can receive a discharge of debts under
  Chapter 7 only once every six years.

11
Credit Scoring

• Credit Reports are summaries of a persons credit
  history that are prepared by businesses known as
  Credit Reporting Agencies (CRA).
• There are three major CRAs in the U. S.
• Experian
• Equifax
• TransUnion
• You may get one free report under certain
  circumstances.

12
CRAs and Costs of Reports

• This is a good table to put into your notebook of
  handy reference pieces for use in your practice.

13
What a Credit Report Contains

• Identifying information Name, Address, DOB,
  etc.
• Credit history There may be codes to tell how
  well the borrower has repaid.
• Public records This is the part of the report
  borrowers want to be absolutely blank. It is
  where judgments, liens, etc. would appear.
• Inquiries section This says who has asked to
  see the report.

14
The FICO Credit Score

• FICO stands for Fair, Isaacs and Co., who
  originated the scoring.
• Boils the whole credit report down to one number
  that has proven reliable.
• Different lenders will weight different factors
  differently.
• Can be as high as 800. Average is in the mid to
  high 600s High 600s and 700s are excellent.

Breakdown of Credit Scores Fair Isaac
Corporation
15
Determining the FICO Score

• Past delinquency Late payments lower the score.
• The way credit has been used Someone who is
  maxed out or close to the limit on a credit card
  is considered a greater risk than someone who
  does not look at the high credit line as a
  license to print money.
• The age of the credit file Fair, Isaacs model
  assumes people who have had credit for a long
  time are less risky.
• The number of times a person asks for credit.
• A customers mix of credit Someone with only a
  secured credit card is generally considered
  riskier than someone who has a combination of
  installment and revolving loans.
• A complete explanation can be read at
  http//www.myfico.com/CreditEducation/WhatsInYourS
  core.aspx?fire5

16
Mortgages FICO

• Freddie Mac
• score above 660 is acceptable.
• Under 620 is high risk.
• Very good scores are in the mid-700s, for
  borrowers above 750, there can be discounted
  rates.
• Table at right is for 150,000 30-year fixed loan
  on August 30, 2005. Source FairIsaac , which
  updates this table daily at http//www.myfico.com/
  FICOCreditScoreEstimator/AboutScores.aspx

17
Credit Cards Auto Lenders

• Credit Cards
• Weight on-time payment of revolving accounts very
  highly
• Different rules for students with starter card
  some say too lenient
• Auto lenders
• More like mortgages
• Uses debt ratios
• Weights car payments more highly than revolving
  credit

18
Improving Ones Credit Report

• First, pay bills on time, reduce use of credit
  lines available, and reduce your debt ratios.
• Some credit reports contain errors. You can use
  the form letter in your text as a model to
  request changes.
• The CRA is legally bound to investigate and
  notify the originator of the bad report.
• If the originator does not respond in 30 days,
  the CRA must eliminate the bad report.
• Accurate negative information can only be erased
  by the passage of time.

19
Time limits for certain accurate negative items

• Bankruptcy 10 years.
• Credit information reported in response to an
  application for a job with a salary of more than
  75,000 has no time limit.
• Information about criminal convictions has no
  time limit.
• Credit information reported because of an
  application for more than 150,000 worth of
  credit or life insurance has no time limit.
• Default information concerning U.S. Government
  insured or guaranteed student loans up to seven
  years.
• Information about a lawsuit or an unpaid judgment
  against the consumer seven years or until the
  statute of limitations runs out, whichever is
  longer.

20
Identity Theft

• Identity theft occurs when an imposter obtains
  key pieces of information such as Social Security
  and drivers license numbers to obtain credit,
  merchandise, and services in the name of the
  victim. The victim is left with a ruined credit
  history and the time-consuming and complicated
  task of regaining financial health. Tools
  Techniques of Financial Planning.

21
What To Do About Identity Theft

• Contact one of the three Credit Reporting
  Agencies.
• View credit reports.
• Write a victim statement.
• Contact creditors of tampered accounts.
• Contact law enforcement agency.
• Change all passwords and PINs.
• Change your drivers license number.
• Contact your telephone and utility companies.
• See http//www.consumer.gov/idtheft/index.html
  for more information.

22
Avoiding Credit Scams

• Ads Promising Debt Relief May Be Offering
  Bankruptcy.
• Advance-Fee Loan Scams
• Credit Repair Scams
• The Credit Repair Organizations Act
• If it sounds too good to be true, it probably
  is.

23
Other Consumer Protection Laws

• Many consumer publications are available at
  http//www.federalreserve.gov/consumers.htm.
• Consumer Credit Protection Act of 1968 - Truth
  in Lending
• Consumer Leasing
• Real Estate Settlement Procedures Act
• Equal Credit Opportunity Act
• Fair Credit Billing Act