CHAPTER 6: BORROWING ON OPEN ACCOUNT

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CHAPTER 6 BORROWING ONOPEN ACCOUNT
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The Basic Concepts of Credit

• Why Borrow?
• To smooth consumption
• To avoid paying cash for large purchases (like a
  car)
• To meet financial emergencies
• Convenience

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Some Credit Danger Signs

• Regularly use credit cards to buy on impulse
• Regularly exceed the borrowing limit on the
  credit cards
• Take 60 to 90 days to pay bills that once took 30
  days
• Have to borrow just to meet basic living needs
• Can barely make the minimum required payments on
  bills
• Have no savings

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Rule of Thumb!

• THE PRODUCT PURCHASED SHOULD OUTLIVE THE CREDIT
  PAYMENTS

Dont let credit squash you!
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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.

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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.
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Steps for Women in Establishing Credit

• Consistently use your own legal name to build
  credit history.
• Ex Mary Brown, not Mrs. John Brown
• Have information reported to credit bureau in
  your name as well as your husbands.
• Consider retaining separate credit file when you
  marry.

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Open Account Credit

• Credit extended to a consumer in advance of any
  transaction.
• Consumer can buy/borrow up to a specified amount,
  the credit limit.
• Usually, interest can be avoided by paying
  balance in full promptly.

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Bank Credit Cards

• Issued by financial institutions
• Features include
• Line of credit dependent upon applicants
  financial status and ability to pay
• Cash advances and balance transfers
• Other services or rebates
• Interest rates and fees

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Other Credit Cards Charge Accounts

• Retail charge cards (ex Sears)
• 30-day charge accounts
• Travel entertainment cards
• Prestige cards
• Affinity cards
• Secured credit cards
• Student credit cards

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Debit Card

• Looks like a credit card but works like writing a
  checkaccesses your checking account.
• Does not provide line of credit.
• Greater liability exposure in event of fraudulent
  use.
• Prepaid card is a debit card with fixed amount
  availabledoes not access your checking account.

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When Losing a Credit Card or Debit Card

• Credit card
• Card holder not liable for fraudulent charges if
  loss is reported before the card is used
• If reported after the card is used, maximum
  liability is 50

• Debit card
• If stolen, the thief could wipe out your checking
  account!
• Check with your bank regarding policies on lost
  or stolen cards

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Revolving Credit Lines

• Open account credit offered by banks and other
  financial institutions.
• Usually offer higher credit lines and lower
  interest rates than credit cards!
• Money accessed by writing checks.

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Forms of revolving credit

• Overdraft protection lines
• A line of credit linked to a checking account
• Enables a depositor to overdraw the account up to
  a predetermined limit
• Usually with limits between 500 to 1000
• Unsecured personal credit lines
• Available on an as-needed basis
• Money is accessed by writing checks
• Repayment is set up on a monthly installment
  basis

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Forms of revolving credit

• Home equity credit lines
• Secured by the equity in owners home
• Interest tax deductible up to 100,000 (if you
  itemize deductions)
• Lenders usually set the maximum credit line at
  75-80 of the market value of the home
• Example A couple buys a home for 85,000, ten
  years later, its worth 165,000. Mortgage
  balance is 45,000. Using 75 loan-to-market
  value ratio, how much can they borrow?
• Answer 0.75165,000-45,000 78,750.

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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.

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The Credit Application
Applicant submits information on income, marital
status, employment history, existing accounts,
etc.
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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.
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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

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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
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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.

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• ADB excluding new purchases
• The most consumer friendly!
• ADB including new purchases
• Most frequently usedno grace period on new
  purchases if you carry a balance.
• Two-cycle ADB excluding new purchases
• Calculated using last 2 billing cycles.
• Two-cycle ADB including new purchases
• Least consumer friendly method!

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• 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.
• (Refer to Exhibit 6.8 in text.)

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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

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• Refer to Exhibit 6.7 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
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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.

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Using Credit Wisely

• Shop around, comparing
• Annual fees other fees
• APR
• Length of grace period
• Balance method

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• 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

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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.

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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.

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Credit Card Fraud

• Never give account number to someone who calls
  youyou 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!

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Options if youre getting into trouble...

• File Bankruptcy
• Wage Earner Plan (Chapter 13debt restructuring).
• Viable for one with a steady income and a
  reasonable amount of debt
• A majority of the creditors must agree to the
  plan
• Interest charges and late-payment penalties are
  waived for the repayment period
• Account for less than 30 of all bankruptcies
• Straight bankruptcy (Chapter 7wipe the slate
  clean).
• Debtor must make certain tax payments and keep up
  alimony and child-support payments
• Debtor is allowed to retain certain payments from
  Social Security, retirement, veterans, and
  disability benefits
• Debtor may retain the equity in a home, a car,
  and other personal assets to a certain limit.

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Options if youre getting into trouble...

• Other bankruptcy options
• Chapter 20 allow individual to wipe out
  unsecured debt, as per Chapter 7 then use
  Chapter 13 to restructure their secured debt,
  including mortgages, home equity loans, and other
  non-dischargeable debts.
• Try credit counselors
• Help you prepare a budget and repayment schedule.
• Deal with creditors to possibly reduce some
  interest fees.