About Credit

1
About Credit

• KFL

2
What is Credit?

• Credit is the ability to borrow money with a
  promise of future payment.

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Advantages and disadvantages

• Advantages
• Able to buy needed items now
• Dont have to carry cash
• Creates a record of purchases
• More convenient than writing checks
• Consolidates bills into one payment

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Advantages and disadvantages

• Disadvantages
• Interest (higher cost of items)
• May require additional fees
• Financial difficulties may arise if one loses
  track of how much has been spent each month
• Increased impulse buying may occur

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Two Basic Forms ofConsumer Borrowing

• LOANS
• Get borrowed amount all at once, then need to
  make payments to lenders with interest
• 2. CREDIT CARD ACCOUNTS
• Purchase amount added to your account, then need
  pay required minimum each month

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It COSTS to Use Credit

• Future repayment usually includes interest.
• Opportunity cost of using credit is what you
  could have spent in the future if you werent
  repaying a loan plus interest!

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Say What?
For example You want to use credit to buy an
outfit for 100. 100 X .15 interest 15 100
15 115 Therefore, you are really giving up
115 worth of future spending for the ability to
spend 100 now. The opportunity cost of of using
credit to buy this outfit is whatever you would
have bought for 115 one year later.
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More about APR

• When you borrow money, you eventually have to pay
  the lender something if you carry a balance.
  That something is APR.
• Annual Percentage Rate

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More about APR

• Ted owes 720 on his credit card, which has an
  interest rate of 18 per year. What is Teds
  monthly interest rate?
• Take yearly interest rate and divide by 12 (for
  12 months).
• .18 / 12 .015 (1.5 per month)

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More about APR

• Now, Ted decides to pay his minimum payment of
  20 on his 720 balance.
• How much of his payment will be interest?
• Take amount owed and multiply it by monthly
  interest rate.
• 720 .015 10.80 (10.80 of his 20 payment
  is going toward interest)

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More about APR

• Now, how much will this 20 payment reduce Teds
  debt?
• Take the minimum payment and subtract the monthly
  interest total.
• 20 - 18.80 9.20 (Teds debt of 720 is only
  reduced by 9.20)

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How long before Ted pays his debt?

• At this rate, it will take Ted over 5 years to
  pay off the original debt of 720!
• Always pay more than the minimum balance, or try
  to pay off your balance each month to avoid
  paying more than you need to.

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The Three Cs

• Character will you repay the debt?
• From your credit history, does it look like you
  possess the honesty and reliability to pay credit
  debts?
• Have you used credit before?
• Do you pay your bills on time?
• Can you provide character references?
• How long have you lived at your present address?
• How long have you been at your present job?

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The Three Cs

• Capital what if you dont repay the debt?
• Do you have any valuable assets such as real
  estate, savings, or investments that could be
  used to repay credit debts if income is
  unavailable?
• What property do you own that can secure the
  loan?
• Do you have a savings account?
• Do you have investments to use as collateral?

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The Three Cs

• Capacity can you repay the debt?
• Have you been working regularly in an occupation
  that is likely to provide enough income to
  support your credit use?
• Do you have a steady job? What is your salary?
• How many other loan payments do you have?
• What are your current living expenses? What are
  your current debts?
• How many dependents do you have?

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Your Responsibilities

• Borrow only what you can repay
• Read and understand the credit contract
• Pay debts promptly
• Notify creditor if you cannot meet payments
• Report lost or stolen credit cards promptly
• Never give your card number over the phone unless
  you initiated the call or are certain of the
  callers identity

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Your Rights

• Truth in Lending Act (1968)
• Ensures consumers are fully informed about cost
  and conditions of borrowing
• Fair Credit Reporting Act (1970)
• Protects the privacy and accuracy of information
  in a credit check

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Your Rights

• Equal Opportunity Act (1974)
• Prohibits discrimination in giving credit on the
  basis of sex, race, color, religion, national
  origin, marital status, age, or receipt of public
  assistance
• Fair Credit Billing Act (1974)
• Sets up a procedure for the quick correction of
  mistakes that appear on consumer credit accounts

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Your Rights

• Fair Debt Collections Practices Act (1977)
• Prevents abuse by professional debt collectors,
  and applies to anyone employed to collect debts
  owed to others does not apply to banks or other
  businesses collecting their own accounts

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Rights one more

• President Bush Signs the Fair and Accurate Credit
  Transactions Act of 2003
• Improving the quality of credit information, and
  protecting consumers against identity theft
• Gives every consumer the right to their credit
  report free of charge every year
• Helping prevent identity theft before it occurs
  by requiring merchants to leave all but the last
  five digits of a credit card number off store
  receipts

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Fair and Accurate Credit Transactions Act of
2003

• Creating a national system of fraud detection to
  make identity thieves more likely to be caught.
  Previously, victims would have to make phone
  calls to all of their credit card companies and
  three major credit rating agencies to alert them
  to the crime. Now consumers will only need to
  make one call to receive advice, set off a
  nationwide fraud alert, and protect their credit
  standing.

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Building a Credit History

• Establish a steady work record
• Pay all bills promptly
• Open a checking account and dont bounce checks
• Open a savings account and make regular deposits
• Apply for a local store credit card and make
  regular monthly payments or pay off
• Apply for a small loan using your savings account
  as collateral

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Types and Sources of Credit

• Single payment credit
• Items and services are paid for in a single
  payment, within a given time period, after the
  purchase. Interest is usually not charged.
• Utility companies, medical services
• Some retail businesses

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Types and Sources of Credit

• Installment Credit
• Merchandise and services are paid for in a two or
  more regularly scheduled payments of a set
  amount. Interest is included.
• Some retail businesses, such as car appliance
  dealers
• Money may also be loaned for a special purpose,
  with the consumer agreeing to repay the debt in
  two or more regularly scheduled payments
• Commercial banks
• Consumer finance companies
• Savings and loans
• Credit unions

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Types and Sources of Credit

• Revolving Credit
• Many items can be bought using this plan as long
  as the total amount does not go over the credit
  users assigned dollar limit.
• Repayment is made at regular time intervals for
  any amount at or above the minimum required
  amount. Interest is charged on the remaining
  balance.
• Retail stores
• Financial institutions that issue credit cards

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How much can you afford?The 20-10 rule

• Never borrow more than 20 of your yearly net
  income
• If you earn 400 a month after taxes, then your
  net income in one year is
• 12 x 400 4,800
• Calculate 20 of your annual net income to find
  your safe debt load
• 4,800 x 20 960
• So, you should never have more than 960 of debt
  outstanding

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How much can you afford?The 20-10 rule

• Note Housing debt (mortgage payments) should
  not be counted as part of the 20, but other debt
  should be included, such as car loans, student
  loans, and credit cards.

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How much can you afford?The 20-10 rule

• Monthly payments shouldnt exceed 10 of your
  monthly net income
• If your take-home pay is 400 a month
• 400 x 10 40
• Your total monthly debt payments shouldnt total
  more than 40 per month

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How much can you afford?The 20-10 rule

• Note Housing debt (mortgage payments) should
  not be counted as part of the 20, but other debt
  should be included, such as car loans, student
  loans, and credit cards.

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A Credit Report
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Manner of payment codes
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How much can they safely carry?

• Most people can afford a certain amount of credit
  and stay within a safe budget. This amount is
  called a safe debt load.
• The following exercises will give you practice
  determining safe debt loads based on various
  incomes and fixed expenses.

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How much can they safely carry?

• David has a monthly net income of 1,360. His
  fixed monthly expenses consist of a rent payment
  of 450. He is paying off a student loan of 116
  per month.
• David would like buy a new television set using
  a credit card. What is the largest monthly
  payment David can afford for the television set
  so that his credit card payments and student loan
  keep him within a safe debt load of 10?

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How much can they safely carry?

• David can afford 20 a month.
• 1,360 x 10 136
• (his monthly debt load)
• 136 - 116 20
• (debt load existing debt)

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How much can they safely carry?

• Marsha and Michael have a combined monthly net
  income of 3,500. Their fixed monthly expenses
  consist of 675 for rent. They also have an
  outstanding student load balance of 6,000 and a
  balance of 1,000 for the stereo they bought last
  month.
• How much more debt can they take on and still be
  within a safe debt load?

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How much can they safely carry?

• Marsha and Michael can afford 1,400
• 3,500 x 12 42,000
• 42,000 x 20 8,400
• 8,400 - 6,000 - 1,000 1,400