I. Borrowing on open account

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Lecture 5

• I. Borrowing on open account

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Why Borrow?

• Avoid paying cash for large purchases (like a
  car)
• Meet financial emergencies
• Convenience
• Investment purposes

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Improper Uses of Credit

• Meet basic living expenses
• Make impulse purchases
• Purchase non-durable goods(like restaurant
  meals)
• Rule of Thumb
• THE PRODUCT PURCHASED SHOULD OUTLIVE THE
  CREDIT PAYMENTS

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Establishing Credit

• Open checking and savings accounts.
• Get one card and make small purchases.
• Build a good credit history by
• paying on time
• fulfilling all credit obligations
• 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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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.

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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 (not a good deal)
• Other services or rebates
• Interest rates and fees

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Other Credit Cards Charge Accounts

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

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Debit Card

• Looks like credit card but works like writing a
  checkaccesses your checking account.
• Does not provide line of credit.
• Prepaid card is a debit card with fixed amount
  availabledoes not access your checking account.

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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!
• Money accessed by writing checks

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Forms of revolving credit

• Overdraft protection
• Unsecured personal credit lines
• available on an as-needed basis
• Home equity credit lines
• secured by the owners equity in their home
• interest tax deductible (if you itemize
  deductions)

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Opening a Credit Account

• The Application
• The Investigation
• The Credit Bureau
• The Credit Decision

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The Credit Application
Applicant submits information on income, marital
status, employment history, existing accounts.
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The Credit Application
Applicant submits information on income, marital
status, employment history, existing accounts.
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.
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.
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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If You Are Denied Credit

• You must be told why (see laws in Ex. 6.12).
• You are entitled to a free copy of your credit
  report within 60 days of denial (you may have to
  ask for it).
• If you can prove error, it must be corrected.
• If you cannot prove error, you may supply an
  explanation.

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Computing Finance Charges

• Interest rate applied to outstanding balance.
• Balance 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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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
• Easy resolution to unsatisfactory purchases
• Convenience and emergencies
• Disadvantages of Credit Cards
• Easy to overspend
• High interest costs

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If youre getting into trouble...

• Try a credit counselor
• Helps you prepare budget and repayment schedule
• Deals with creditors to possibly reduce some
  interest fees
• File Bankruptcy
• Chapter 13debt restructuring
• Chapter 7wipe the slate clean