Chapters Six and Seven

1
Chapters Six and Seven

• Credit CardsCh 6
• The Basic Concepts of CreditCh 7

2
Definitions and Examples of Credit

• Credit -- receiving cash, goods, or services with
  an obligation to pay later.
• Examples -- auto loans or personal loans
• Open credit -- credit that you can use and repay
  at your pace so long as you pay the required
  minimum monthly payment.
• Examples -- Credit cards or department store
  credit cards

3
Determining the Costs of Open Credit

• The balance owed
• Interest rates
• Balance calculation method
• Cash advance costs
• The grace period
• The annual fee
• Additional or penalty fees

We will look at some of these in detail on the
next slides.
4
Interest Rates

• Annual percentage rate (APR) true simple
  interest rate paid over the life of the loan
• Teaser rates introductory rates used to attract
  new customers, some as low as 2.9
• Most credit cards compound interest

5
Balance Calculation Methods

• Average daily balance, most common
• Including new purchases
• Excluding new purchases
• Two-cycle
• Previous balance most expensive
• Adjusted balance least expensive

6
Average Daily Balance Method of Computing
Interest.

• Opening Balance is 250on 3/23
• Purchases 300 on 4/12 and 150 on 4/18
• Payment of 100 on 4/19
• Ending Date is 4/22
• Interest Rate is 21 annual

7
Buying Money The Cash Advance

• An extremely expensive way to borrow
• Interest begins immediately and may be at a
  higher rate than for purchases
• Usually there is a cash advance fee of 2 to 4
  of the amount advanced
• Some cards require payment of the purchase
  balance before payment of the cash advance balance

8
The Grace Period

• Normally 20 to 25 days, excluding cash advances
• Doesnt apply if you carry a balance
• With no balance, you could avoid paying for a
  purchase for nearly 2 months
• Not all credit cards offer a grace period

9
The Annual Fee

• Range from 0 to 100 (American Express charges
  300 for their Platinum card.)
• 70of the 25 biggest card issuers dont charge an
  annual fee.
• Merchants discount fee -- charged to merchants,
  typically 1.5 to 5.0 of the purchase amount

10
Additional Fees

• Cash advance fee
• Late fee
• Over-the-limit fee
• Penalty rates
• Be alert-- Important Notice of Change of Terms

11
The Pros of Credit Cards

• Convenience or ease of shopping
• Emergency use
• Consume and use before the purchase is fully paid
  for
• Bill consolidation
• Can be used in anticipation of price increases

12
The Pros of Credit Cards (contd)

• Interest-free credit
• Make reservations
• Use as identification
• A source of free benefits

13
The Cons of Credit Cards

• Its too easy to lose control of spending.
• Its, in general, an expensive way to borrow
  money.
• Its an obligation of future income--youll have
  less to spend in the future.

14
Choosing a Source of Open Credit

• Bank credit cards
• Bank card variations
• Travel and entertainment (TE) cards
• Single-purpose cards
• Traditional charge account

15
Know Your Credit Card Philosophy

• Credit user
• Low APR
• Convenience user
• Low annual fee
• Long, interest-free grace period
• Free benefits
• Convenience and credit user
• Balance interest rate and annual fee for the
  lowest total cost

16
Getting a Credit Card The Five Cs of Credit

• Character
• Capacity
• Capital
• Collateral
• Conditions

17
Credit Evaluation The Credit Bureau

• The credit bureau collects and reports
  information from creditors, public court records,
  and the consumer.
• Determining your creditworthiness -- credit
  scoring determines if you qualify for credit and
  the interest rate offered.

18
Information on Your Credit Report

• Personal demographics
• age
• Social Security number
• addresses
• Employment history
• Credit history

19
Information on Your Credit Report (contd)

• Criminal convictions and judgments
• Previous two years of inquiries

20
Factors That Determine Creditworthiness

• Annual income
• Length of time at current residence
• Length of time at current job
• Type of residence
• Age
• Employment

21
Factors That Determine Creditworthiness (contd)

• Number of bank accounts
• Number of credit cards
• If you have a telephone
• Credit history
• Note All the factors provide information
  historically linked with individuals that are
  good credit risks.

22
Managing Your Credit Cards and Open Credit
Issues to consider

• Reducing your balance
• Protecting against fraud
• Trouble signs in credit card spending
• Controlling spending
• If you cant pay your credit card bills

In Detail on next slides
23
Reducing Your Balance

• Pay more than the 2 to 3 minimum monthly
  payment
• Find a card that offers a lower interest rate

24
Protecting Against Fraud

• Save your credit card receipts.
• Compare them to your statement.
• Destroy old receipts.
• Use caution when giving out your credit card
  number.
• Never leave a store without your card.

25
Trouble Signs in Credit Card Spending

• Take the Credit Card Habits Quiz.
• Evaluate your credit card usage.

26
Controlling Your Credit Card Spending

• Set goals
• Develop a budget
• Track your credit spending
• Record all credit purchases in a ledger

27
What to Do If You Cant Pay Your Credit Card Bills

• Act your wage!!
• Make sure you have the least expensive credit
  card.
• Consider using savings, if possible, to pay off
  debts.
• Consolidate your debts with a home equity loan or
  secured personal loan.

28
Characteristics of Consumer LoansChapter Seven

• Single-payment versus installment loans
• Secured versus unsecured loans
• Variable-rate versus fixed-rate loans

29
Single-Payment Loans Versus Installment Loans

• Single-payment or balloon loans
• sometimes called bridge or interim loans, because
  they are used until permanent financing can be
  arranged
• loan is repaid in one lump-sum, including
  interest
• normally for short-term lending of one year or
  less

30
Single-Payment Loans Versus Installment Loans
(contd)

• Installment loans
• loan is repaid at regular intervals
• payment includes both principal and interest
• normally used to finance cars, appliances, and
  other expensive items

31
Installment Loan Amortization

• The process of your payment going more toward
  principal and less toward interest each
  subsequent month.
• Based on a simple-interest calculation.

32
Computing Payments on Installments Buy 2,000 of
merchandise 9, 2-year with monthly payments.

• Traditional
• Add-on

33
Secured Versus Unsecured Loans

• Secured loans
• are guaranteed by a specific asset
• typically have lower rates

34
Secured Versus Unsecured Loans (contd)

• Unsecured loans
• require no collateral
• offered to borrowers with excellent credit
  histories
• normally have high rates of interest 12 to 21
  annually

35
Fixed-Rate Versus Variable-Rate Loans

• Fixed-rate loans
• have the same interest rate for the duration of
  the loan
• normally have a higher initial interest rate
  because the lender could lose money if the rates
  increase
• most consumer loans are fixed-rate loans

36
Fixed-Rate Versus Variable-Rate Loans (contd)

• Variable-rate loans
• have an interest rate that is tied to an index
  (e.g., prime rate, 6-month Treasury bill rate)
• can adjust on different intervals such as
  monthly, semi-annually, or annually
• have a lifetime adjustment cap
• normally have a lower initial interest rate
  because the lender wont lose money if the rates
  increase

37
Fixed-Rate Versus Variable-Rate Loans (contd)

• Convertible loans begin as a variable rate loan
  and can be locked into the current rate a some
  predetermined time in the future.

38
The Loan Contract

• Insurance agreement clause
• Acceleration clause
• Deficiency payments clause
• Recourse clause

39
Special Types of Consumer Loans

• Home equity loans
• Student loans
• Automobile loans

40
Home Equity Loans

• Are basically second mortgages
• Use the equity in your home to secure your loan
• Normally allow you to borrow up to 80 of your
  equity

41
Home Equity Loans (contd)

• Advantages
• interest payments are tax-deductible
• lower rates of interest than other types of
  consumer loans
• Disadvantages
• puts your home at risk if you default
• sacrifices future financial flexibility because
  you can only have one outstanding home equity loan

42
Student Loans

• Loans with low, federally subsidized interest
  rates used for higher education.
• Are tax-advantaged under the 1997 Taxpayer Relief
  Act.
• Examples Federal Direct/Stafford loans for
  students PLUS Direct/PLUS Loans for parents.

43
Student Loans (contd)

• Federal Direct and PLUS Direct available through
  the school Stafford and PLUS loans available
  through lenders.
• Payment on Federal Direct and Stafford loans
  deferred for 6 months after graduation.
• Borrowing limits apply.

44
Automobile Loans

• A consumer loan that is secured with an
  automobile.
• Has a lower interest rate than an unsecured loan.
• Normally has a maturity length of 2 to 6 years.

45
Cost and Early Payment of Consumer Loans (see
examples)

• Cost of single-payment loans.
• Cost of installment loans.
• Early repayment of installment loans.
• Understanding the relationship between your
  payments, interest rates, and the term of the
  loan.

46
Payday Loans

• High fees charged.
• Short-term loan of 1-2 weeks.
• Those with jobs and checking accounts and
  students are typical users.
• Check held by the payday lender.

47
Payment, Interest Rate and Loan Term

• The total interest cost of your loan is directly
  related to the interest rate.
• The total interest cost of your loan is inversely
  related to the maturity length.
• Your periodic payment is directly related to both
  the duration and interest rate.

48
Sources of Consumer Loans

• Inexpensive sources of loans
• home equity loans
• other secured loans
• More expensive sources of loans
• credit unions
• savings and loans
• commercial banks

49
Sources of Consumer Loans (contd)

• Most expensive sources of loans
• retail stores
• finance companies
• Those who are in the worst financial shape have
  to pay the most for credit. You must have a
  solid credit rating to borrow from the cheaper
  lenders.

50
Know How to Borrow

• Maintain a strong credit rating
• Reduce the lenders risk
• use a variable rate loan.
• keep the loan term as short as possible.
• provide collateral for the loan.
• pay a large down payment on the item to be
  purchased with financing.

51
Know When to Borrow

• Do you really need to make this purchase?
• Does it fit into your financial plan?
• If cash is used, can you maintain sufficient
  liquidity?
• What is the after-tax cost of borrowing versus
  the after-tax lost return from using savings to
  make the purchase?

52
Control Your Use of Debt

• Calculate the debt limit ratio
• Apply the debt resolution rule
• Control your consumer debt