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?
• 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)

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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?
MAXIMUM 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 (ex 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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Forms of revolving credit

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

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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.
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.
• 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 an error is on your credit
  report, it must be corrected.
• If you cannot prove the error, you may supply an
  explanation.

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Computing Finance Charges

• Lenders must disclose
• Annual percentage rate (APR) applied to
  outstanding balance.
• Method used in computing finance charges.
• Balance to which interest rate is applied is
  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 interest rate of 18 and
  uses the average daily balance method including
  new purchases.

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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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• See what a difference the balance method makes
  in this example where the same interest rate and
  pattern of purchases and payments were used!

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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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

• Can be used for short, interest-free loans
• 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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Options if youre getting into trouble...

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

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THE END