Credit Cards and Other Forms of Credit Chapter 11 Credit Cards and Other Forms of Credit

Learning Objectives Explain how credit cards work Describe different credit card features Discuss how to use a credit card correctly Identify other risky credit arrangements

Objective 1: Explain how credit cards work

How Credit Cards Work Credit cards provide people with revolving open-end credit, which they can draw from repeatedly up to some preset limit Credit providers (like a bank) agrees to make a certain amount of credit available to the cardholder The cardholder can use card as he/she wishes as long as he/she doesn’t go over credit limit He/she will be a monthly bill listing all purchases Usually your credit score will NOT be on your credit card statement

Credit CARD Act of 2009 Listing the length of time necessary to completely pay the debt when making only minimum payments is a reporting requirement mandated by the Credit CARD Act.

Advantages of Credit Cards You can purchase products without carrying large amounts of cash or a checkbook As long as you pay the balance in full at the end of each billing cycle, you don’t incur any interest charges You receive a monthly statement that contains a list of your purchases for that month which helps you keep track of spending

Applying for a Credit Card Lenders will run a credit check on you (look at your credit report in order to look at your credit history and determine your ability to repay) They will check your cash inflows and outflows They’ll do an evaluation of your assets They will NOT ask for personal references

Types of Credit Cards Most popular brands: Visa, MasterCard, American Express, and Discover Credit cards are accepted by most merchants in the US and globally There are also retail cards available: Target, Sears, Shell, Exxon Mobil, etc. Target cards only accepted at Target

Objective 2: Describe different credit card features

Credit Card Features Credit Limit Overdraft Protection Annual Fee The maximum that you can borrow at any one time Example: $5,000 Creditors monitor how much of your limit you keep charged up If you have a $5,000 limit and keep it near that limit, it negatively impacts your credit score A feature that allows you to “overdraw” or exceed your credit limit Overdraft charge can be very high An overdraft triggers higher interest rates on your remaining balance Overdraft fees cannot exceed the amount of purchase that caused the overdraft Many credit card companies charge an annual fee of $20-$70 for the privilege of using their card Sometimes fee is waived for people with good credit history

Features Incentives to Use Card Prestige Cards Grace Periods Incentives encourage people to use their cards Cash-back bonuses Airline miles Donations to charities Cash-in points for gifts Aka platinum or gold cards Provides additional benefits to cardholders Special warranties on purchased products Insurance on travel Period in which you are not charged interest on your purchases Credit cards offer a grace period of at least 21 days from the time the statement is closed and the bill is calculated. If you pay your full balance within this grace period, you will not be charged any interest on your purchase.

Features Cash Advances Financing Prepaid Cash Cards You can use your card to get cash out at a bank or ATM You must pay special transaction fees Cash advances have higher interest rates No grace period Most credit cards charge interest rates 15%-22% If you’re late on a payment, interest rates will increase more than 30% Using a credit card as a type of financing is convenient, but it’s also expensive. Some companies allow you to purchase a card that you can “load” with cash Example: $100 on a Walmart prepaid cash cared. You can use it until the $100 is gone Experts estimate that a significant percentage of these cards are lost or never used The business issuing the cards get to keep the cash

Objective 3 - Discuss how to use a credit card correctly

Tips on Using Credit Cards Use credit cards only for convenience and NOT as a source of financing Set a credit limit for yourself based on the amount you can afford to repay each month Don’t go over your own preset limit A savings account generally earns LESS interest than credit companies charge for balances – so pay your debt off first You need greater cash inflow than outflow to pay off debt

If You Experience Problems Try to negotiate terms (ask lender to lower interest rates – they may do it because they’d rather you not file bankruptcy) Get credit counseling Limit your spending and try to increase inflow (work more hours, get a second job) Debt consolidation: combining several small accounts into one larger account that you may be able to finance at a lower rate at a bank or with another lender Works best when you have an asset you can pledge as collateral (like a home equity loan)

Filing Personal Bankruptcy LAST RESORT What it is: process in which the courts provide protection for a person who is unable to pay off his or her debts Courts help propose a plan to repay at least a portion of his or her debts Most involve a 3-5 year repayment plan Reported to the credit bureau and will be on your credit report for seven years (public record) During that time, the person will likely NOT get approved for new loans, if they do, the interest rate will be extremely high

Objective 4 - Identify other risky credit arrangements

Other Risky Credit Arrangements Payday Lending Tax Refund Loans or Tax Anticipation Loan A lender provides cash advances at a high cost to customers who provide a check dated for some time in the future Small loans that last 7-14 days Advantage: no credit check Ex: It’s 11/6 and you don’t get paid until 11/13 but you need $400. Payday lending will give you $400 but you must write them a check dated 11/13 for $500. Short-term loan with the idea that you use your income tax refund to repay what they’ve borrowed Aka “Rapid Refund” Fees are high Refund may be lower than expected Debt > refund

Other Risky Credit Arrangements Pawn Shops Cell Phone Leases Pawnbroker: receives and holds items in exchange for loans that run for 30 days – 3 months Commonly pawned items = jewelry, vehicles, firearms, etc. If you don’t repay the loan, they can sell your item Your pawned item = collateral for pawnbroker If you pay back the loan before the due date, you get your item back Cell phone plans = type of debt Landline services = utilities Cell phones have a lease of at least a year When you sign the lease, you’re entering into a contract If you default on a cellphone lease, it will appear on your credit score