Credit Terms and APRs

Key Concepts You can begin to establish a good credit rating without a credit card by holding a job, maintaining checking or savings accounts, and paying your rent and utilities on time. It is a good idea to check your credit report regularly for errors or any missing information that could affect your credit rating. Knowing about finance charges can help you determine the additional cost of using credit and whether or not you can afford to. Managing your credit wisely involves knowing when to use credit. It also involves knowing what to do if you have a financial problem.

Credit allows you to buy goods and services now and pay for them later.

Understanding Credit When you buy with credit instead of giving money for your purchases, you promise to pay later. In other word, you are using your future income now. Although you may make a credit purchases now, the exchange is not complete until you finish paying later. Credit is based on trust between the creditor and the credit user, or borrower. A creditor makes credit available to consumers by loaning money or selling goods and services on credit. Since credit is based on trust, the creditor must believe the borrower can and will pay what is owed. Finance Charges are the total amount a borrower must pay for the use of credit.

Disadvantages of Credit Using Credit Advantages of Credit Disadvantages of Credit Credit allows the use of goods, such as a car or house, as you pay for them. Credit allows you to buy an expensive item without saving large amounts of money in advance. Credit can offer a source of cash to provide temporary help for an unexpected expense or emergency. Credit offers convenience. It eliminates the need to carry large amounts of cash when shopping. Credit provides a record of purchases. Exchanges, returns or purchases, exchanges, returns, and online orders are easier with credit. Using credit reduces future income. By using credit now, you are spending tomorrow’s income. This reduces the amount of money you will have to spend in the future. Using credit is expensive. The more credit you use and the more time you take to repay, the greater the finance charges are. Using credit can encourage impulse buying. Credit makes it easy to spend money you do not have and buy more than you can afford. Misusing credit can cause serious problems, such as a bad credit rating, repossession of goods, or bankruptcy.

Types of Credit Various types of credit are available to consumers. Each type comes in a different form to meet different consumer needs. Some types are used to buy goods and services, while others are used to borrow money.

Credit Card Accounts Many retail stores and businesses issue credit cards so consumers can use credit to buy their goods and services. These cards have a credit limit and can only be used at the business that issues the credit. Banks and other financial institutions also issue credit cards. These cards have a credit limit as well, but they can be used wherever they are accepted by business. In addition to making purchases at numerous businesses, these credit cards can also be used to obtain cash advances. It is important to remember that the cost of using credit cards is often high. Many credit card companies charge an annual fee for using their card. There is usually a fine for failing to make your payments on time. Interest rates on credit cards tend to be high as well. Interest is the price paid for the use of money over a period of time. It is usually stated as an annual percentage rate (APR). An annual percentage rate (APR) is the actual rate of interest charged on a yearly basis.

Credit pays for the merchandise according to a set schedule of payments. Finance charges are included in the payments. Buyers are usually asked to sign a contract for the type of credit purchase. A down payment in cash may also be required. If the buyer fails to make payments, the seller can repossess the merchandise. Overusing credit cards is a major reason many people get into financial trouble. It is usually not a good idea to get a credit card before you are financially secure. Many credit cards offer incentives to encourage you to open and use accounts. Some eliminate the annual fee. Others offer you cash rebates for using your credit cards based on a percentage or your charges each month. Various credit cards offer rebates on groceries, gasoline, movie rentals, automobiles, airline tickets, and many other items. Most credit card accounts are known as a revolving charge account. This type of credit card account allows customers the choice of paying for purchases in full each month or spreading payments over a period of time.

Effects of Minimum Payments and Finance Charges on Credit Card Balances Month Balance Minimum Payment Finance Charge January $500.00 $10.00 $7.50 February $497.50 $7.46 March $494.96 $7.42 April $492.38 $7.39 May $489.77 $7.35 June $487.12 $7.31 TOTALS $484.43 $60.00 $44.43

Charge Accounts Some businesses allow customers to charge goods and services on a charge account on file at the business. This is another way businesses can extend credit to customers without using credit cards. Once a month, the business will send the customer a bill or statement. The customer is then expected to pay in full by the assigned due date. If the customer pays on time, there is no finance charge. Can you think of local businesses that offer this type of account?

Installment Accounts An installment account is often used to charge expensive items such as a major appliance or piece of furniture. The buyer pays for the merchandise according to a set schedule of payments. Finance charges are included in the payments. Buyers are usually asked to sign a contract for this type of credit purchase. A down payment in cash may also be required. If the buyer fails to make payments, the seller can repossess the merchandise.

Vehicle Leasing Vehicle leasing is a credit transaction by which a person rents a car according to certain restrictions. The transaction usually requires a lower down payment and monthly payment. This makes a lease agreement appear attractive. With a lease, however, you do not own the vehicle. The contract may limit the driver to a certain number of miles. You may also be charged a fee for excess mileage as well as the extra wear and tear.

Cash Loan It may become necessary to borrow money to buy items you need or want. This type of credit is called a cash loan. Commercial banks, savings banks, credit unions, loan companies, and some life insurance companies make various types of cash loans. To get most cash loans, a borrower is required to pledge collateral. Collateral is something of value held by the creditor in case you are unable to repay the loan. For an auto loan, the car is collateral. For a mortgage, the house serves as collateral. If the borrower fails to pay according to the agreement, the creditor may take the property to settle the claim against the borrower. Although a person may have nothing to pledge as collateral, getting a loan is still possible if the person has a cosigner. A cosigner is a responsible person who signs a loan agreement with the borrower. By signing the agreement, the cosigner promises to pay the loan if the borrower fails to pay. Most cash loans are repaid like an installment account. The borrower makes regular monthly payments that include finance charges.

Home Equity Loans Lenders offer a home equity loan to homeowners. This types of loan provides automatic access to a sum of money separate from the amount the homeowner borrowed to purchase the house. A home equity loan is based on the homeowner’s equity in the house. Equity is determined by subtracting how much is owed on a house from the amount the house is worth. If your house is worth $120,000 and you still owe the bank $90,000, the amount of equity in your house is $30,000. Once the loan is approved, it resembles a checking account. You can write yourself a check that draws money from your preapproved loan. The advantage of this type of loan is that the interest on it is often tax deductible. Because a home equity loan is so easy to obtain, it may temp you to make unnecessary purchases. In this case, a home equity loan may be a disadvantage. You should think very carefully about getting a home equity loan. The collateral for a home equity loan is the house itself. Nonpayment of a loan, or sometimes a late payment, has caused some home owners to lose their homes.

Establishing Credit When you first try to establish credit, you may have a hard time. This is because creditors want evidence before they grant you credit that you can and will pay your debts. When you apply for credit, you will be asked to fill out a credit application form. This form helps creditors evaluate your credit rating. A credit rating is the creditor’s evaluation of a person’s willingness and ability to pay debts. In evaluating a credit rating, creditors look for a person who is a good credit risk. That is, they issue credit to people who are most likely to repay the debt. Creditors consider people who have jobs with steady incomes as good credit risks. They also look for factors such as: Making regular, on-time payments on credit purchases, loans, or fixed expenses such as rent or utilities. Owning a car, home, stocks, or bonds. Living in the same community for a period of time.

The Cost of Credit Anytime you use credit, it is important to find out how much it will cost you. Knowing the exact cost of credit can help you compare finance charges and find the best deal. Knowing this cost can help you decide how much credit you can afford. It can also help you decide if buying now and paying later is worth the extra price. When you apply for credit, the following factors determine the amount of finance charges you may pay: Amount of credit used. Interest rate. Length of the repayment period.

The Amount of Credit Used The more you charge or borrow, the more interest you are likely to pay.

The Interest Rate You will pay more in finance charges with higher interest rates. The credit agreement indicates the rate(s) that will be charged. Sometimes a creditor offers an extremely low rate as an introductory offer that increases after a specified time. Make sure you know the terms of a credit agreement before signing it. Also be aware of the grace period. The grace period is the number of days allowed to pay for a new purchase before interest is charged.

Cost of Using Credit Based on Annual Percentage Rate Annual Percentage Rate (APR) 18% 21% 24% Amount Financed $300 Number of Monthly Payments 12 Finance Charge $30.00 $35.16 $40.44 Monthly payment amount $27.50 $27.93 $28.37 Total Paid $330.00 $335.16 $340.44

The Repayment Period The more time you take to pay back the money you borrow or charge, the more you will pay in interest. By law, creditors are required to state finance charges in credit agreements as a dollar amount and as an annual percentage rate.

Cost of Using Credit Based on Repayment Time Number of monthly payments 12 18 24 Amount Financed $300 Annual Percentage Rate (APR) 18% Finance Charge $30.00 $44.66 $59.46 Monthly payment amount $27.50 $19.15 $14.98 Total Paid $330.00 $344.66 $359.46

Guidelines for Using Credit Wisely Stay within your credit limits. Use credit sparingly and only after careful thought. Shop around for the best credit terms before you borrow or charge. Deal only with reputable creditors. Read credit agreements before signing them. Make sure you understand all the credit terms and can fulfill your obligation. Keep records of all credit transactions. Include receipts, payments, contracts and correspondence. Keep the records organized in a file, not scattered in a drawer. Pay off balances on revolving charge accounts each month to avoid finance charges. Keep a good credit rating by paying promptly. Contact creditors about billing errors and have them corrected quickly. If you have trouble making credit payments, contact your creditors right away. Notify creditors immediately if your credit card is lost.

Should You Use Credit? Consider your needs, your available cash, and the alternatives to using credit. Then evaluate your choices. You could choose not to buy the item. You could pay for the item with your savings, or save your money any buy the item later. Ask yourself the following questions to help decide: How important is it to buy the item now? Can I do without it? The extra cost of using credit can eliminate the benefit of having what you want now. Should I use my savings to make the purchase? Replacing the savings used for an unplanned purchase can be difficult and risky. This may leave you unprepared for emergencies for financial problems. Should I same money and buy the item later? This is often the wisest choice. You may find by waiting that you did not really need the item after all. One way to help you decide if you can afford to buy on credit is to figure your debt-to-income ratio. First total all your monthly debts such as car loan and credit card payments. Then divide that amount by your monthly take home pay. Ideally, the resulting debt ration should not be more than 15%. Consider buying on credit only if your debt-to-income ration will stay under 15% after the loan.

Shopping for Credit Compare the three factors that affect credit costs: Size of the loan or the amount of credit used Annual percentage rate Repayment time. Compare the total cost of the credit, including all finance charges and other fees to make sure you are really getting the best deal. Sometimes low-priced items offer no cost savings because of high finance charges.