Chapter 6 Using Credit Cards: The Role of Open Credit Professor Payne, Finance 4100

Learning Objectives Know how credit cards work. Understand the costs of credit. Describe the different types of credit cards. Know what determines your credit card worthiness and how to secure a credit card. Manage your credit cards and open credit.

Introduction Convenient, but if you’re not careful, credit cards will cost you. Some charge over 20% interest on unpaid balances. Most people don’t consider interest charges on purchases they have to have. Manage credit wisely to avoid high interest.

A First Look at Credit Cards and Open Credit Credit involves receiving cash, goods, or services with an obligation to pay later. Open credit (revolving credit) is a line of credit extended before the purchase. Unpaid balance plus interest carries over to next month. Higher balances on credit lines, higher costs.

Interest Rates Annual Percentage Rate (APR)—the true simple interest rate paid over the life of the loan APR for all consumer loans must be disclosed Fixed APR vs. variable APR Teaser Rates Compound interest

Calculating the Balance Owed The method of determining the balance (balance calculation method) Average daily balance method Previous balance method Adjusted balance method Variations—include new purchases or exclude

Buying Money: The Cash Advance Cash advances at ATMs are just like taking out a loan Higher interest rate charged immediately on cash advances Up-front fee of 2 to 4 percent of the amount advanced Pay down the balances for purchases before paying down the higher interest rate cash balance

Grace Period Grace period—the length of time given to make a payment before interest is charged against the outstanding balance on a credit card. 21-25 days from date of bill. Some credit cards have no grace period. No grace period with cash advances. On most cards, the grace period is canceled if there is unpaid balance from previous month.

Annual Fee A fixed annual charge imposed by a credit card. Over 70% of biggest credit card issuers do not charge an annual fee. Many don’t charge the fee if the card is used at least once a year. Merchant’s discount fee—the percentage of the sale that the merchant pays to the credit card issuer.

Additional Fees Cash Advance Fee Late Fee Over-the-Limit Fee Penalty Rate

Pros and Cons of Credit Cards Advantages: Convenience Used as identification Phone and internet purchases Temporary funds Use product before paying for it Bill consolidation Pay less today and earn interest elsewhere Extended warranties, travel insurance, and rewards

Pros and Cons of Credit Cards Disadvantages: Too easy to spend money Too easy to lose track of spending High interest rate Obligating future income Heavy budgetary problems with uncontrolled spending

What the CARD Act Means for You Your credit card company has to tell you when they plan to increase your rate or other fees. Your credit card company has to tell you how long it will take to pay off your balance. No interest rate increases for the first year. Increased rates apply only to new charges.

What the CARD Act Means for You Restrictions on over-the-limit transactions. Caps on high-fee cards. Protections for underage consumers. Standard payment dates and times. Payments directed to highest interest balances first. Your credit card company cannot charge you a fee of more than $25 in most cases. No inactivity fees.

Choosing a Source of Open Credit Bank Credit Cards—a credit card issued by a bank or large corporation, generally a Visa or MasterCard. Bank Card Variations—different classes (credit levels) of bank credit cards. Premium or Prestige card Affinity card Secured credit card

Choosing a Source of Open Credit Travel and entertainment (T&E) cards—do not offer revolving credit and require full payment of balance each month. Interest-free grace period. Issuers receive annual fee and merchant’s discount fee. American Express, Diners Club, and Carte Blanche are the primary issuers.

Choosing a Source of Open Credit Single-Purpose Cards—can be used only at a specific company. Companies issue their own cards to avoid merchant’s discount fees. Terms vary, some offer revolving credit. Typically, no annual fee.

Choosing a Source of Open Credit Traditional charge account—can be used to make purchases or get services only at the issuing company such as utility companies and doctors who provide services and bill later. Convenient for both issuer and payee. Pay monthly bill in full or pay interest/fee.

The Choice: What’s Best for You Credit user—carries an unpaid balance from month to month. Convenience user—pays off the credit card balance each month (avoids interest). Convenience and credit user—generally pays off all the balance

Getting a Credit Card Excellent idea for students. Emergency funds. Build solid credit history if used prudently. First step is to apply.

Credit Evaluation: The Five C’s of Credit Character Capacity Capital Collateral Conditions

The Key to Getting Credit: Your Credit Score A credit bureau—gathers information on consumers’ financial history, including payment history and sells to customers. Credit bureaus compile credit report and assign a credit score. Credit report—information on financial situation and dealings. Credit information impacts whether you get a loan, it affects your interest rate.

Determining Creditworthiness Credit scoring—numerical evaluation of ‘scoring’ of applicants based on their credit history Reduces the lender’s uncertainty Lender able to make credit available to good risk customers at lower interest rates

Your Credit Score Affects rates you pay on credit cards Affects size of credit line Affects insurance rates Affects mortgage rate Strong credit score—lower interest rate

How Your Credit Score is Computed Based on models developed by Fair Isaac Corporation. FICO Score but name and your score varies with bureau. Scores range from 300-850. Visit www.myfico.com/ficocreditscoreestimator to get an estimate of your score.

What is a good score? A good credit score doesn’t just mean that you’ll get a loan, it also means you’ll pay less for it through lower rates. Creditworthiness also based on employment history, job history, and amount of debt you currently have.

What’s in Your Credit Report? Identifying Information Trade Lines or Credit Accounts Inquiries Public Record and Collection Items

Monitoring Your Credit Score Check for errors in credit report. Get free copy of your credit report each year from the three major credit bureaus at www.annualcreditreport.com. Check all information correct, all accounts on report are yours.

Consumer Credit Rights Take credit complaints directly to the creditor. Federal laws protect consumers with complaints about credit.

The Credit Bureau and Your Rights Fair and Accurate Credit Transactions (FACT) Act—you can request one free copy for your credit report from national bureaus and contact them for inaccuracies. Bureau must investigate and correct. File a statement to explain negative information that is accurate, not corrected. Fair Credit Reporting Act (FCRA)—negative information remains on report for 7 to 10 years.

If Your Credit Card Application is Rejected Apply for a card with another financial institution. Find out why you have been rejected. Set up an appointment with credit card manager. Address the problem.

Resolving Billing Errors Fair Credit Billing Act (FCBA)—procedures for correcting billing errors. Withhold payment for item in question. Notify card issuer within 60 days of statement date. Use “billing inquiry” or “billing error” address on credit card bill. Should receive notification within 30 days. Card issuer investigates within 90 days—account is credited or not with explanation.

Consumer Financial Protection Bureau Provides single location for financial protection and oversight Ensures that financial markets are easier to understand Makes prices clear and easy to see Makes comparison shopping easier

Identity Theft Use of your name, address, Social Security number, bank or credit card account number, or other identifying information by someone other than you without your knowledge to commit fraud and other crimes.

How Do You Know if You’re a Victim of Identity Theft? Receive a credit card you didn’t apply for. Denied credit or offered less favorable terms. Receive calls or letters from debt collectors. Fail to receive bills or other mail.

What To Do If Your Identity Has Been Stolen Put fraud alert on credit file. Close accounts that have been tampered with or you didn’t open. File police report. File report with the FTC. http://www.consumer.gov

Controlling and Managing Your Credit Cards and Open Credit Reducing your balance Protecting against fraud Trouble signs in credit card spending If you can’t pay your credit card bills

Summary Main form of open credit is the credit card which you can use to make charges up to a certain point as long as you pay off the minimum amount of your debt each month. Costs of open credit include interest rate, cost of cash advances, annual fee, penalty fees. Choices of open credit lines include different types of credit cards and charge accounts.

Summary Lenders determine creditworthiness using the “five C’s” of credit—character, capacity, capital, collateral, and condition. Different credit cards charge different APR and calculate finance charges differently. Focus on controlling credit card spending and look for signs of trouble.

End of Chapter 6 Slides