Chapter 5 Consumer Credit: Advantages, Disadvantages, Sources, and Costs McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

Consumer Credit Chapter Objectives Analyze advantages and disadvantages of using consumer credit Assess the types and sources of consumer credit Determine whether you can afford a loan and how to apply for credit Determine the cost of credit by calculating interest using various interest formulas Develop a plan to protect your credit and manage your debts 5-2

Objective 1 Analyze Advantages and Disadvantages of Using Consumer Credit An arrangement to receive cash, goods or services now, and pay for them in the future Based on trust in people’s ability and willingness to pay bills when due Consumer credit Use of credit by individuals for personal needs, except a home mortgage A major force in our economy 5-3

Uses and Misuses of Credit Before you use credit for a major purchase, consider: 5-4

Advantages of Credit 5-5

Advantages of Credit 5-6

Disadvantages of Consumer Credit 5-7

Objective 2 Assess the Types & Sources of Consumer Credit Two Basic Types of Consumer Credit Closed-End Credit One-time loans for a specific purpose paid back in a specified period of time Open-End Credit Use as needed until line of credit max reached 5-8

Closed-End Credit 5-9

Open-End Credit 5-10

Sources of Consumer Credit Loans Inexpensive loans Medium-priced loans Expensive loans 5-11

Sources of Consumer Credit Home Equity Loans Credit Cards 5-12

Sources of Consumer Credit Debit Cards Stored Value Cards 5-13

Sources of Consumer Credit Smart Cards Travel and Entertainment (T&E) cards 5-14

Before you take out a loan, ask yourself... Objective 3 Determine Whether You Can Afford a Loan and How to Apply for Credit Before you take out a loan, ask yourself... Can you meet all your essential expenses and still afford the monthly loan payments ? What do you plan to give up in order to make the payment? 5-15

General Rules of Credit Capacity Debt Payments-to-Income Ratio Monthly Debt Payments* Net Monthly Income *Not including house payment which is a long-term liability 5-16

General Rules of Credit Capacity Debt To Equity Ratio Total Liabilities = Should be < 1 Net Worth* *Excluding home value 5-17

The Five C’s of Credit Character - Capacity – Capital – Collateral – Conditions- 5-18

FICO & VantageScore FICO Credit Score VantageScore 5-19

Factors of Creditworthiness ECOA (Equal Credit Opportunity Act) If you are denied credit, you have the right to know the reasons 5-20

Your Credit Report Credit Reports Credit Bureaus Experian, Trans Union and Equifax are the 3 major credit bureaus 5-21

Your Credit Report Credit Files Typically contain detailed credit data along with considerable personal information: Fair Credit Reporting Act (1971) 5-22

Your Credit Report Who can obtain a credit report? Time Limits on Unfavorable Data 5-23

Your Credit Report What are Your Legal Rights? Incorrect Information in Your File What are Your Legal Rights? 5-24

It is important to shop for credit Objective 4 Determine the Cost of Credit by Calculating Interest Using Various Interest Formulas Finance charge Annual Percentage Rate (APR) It is important to shop for credit 5-25

Tackling the Trade-Offs 5-26

Calculating the Cost of Credit Simple interest Simple interest on the declining balance Add-on interest I 5-27

Calculating the Cost of Credit Cost of Open-End Credit Cost of Credit and Expected Inflation Avoid the Minimum Monthly Payment Trap 5-28

Declaring Personal Bankruptcy U.S. Bankruptcy Act of 1978 Chapter 7 = Chapter 13 = Bankruptcy should be the last resort, because of the damage to your credit rating 5-29

Chapter 7 Bankruptcy 5-30

After Chapter 7 You May No Longer Owe: You Still May Owe... 5-31

Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 Makes it more difficult for consumers to file a Chapter 7 bankruptcy 5-32

Chapter 13 Bankruptcy 5-33

Obtaining Credit after Bankruptcy 5-34