The Costs and Methods of Obtaining Credit Chapter 8.2 The Costs and Methods of Obtaining Credit

What is a loan? A loan is money that you borrow and must repay. Loans cost money to the borrower in the form of interest. Will you be able to meet all your usual expenses plus the monthly loan payments you will have to make? (take home pay) - (total of basic monthly expenses) = spending Consider giving something up so you can make the loan payment

Debt Payments-to-Income Ratio (DPR) Percentage of debt you have in relation to your net income. Net Income is the income you receive Examples: take home pay, allowance, gifts, and interest No more than 20% should be spend on debt (Total monthly debt payments/monthly net income) = DPR

EXAMPLES Suppose that your monthly net income is $1,200. Your monthly debt payments include your student loan payment and a gas credit card, and they total $180. What is your debt payments-to-income ratio? Formula: Monthly Debt Payments/Monthly Net Income = DPR 180/1200 = .15 or 15%

EXAMPLES What is your monthly DPR if your debt payments total $342 and your net income is $1,000 per month?

What does it cost to apply for credit? Two key factors in shopping for credit: Finance Charge Annual Percentage Rate (APR)

The Finance Charge and the Annual Percentage Rate (APR) Finance charge = total dollar amount your pay to use credit. Calculated using the APR APR is the cost of credit on a yearly basis, expressed as a percentage Example: an APR of 18% means that you pay $18 per year on each $100 you owe.

Tackling the Trade-Offs Various features to choose when financing: Length of the loan Variable interest rate or fixed interest rate Size of monthly payments Interest rate

TERM VERSUS INTEREST COSTS Longer the term, smaller the payments Greater amount you will pay in interest charges.

EXAMPLES: Calculating simple interest on a loan Janelle’s cousin agreed to lend her $1,000 to purchase a used laptop computer. She has agreed to charge only 5 percent simple interest, and Janelle has agreed to repay the loan at the end of one year. How much interest will she pay for the year? Use the formula below to help compute Janelle’s loan interest. Formula: Principal x Interest Rate x Amount of Time = Simple Interest

Examples You just bought a used car for $3,500 from your aunt. She agreed to let you make payments for 3 years with simple interest at 6 percent. How much interest will you pay?

LENDER RISK VERSUS INTEREST RATE Variable Interest Rate – based on changing rates in the banking system. A Secured Loan – lower interest rate, pledge collateral Up-Front Cash – large down payment in hopes of better loan features A Shorter Term – easier to repay your loan, lower lender risk, higher monthly payments

Worksheet Chapter 8.2 The Cost of Credit Complete with a partner Show all work! Turn in when finished-you will have time to work on this tomorrow in-class!

The Five Cs of Credit Used by lenders to determine who will receive credit. Character: Will You Repay the Loan? Personal/professional references, criminal history Questions asked: Have you used credit before? How long have you lived at your present address? How long have you held your current job?

The Five Cs of Credit Capacity: Can You Repay the Loan? Your income in relation to your debts Questions asked: What is your job, and how much is your salary? Do you have other sources for income? What are your current debts? Capital: What Are Your Assets and Net Worth? Items of value that you own including savings Questions asked: What are your assets? What are your liabilities?

The Five Cs of Credit Collateral: What If You Do Not Repay the Loan? Creditors look at what kinds of property or savings you already have, because these can be offered as collateral to secure the loan. Questions: What assets do you have to secure the loan? Do you have any other assets? Conditions: What If Your Job Is Insecure? Unemployment, recession, general economic conditions

Credit Rating Combined information gathered from your application and the credit bureau. A credit rating is a measure of a person’s ability and willingness to make credit payments on time. Brainstorm: What are some factors that influence your ability and willingness to make these credit payments?

FICO and Vantagescore FICO Vantagescore A number between 350 and 850 that rates how risky a borrower is. Higher the score, the less risk you are to creditors Vantagescore Relatively new scoring technique developed through three credit reporting companies Ranges from 501 – 990

How Can I Improve My Credit Score? Consistently review your credit report for accuracy Long-term, responsible credit behavior Pay bills on time Lower balances Use Credit wisely

What If Your Application Is Denied? They have to let you know why, Equal Credit Opportunity Act (ECOA) Can request a copy of your credit report, free within 60 days

Why is your credit report important? Lenders rely heavily on credit reports when they consider loan applications. Lender will review your credit history. Credit Bureaus Collect information on how promptly people and businesses pay their bills. Three major: Experian, Trans Union, and Equifax Get information from banks, stores, credit card companies, other lenders, finance companies

Why is your credit report important? Your credit report shows: Name Address Social Security Number Birth date Employer, position, income Previous address Previous employer Spouse’s name, SSN, employer, income Homeowner or renter Checks returned for insufficient funds Detailed loan information and payment information

Protecting Your Credit Chapter 8.3 Protecting Your Credit

What can you do to correct billing errors? In your lifetime you will probably receive a bill for something you did not pay for, or you will make a payment and it will not be credited to your account. Steps to follow to correct errors: Notify your creditor in writing Include information that will support your case Pay the portion of your bill that is not in question The creditor must notify you within 30 days. If the creditor made a mistake, you do not have to pay finance charges on the disputed amount.

Protecting Your Credit Rating Your credit rating cannot legally be damaged while you are negotiating. Your complaint must also be answered before a creditor can collect the amount in question

How can someone steal your identity? People who deceive others by assuming different identities, use your name, SSN, credit card number, or other personal information for their owner purposes are called impostors. When this occurs, the impostors are committing identity theft. Identity theft is the fastest growing financial crime. The Federal Trade Commission recommends you: Contact the credit bureaus Contact the creditors File a police report

What should you do if your credit has been stolen? To protect your card, you should take the following actions: Be sure that your card is returned to you after you make a purchase. Keep a record of your credit card numbers. You should keep this record separate from your cards. The maximum you have to pay if your card is used illegally is $50. If notified before the card is used, you will not have to pay

Keeping Track of Your Credit You may not realize you have been a victim of identity theft until you realize something is wrong Steps to Protect Other Accounts: If your ATM or credit card has been lost, cancel the card. Create new PINs If your bank account has been accessed, close that account. Government Agency Protection: Contact the Federal Trade Commission (FTC) if you are still experiencing problems. Provides information on how to network with other victims.

Keeping Track of Your Credit Credit Information on the Internet: Use a secure browser (https not http when giving personal information) Keep records of online transactions Review your monthly bank and credit card statements Read the privacy and security policies of Web sites you visit Keep your personal information private Never give your password to anyone online Do not download files sent to you by strangers

Why would someone ask a friend or relative or cosign a loan? Cosigning a loan means that you agree to be responsible for the loan payments if the other person fails to make them. The lender would not require a cosigner if the borrower were considered a good risk. If you cosign a loan and the borrower does not pay, you will have to pay up to the full amount of the debt as well as any late fees. Can damage your credit score if the debt is not repaid

Why would someone ask a friend or relative or cosign a loan? If you decide to cosign a loan, consider the following: Be sure you can afford to pay the loan. Consider that even if you are not asked to repay the debt, your liability for this loan may keep you from getting other credit. Before you pledge property to secure the loan, understand that you could lose the property you pledge if the borrower defaults. Check your state law. Some states have laws giving you additional rights as a cosigner. Requires that a copy of overdue-payment notices be sent to you so that you can take action to protect your credit history.

When should you complain about a lender? Consumer Protection Laws There are six laws that protect consumer credit: Credit Card Act Truth in Lending and Consumer Leasing Acts Equal Credit Opportunity Act (ECOA) Fair Credit Opportunity Act Fair Credit Reporting Act Consumer Credit Reporting Reform Act

Credit Card Act Passed in 2009 Prevents unfair increases in interest rates and changes in terms. Prohibits excessive and unnecessary fees. Penalty fees must be reasonable and proportional to the violation. Requires fairness in timing of card payments. Provides enhanced disclosures of card terms and conditions. Ensures adequate safeguards for young people. Under the age of 21 you must have a cosigner

Truth in Lending and Consumer Leasing Acts If a creditor fails to disclose information or gives inaccurate information, you can sue for any money loss you suffer. Permits class-action lawsuits.

Equal Credit Opportunity Act (ECOA) If you can prove that you have been discriminated against, you can sue for actual damages plus punitive damages A payment used to punish the creditor who has violated the law - $10,000

Fair Credit Opportunity Act A creditor that fails to follow the rules that apply to correcting any billing errors will automatically give up the amount owed on the item in question.

Fair Credit Reporting Act You may sue any credit bureau or creditor that violates the rules regarding access to your credit records. Or fails to correct errors in your credit file

Consumer Credit Reporting Reform Act Passed in 1997 Places the burden of proof for accurate credit information on the credit bureau. The creditor must prove that disputed information is accurate. If a creditor or the credit bureau verifies incorrect data, you can sue for damages.