Chapter 22 Borrowing Money

Creditor- the party who sells the goods on credit or lends the money Debtor- the party who buys the goods on credit or borrows the money There are two classes in which someone can obtain credit: open-end credit closed-end credit

open-end credit- credit that can be increased by the debtor up to a limit set by the creditor by continuing to purchase goods or services on credit Must pay the balance owed in full or in installments Interest will be charged on the unpaid balance

Revolving charge account- customers can keep an outstanding balance all the time and simply pay a small amount each month Costly for the buyer because interest of usually more than 18% is charged Credit card- a card, plate, coupon book, or other device used to obtain money, goods, or services on credit Can be issued by banks and other companies that are in the business of loaning money Issuing company handles the billing and collection procedures and receives the interest that is charged

closed-end credit- borrowing money from a lending institution for an expensive item such as a car or house which paid for in monthly installments Only extended for a specific amount of money and cannot be increased by making additional purchases

Usury- charging more interest on a loan than is allowed by law Criminal offense Interest does not have to be paid by the debtor

Borrowing Money fill out a loan application interview with the prospective borrower

3. Considerations during the loan interview: Reputation for paying bills Job or other source of regular income Regularity of income, amount of debt, property owned, savings Competency to contract What the money is to be used for, length of time required to repay it, and the security offered

4. lender checks credit references 5. the loan will be made within one to two days

Secured versus Unsecured Loans Secured loan- creditors obtain an interest in something of value Collateral- something of value surrendered if the debtor faults on repayment of a loan Example 1: Jill wishes to buy a car and must borrow money to do so. She is a recent high-school graduate, just beginning her first fulltime job. She has never borrowed money from a commercial source, so she has not yet established a credit rating. Nevertheless, she may be able to obtain financing by giving the lender security interest in the car she buys.

Secured party- the lender or seller who holds the security interest Repossess- take back the goods

Truth in Lending Under regulation Z- creditors must follow specific rules when extending credit to customers Regulation Z- lets borrowers and consumers know the exact cost of using credit Example 2: Peter purchased a car for his personal use at a cost of $4,400. He paid $400 down and agreed to pay the balance of $4,000 in monthly installments over a two-year period. This transaction was governed by Regulation Z. the regulation would not apply if Peter had purchased the car for business purposes.

Required Disclosures Under Regulation Z, creditors must disclose two things: 1. the finance charge- the actual cost of the loan in dollars and cents 2. the annual percentage rate- the true rate of interest computed according to a specific formula Example 3: Suppose you borrow $100 for one year and pay a finance charge of $8. If you can keep the entire $100 for the whole year and pay it all back at once, you are paying an APR of 8%. But, if you repay the $100 and the finance charge (a total of $108) in 12 equal payments of $9 each, you don’t really get to use the $100 for the whole year. In fact, you get to use less and less of that $100 each month. In this case, the $8 charge for credit amounts to an APR of 14.5%.

APR is computed using a mathematical formula: Example 4: Before purchasing the car in Example 2, Peter asked the car dealer what the APR would be to finance the purchase through the dealer. The dealer said that it would be 7.9%. Peter then inquired at a bank and found that the APR there would be 12%. He saved money borrowing from the car dealer instead of financing the purchase through the bank.

Calculating the Finance Charge Adjusted-balance method- add finance charges after subtracting payments made during the billing period Previous-balance method- no credit is given for payments made during the billing period Average-daily-balance method- add balances for each day in the billing period and then divide by the number of days in the billing period

Assignment Page 492 #1-4 and CT

Credit Cards Over half of all Americans have at least one credit card Extremely profitable because creditors are able to charge as much as 22% interest

Consumers use credit cards for two reasons: convenience to obtain credit Example 5: John charged several items on his credit card, up to its $2,000 limit. Each month he pays $40 on the account, which is the minimum required by the card issuer. The interest rate is 19%. If John maintains the same rate of paying the money back, it will take him 33 years to erase the debt, and he will pay $7,000 in interest on the $2,000 that he borrowed to make his purchases. John could save a considerable amount of money by doubling his monthly payments and making every effort to bring the account balance down to zero as soon as possible.

Credit cards can be lost. Example 6: Susan lost her purse, which contained a credit card issued to her by Golden’s Department Store. A week after discovering the loss, she notified the store. By then, someone had charged a purchase of $175 with the credit card. Susan will have to pay $50 to the store for the unauthorized purchase. If she had notified the store before the purchase was made, she would not have to pay the store anything. Notification of loss can be made by: phone, letter, e-mail, fax, etc.

Equal Credit Opportunity Equal Credit Opportunity Act of 1975- passed to prevent discrimination against credit applicants because of gender, marital status, age, religion, race, national origin, or receipt of public assistance income

The following rules apply when people ask for credit: Cannot ask people their sex, race, national origin, or religion Cannot refuse to grant a separate account to a person who qualifies for credit based on sex or marital status

May not ask marital status People do not have to disclose income from alimony or child support unless they will be relying on that income People cannot be prohibited from using their given names when applying for credit Example 7: Donna worked for five years and developed a good credit rating while she was single. After she married, she continued working and applied for a charge account in her maiden name at Golden’s Department Store. The store could not prohibit her from using her maiden name and probably could not ask her if she was married.

Evaluation of the Application The following rules apply when creditors evaluate applications: Creditors may request and consider information about a person’s spouse- only when the spouse will be using or will be liable for the debt or when their income will be relied upon Creditors may consider- alimony, child support, and maintenance payments as income to the extent that such payments are likely to be consistently made Creditors may not consider- the race of the people in the neighborhood where a person wants to buy or improve a house with borrowed money

Creditors may not consider- an applicant’s age Creditors may not discount a spouse’s income because of- sex or marital status or discount income obtained from part-time employment Creditors may not ask- about applicant’s plans to have children

Acceptance and Rejection The following rules apply to the acceptance or rejection of credit applications: Creditors must inform applicants- whether the application was accepted or rejected within 30 days of filing When an application for credit is denied, creditors must provide, upon request- the reasons for the denial within 60 days

With certain exceptions, creditors may not close an account because- of a change in marital status, unless there is evidence that a person has become unwilling or unable to repay Example 8: Ronald and Colleen, while married, got into financial trouble. They bought too many things on credit and got behind in their payments, resulting in a very poor credit rating. Their financial problems eventually led to a divorce. A few years later, however, both obtained better-paying jobs, paid off their debts, and became financially sound. This would be sufficient evidence that their past credit records should not be used against them.

Credit Protection Laws Fair Credit Reporting Act- prohibits the abuse of credit When credit is denied, the company must supply the applicant with the source of its credit report Example 9: George was a successful business owner in Minnesota. He and his family moved to Arizona because of his wife’s health. When George tried to get a job, he had no luck. After he applied to many firms and was turned away from each one, he found out that a credit bureau in Arizona had received incorrect information that he had a very undesirable personal life which included incidents of disorderly conduct. George had the right to support his side of the story and to correct the incorrect information.

Fair Credit Billing Act- procedure for the prompt handling of billing disputes in the case of open-end or revolving charge accounts Consumers must notify the creditor in writing within 60 days of the date of the statement Notice must state- consumer’s name, account number, the charge in question, and why the customer believes there is an error

The creditor has 30 days to acknowledge the letter 90 days to correct the mistake Fair Debt Collection Practices Act of 1977- makes it a federal offense for debt collectors to threaten consumers with violence, use obscene language, or contact consumers by telephone at inconvenient times or places in an effort to collect debt

Bankruptcy Bankruptcy Reform Act of 1978- gives overwhelmed debtor’s a fresh start and provides a fair way of distributing a debtor’s assets among all creditors Chapters 7, 11, and 13 of the Bankruptcy Reform Act are the most important:

Chapter 7 Liquidate- turn the debtor’s belongings into cash to pay creditors Chapter 11 Reorganization- provides a means for businesses to reorganize their financial affairs and still remain in business If allowed to continue in operation, companies may be able to: overcome their financial difficulties, pay their creditors, and again become a profit-making organization

Chapter 13 Adjustments of debts- allows debtors to set up a payment plan, and upon completion of payments, to receive a discharge from most remaining debt

Assignment Page 495 #1-2 and CT