Section 6.1 – What is Consumer Credit Chapter 6 Section 6.1 – What is Consumer Credit

Credit…. What is it and why is it important? Credit – is an arrangement to receive cash, goods, or services now to pay for them in the future.

Consumer Credit Most common type of consumer credit is credit cards. Creditor – is the bank Or person loaning the money to you.

Credit uses and misuses Why do we use credit? Can purchase a good or service now instead of later, even maybe at a lower price. When not to use it, when you can’t make high monthly payments

Types of Credit Closed-end Credit – is a one-time loan that you will pay back over a specified period of time. Home mortgage Loan for furniture Open-Ended Credit is credit as a loan with a certain limit on the amount of money you can borrow for a variety of goods and services. A credit card – REVOLVING CREDIT. Line of Credit – is the maximum amount of money a creditor will allow a credit user to borrow.

Types of Loans Inexpensive Loans Medium Priced Loans Loaned by friends, family, or relatives. Sometimes these are worse than other types. Look at Judge Judy !!!! Medium Priced Loans Loans from commercial banks, savings and loans associations, and credit unions. Some of these organizations you must be members of in order to get loans from.

Types of Loans Expensive Loans Loans that charge a high interest rate, but are very easy to get loans from. Rent –A-Center http://www.motherjones.com/news/outfront/2005/0 5/paynow_paylater.html http://www.nyccouncil.info/pdf_files/reports/rent-to- own.pdf

Types of Loans con’t Home Equity Loans Based on the Equity of your home.. What does equity mean? The value that you have paid into your home. The interest on the home is tax-deductible What does that mean You will get a large portion of that back when you figure your taxes. You can take the value of the money you invested into the home and use that money to purchase other things. Downside if you miss a payment they can take make you pay back most of the loan plus the difference that you still owe.

Types of Credit (Cards) Average number of credit cards people have. Schumer Box.. Credit Card Worksheet

A few more terms Grace Period – a time period during which no finance charges will be added to your account. Finance charge – is the total dollar amount you pay to use credit. Annual Credit Cards – American Express charges $50 a year to use their credit card. Why would I pay $50 a year to use their card? Credit Card Menu

6.2 The Cost and Methods of Obtaining Credit…. Chapter 6 6.2 The Cost and Methods of Obtaining Credit….

Debt Payments to Income Ratio Sounds difficult but what we are looking at is the relationship to how much money you make to how much money you owe. Terms that you need to know: Net Income – is the income you take home. Experts say that you should spend no more than 20% of your net income on debt. Example if you make $1000 per month in net income. You should spend no more than $200 on debt.

Debt to Income Ratio Monthly Debt Payments Formula ------------------------------- Monthly Net Income If Bob spends $180 on debt and he makes $1200 a month what is his Ratio. $180/$1200 = .15 or 15% if you stay below 20% then things should be fine.

Lets Practice a couple Sally makes 60 a month babysitting, 20 a month cutting grass, and has to pay her parents 40 a month for the car accident she had. What is her ratio? (Back) Bill makes 10 a week allowance, 80 a month working at Taco Bell and spends 15 on her MasterCard every month.

The Calculations Monthly Debt Payment Monthly Net Income Debt to Income Ratio 40 80 .5 or 50% Back We would say that this ratio is bad because it is higher than the 20% it should be. The second on is a little bit harder…… Remember that this is based on per month not per week. Monthly Debt Payment Monthly Net Income Debt to Income Ratio $15 $120 .13 or 13% $10 a week for 4 weeks = $40 + $80 = $120 We would say this is a good ratio because it is under the 20% experts say we need to be under.

When dealing with Credit what is the cost to you? There are two major factors that you need to deal with when you shop for the best deal in credit. Finance Charges A.P.R.

Finance Charges and Annual percentage rate We have discussed this in the previous part of the chapter with Rent-A-Center. Finance Charges is the total dollar amount you pay to use credit. In most cases you will have to pay finance charges to the creditor on the amount that is unpaid. A.P.R. – is the cost of credit on a yearly basis expressed as a percentage.

What do we mean…… Lets pretend that you have a MasterCard. You go on a shopping spree for spring break. At the end of the month you get the bill from MasterCard that says you owe them $900. (OUCH!!!!!) You can not afford to pay the total amount this month. So you see in the credit card statement that you can pay the minimum amount of $20. Credit Card Balance Payoff

Here is what happens….. You send that check in for $20 for the minimum payment, but you still owe them $880. However at the end of the month they are going to charge you a finance charge of 19.8% Original Amount Interest Rate New amount additional $880 19.8% $174.24 $974.24

Tackling the trade-offs Terms versus Interest Costs Many people take the longer terms… It spreads the payments out over a longer time, but the payments per time are less. HOWEVER you end up paying more in the long run. Creditor APR Term of Loan Monthly Payment Total Finance Charge Total Cost Creditor A 14% 3 years $205.07 $1,382.52 $7,382.52 Creditor B 4 years $163.96 $1,870.08 $7,870.08

More Trade-Offs Lender Risk Versus Interest Rate Things that would give you a lower interest rate.. Variable interest rate This means that the interest rate may be low now, but if interest rates increase you will have higher monthly payments Secured Loan Pledge Collateral – you put something up of value – Car, house etc… so if you default on the loan the bank or lender will have something of value to sell to recover their loss. UP-Front-Cash You may have to put a large down payment in order to receive a lower interest rate. Shorter Term If you can pay off the loan in a shorter time chances are that you will receive a lower interest payment.

Types of Interest or Cost of Credit Simple Interest Is the interest computed only on the principal, the amount that you borrow. Principal X Rate X Time = Interest Simple Interest on the Declining Balance You pay interest on only the amount you still owe. So if you owe $1000 and you pay back $100 you owe the interest on the $900 left.

Types of interest continued Add-On Interest Interest is calculated on the gull amount of the original principal, no water how often you make payments. So if you owe $1000 and you pay $100 you are still paying the interest on the $1000 Open-end Credit Credit Card companies must give you certain criteria before they lend money to you. How much is the finance charge When does it start to accrue (when is the grace period over?)

Even more on interest…. Cost of credit with Expected inflation If you were to borrow money from your parents…. Lets say $100 and they charged you 5% interest and then the cost of things went up 4% then actually your parents would be only getting a 1% return on their money… Banks are much more sneakier than that. Most banks would realize that the cost of things would increase(inflation) and charge you something more like 9% , so in actuality they would still be making about 5%.

Applying for Credit 5 C’s of Credit Character Will you repay the loan Capacity Can you repay the loan. Capital What are your Assets and your Net Worth Collateral What if you do not repay the loan, do you have something the bank can take. Credit History What is your credit history? What is your credit rating?

Credit and Equal Opportunity ECOA Equal Credit Opportunity Act Gives all credit applicants the same basic rights. A lender may not use race nationality, age, sex marital status, and certain other factors to discriminate against you. You must be legal age to sign a contract in Missouri (18) Must not be denied because of social security or public assistance.

Understanding Credit Reports Family Economics & Financial Education

Credit Reports Credit report - a record of a consumer’s credit history Credit history - a record of transactions involving credit use Individuals do not have a credit report if they have not previously used credit Affects one’s ability to acquire credit

Information on a Credit Report Name and aliases Current and past addresses Marital status Date of birth Employment history Public records Judgments, criminal, and bankruptcy Credit card, store card, book clubs, music clubs, etc. Payment history Credit card, store card, book clubs, music clubs, etc.

Information continued Financial records Loans, bounced checks, closed accounts, etc. Loans/leases Rent-to-own contracts, payday loans, lease agreements, etc. Credit inquiry- Number of credit inquiries Credit inquiry -a request for your credit. Can be done by businesses you apply to for credit or whom pre-approve you for credit *Medical information is not on a consumer’s credit report, but late medical payments are.

Building Credit History Important for consumers to build a credit history to be able to purchase items on credit For example – house, vehicle Affects a young adult’s ability to make a purchase on credit in the immediate future including: Renting an apartment Buying a car Purchasing electronics or other merchandise

Building Credit History continued Store accounts (JcPenny or Sears charge accounts) Credit card accounts Even with a co-signer Loan from financial institution Acquire a small loan from a financial institution and pay the loan off in timely payments to develop a positive credit history

No Credit History Having no history of credit use While the following are all positive financial practices, a credit history is not built if a consumer performs the following actions: Having no history of credit use Not having any credit accounts in own name Paying cash for all major purchases Paying phone and utility bills on time

Positive Credit Practice good banking techniques Being responsible with credit and finances can lead to good credit A consumer may develop and keep good credit by: Practice good banking techniques Keep checkbook balanced, do not bounce checks Pay bills consistently and on time Keep public records free of bankruptcy Have no criminal record Keep a reasonable or small amount of debt Apply for credit sparingly, keeping credit inquiries low Hold a low number or credit/store cards Check credit report annually to remove errors Maintain reasonable amount of unused credit

General Rule Percentage of current debt compared to the total credit available is reviewed by potential lenders Keep the amount of debt currently held at 20% of the total amount of available credit For example - if Sue’s total amount of credit available is $1,000, her current amount of debt should not exceed $250

Negative Credit Bouncing checks Being irresponsible with credit and finances can lead to poor credit A consumer may develop or keep poor credit by: Bouncing checks Routinely paying bills late Having a criminal record Holding a large amount of debt Holding an unreasonable amount of unused credit Not paying utility or cell phone accounts consistently and on time Obtaining a high number of credit inquiries Carrying many credit/store cards Having a public record of bankruptcy Defaulting on a loan Having cards over the limit

Credit Reporting Agency (CRA) Keeps a record of a consumer’s credit transactions and compiles credit reports Acquires information from several different types of lending companies Information on credit reports differ between each individual agency Lenders may only report to one credit agency Consumers should contact all agencies when checking their credit report

CRA’s continued The three main credit reporting agencies are: Equifax www.equifax.com (800) 685-1111 Trans Union www.transunion.com (800) 888-4213 Experian www.experian.com (800) 397-3742

Who Reports to CRA’s? Store accounts Credit card companies Mortgage and other loan lenders Financial institutions Landlords Courts Utility accounts Cellular phone companies Delinquent accounts

Mistakes in Credit Reports More than 50% of the credit reports checked in a study contained errors Consumer Reports (July 2000) The two main errors commonly appearing in a consumer’s credit report are: Mistaken identity – occurs when a lender reports a credit transaction and information is recorded on the wrong person’s credit report, usually of a similar name Fraud

Fair Credit Reporting Act Enacted to protect the consumer in 1971 Designed to promote accuracy and ensure privacy of information in credit reports Consumers have the right: To know the information in their credit report To have errors corrected in their credit report

Credit Scores A mathematical tool created to help lender evaluate the risk associated with lending a customer money Scores range from 150-950, with 950 being the best score Not listed on a credit report Each CRA has an independent scoring system based upon a standard percentage of five different categories Consumer’s scores can differ between each CRA

Five Standard Categories of Scores 35%-Payment history - Timely manner in which a consumer pays debt 30%-Outstanding debt -Amount of debt currently held 15%-Credit history -How long the consumer has held credit accounts and how often they are used 10%-Pursuit of new credit -How much credit is acquired over the length of the consumer’s credit history 10%-Types of credit in use -May include credit cards, gas cards, store cards or accounts, loans, etc.

Credit Scores continued Other factors calculated into a credit score may include: Length of time at current address Current income Financial information Late payments Amount of outstanding credit Amount of credit in use Length of time credit has been established

Financial Effect of Credit Scores Interest rate of loans High score – can insure a lower interest rate on credit Low score– can cause a higher interest rate on credit Ability to receive future loans/credit Financial lending institutions have guidelines of what score will qualify for a loan Reflection of risk of borrower to the lender The lower the score, the higher the possibility the consumer pays bills late Financial security for lifetime Takes time to improve credit, which could take time from building financial security

That’s all folks……

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