Chapter 7 Credit Cards and Consumer Loans

Copyright © Houghton Mifflin Company. All rights reserved.7 | 2 Learning Objectives 1.Compare the common types of consumer credit, including credit cards and installment loans. 2.Describe the types and features of credit card accounts. 3.Manage your credit card accounts to avoid fees and finance charges. 4.Describe the important features of consumer installment loans. 5.Calculate the interest and annual percentage rate on consumer loans.

Copyright © Houghton Mifflin Company. All rights reserved.7 | 3 Introduction Annual Percentage Rate (APR): The cost of credit on a yearly basis as a percentage rate. Finance Charge: The dollar cost of credit for all interest and fees over and above the amount borrowed.

Copyright © Houghton Mifflin Company. All rights reserved.7 | 4 Types of Consumer Credit Installment credit – A closed end credit arrangement in which the borrower must repay the amount owed plus interest in a specific number of equal payments. Non-installment credit – includes open ended credit, single-payment and service credit. Open-ended credit (or revolving credit) –Can borrow up to your Credit limit –Typically by using a Credit (or charge) card

Copyright © Houghton Mifflin Company. All rights reserved.7 | 5 Types of Revolving Accounts Credit (or charge) card accounts –You can make purchases –Or obtain a Cash advance Personal line of credit Home-equity line of credit Service credit

Copyright © Houghton Mifflin Company. All rights reserved.7 | 6 Credit Card Accounts Types of Credit Card Accounts: –Bank credit cards (Visa, Mastercard, etc.) –Cash advance (or convenience) checks –Balance transfer option –Prestige bank cards (Gold, Silver, Platinum) –Affinity cards (Humane Society, College Alumni Assoc., etc.)

Copyright © Houghton Mifflin Company. All rights reserved.7 | 7 Types of Credit Card Accounts Retail credit card accounts (JCPenney, Sears, Best Buy, Dillards, etc.) Allows customers to make purchases on credit at any of the outlets of a particular retailer. Travel and Entertainment (T&E) cards (American Express, Diners Club, Carte Blanche) Acts as a charge card rather than credit card – full balance paid in 30 days Business travel expense for food, lodging

Copyright © Houghton Mifflin Company. All rights reserved.7 | 8 Aspects of Credit Card Accounts Teaser Rate: A temporarily low introductory rate to entice borrowers to apply for a credit card. (Ex: 0% until June. 2013) Default rates – higher rate for late payment forfeits teaser rate –Universal default applies a higher rate to account when payment to other credit accounts are late Variable interest rates, variable interest rate cards – adjust based upon prime rate changes. Lender must provide 45 days advance written notice when rates are subject to change.

Copyright © Houghton Mifflin Company. All rights reserved.7 | 9 Aspects of Credit Card Accounts Preapproved credit card offers – occurs based upon credit history and score Annual and Transaction Fees: –Transaction fee: A small charge levied each time a card is used. (Ex: Cash Advance and balance transfers) Liability for lost or stolen cards - $0 if within 2 days notice to creditor, $50 Max afterwards Secured (or collateralized) credit card – Requires savings account with matching balance to approved credit limit Late-payment, bounced check, and over-the-limit fees – range from $20 to $50 per incident

Copyright © Houghton Mifflin Company. All rights reserved.7 | 10 Copyright ©Cengage Learning. All rights reserved Credit Card Insurance Credit Disability Insurance: Repays the outstanding loan balance if the borrower becomes disabled. Credit LIfe Insurance: Repays the outstanding loan balance if the borrower dies.

Copyright © Houghton Mifflin Company. All rights reserved.7 | 11 Credit Card Disclosure Info

Copyright © Houghton Mifflin Company. All rights reserved.7 | 12 Credit Card Disclosure Info

Copyright © Houghton Mifflin Company. All rights reserved.7 | 13 Managing Credit Cards Wisely Credit (or periodic) statement Billing (or closing or statement) date – last day which transactions are reported for period Due date: The specific day by which the credit card company should receive payment from you. Transaction date: The day on which a credit cardholder makes a purchase. Posting date: The day the credit card company is informed of the transaction and the charge is posted to the account.

Copyright © Houghton Mifflin Company. All rights reserved.7 | 14 Managing Credit Cards Wisely Grace period: Time period between the posting date of a transaction and the payment due date during which no interest accrues. Minimum payment amount: Lowest allowable monthly payment required by the lender. Credit for merchandise returns and errors Credit receipt: Written evidence of any items returned that notes the specific amount and date of the transaction.

Copyright © Houghton Mifflin Company. All rights reserved.7 | 15 Managing Credit Cards Wisely Computation of finance charges: –Periodic Rate is the APR & billing cycles (Ex: 18% APR and 12 billing cycles per year = 1.5% Periodic Rate) –Average Daily Balance – balance owed each day during the billing period for finance charges (Ex: 18% APR = 1.5% per month). If the average daily balance is $2,000 for a month, the finance charge is $30 for the month. Correcting errors on your credit card statement –The Fair Credit Billing Act (FCBA) permits a chargeback to the merchant where the transaction originated based upon billing errors or a goods and services dispute due to damage or poor quality. Time limit to dispute billing errors is 60 days from first statement date when error occurred. –Goods and services dispute occurs when faulty, damaged, shoddy, defective or poor-quality goods and services are received.

Copyright © Houghton Mifflin Company. All rights reserved.7 | 16 How Credit Card Balances Are Calculated Understand consumer installment loans. –Cash Loan – Borrower receives cash and uses it to make purchases, pay other loans or make investments. –Purchase Loan (or Sales Credit) – Borrower makes a purchase on credit with no cash transferring from the lender to the borrower.

Copyright © Houghton Mifflin Company. All rights reserved.7 | 17 Installments Loans Installment loans can be unsecured or secured. Unsecured Loan (or Signature Loan) – Higher risk to the lender as good credit standing of borrower is the only requirement. Secured Loan: –Cosigner – agrees to pay debt if borrower defaults; has legal obligation for repayment –Collateral – a security interest in the property pledged as collateral. Collateral provides lender with loan repayment assurance Acceleration Clause – Unpaid installments (often just one) results in loan default and immediate repayment required for remaining balance due.

Copyright © Houghton Mifflin Company. All rights reserved.7 | 18 Purchase Loan Installment Contracts Installment purchase agreements (or collateral installment loans) – ownership passes to the buyer when the contract is signed. –Ex: Mortgage Loans, Retail Purchases Conditional sales contracts (or financing leases) – ownership passes to the buyer when the last installment payment has been made. –Ex: Car Loans, Equipment Purchases

Copyright © Houghton Mifflin Company. All rights reserved.7 | 19 Calculating Interest on Consumer Loans Truth in Lending Act (or TIL) – Requires lenders to disclose to applicants both the interest rate or APR and the dollar finance charge applied. APR is the Annual Percentage Rate as a measure of the cost of credit expressed in dollars on a yearly basis.

Copyright © Houghton Mifflin Company. All rights reserved.7 | 20 Monthly Installment Payment Required to Repay $1000

Copyright © Houghton Mifflin Company. All rights reserved.7 | 21 The Declining-Balance Method Periodic Interest Rate: The monthly rate applied to the outstanding balance of the loan. MonthBalancePaymentInterestPrincipalEnd Bal 1$1,000.00$91.68$15.00$76.68$ $923.32$91.68$13.85$77.83$ $845.49$91.68$12.68$79.00$ $766.49$91.68$11.50$80.18$ $686.31$91.68$10.29$81.39$ * Interest rate is 18% APR, loan of $1,000 for 12 months Amortization – Loan repayment method in which part of the payment is applied to the principal owed and part to the interest. –Ex: Mortgage and Property Loans

Copyright © Houghton Mifflin Company. All rights reserved.7 | 22 Other Methods Add-On Interest Method – interest calculated by applying an interest rate to the amount borrowed times number of years. Ex: I = PRT, where: I = Interest or finance charge, P = Principal Borrowed, R = Interest Rate, T = Time of loan period Ex: A $2,000 Loan for 2 years borrowed at 9% interest would be: $2,000 X 0.09 X 2 Years = $360 Interest + $2,000 = $2,360 Total / 24 Months = $98.33 / Month Payment Rule of 78s (or Sum of the Digits) method for calculating prepayment penalties – assessed for paying off a loan early due to borrower having use of more money early in loan period than later when paid. Discount method of calculating interest – interest deducted upfront with proceeds paid to borrower. –Ex: $2,000 Loan for 2 years borrowed at 9% interest would result in $1,640 proceeds paid to borrower. Payment is $2,000/24 = $83.33/Mo.

Copyright © Houghton Mifflin Company. All rights reserved.7 | 23 The Top 3 Financial Missteps with Credit Cards and Consumer Loans Consumers experience challenges with building and maintaining good credit when they do the following: 1.Fail to shop for the lowest APR on their credit cards and consumer loans. 2.Pay more than 14 percent of disposable income toward nonmortgage debt payments. 3.Fail to regularly check the accuracy of credit bureau files.

Copyright © Houghton Mifflin Company. All rights reserved.7 | 24 Good Money Habits in Credit Cards and Consumer Loans Move credit card balances to lower-cost accounts, if necessary. Never make convenience purchases on bank credit cards on which you carry a balance. Pay your credit card balances in full each month, or no longer than two or three months later.

Copyright © Houghton Mifflin Company. All rights reserved.7 | 25 Good Money Habits in Credit Cards and Consumer Loans Check your monthly billing statements against your receipts for accuracy, and challenge discrepancies. Use student loans only for direct education expenses rather than to maintain a better lifestyle. Select installment loans that have a low annual percentage rate.