Chapter 6

Learning Objectives (part 1 of 3) Discuss the pros and cons of paying with cash versus credit Describe the various features that different cards have to offer Analyze whether the card with the cheaper rate is always the better deal

Learning Objectives (part 2 of 3) Describe how debit cards and secured credit cards work List the protections a consumer has with credit cards Compute whether a home equity line of credit would be beneficial Compute how large of a home equity line of credit could be obtained

Learning Objectives (part 3 of 3) Describe the difference between a credit counselor and a credit "doctor" Describe what a FICO score means and how it is computed Discuss the role of the credit bureaus in the credit granting process

Types of Credit Cards Bank Credit Cards Visa, Mastercard, Discover Travel & Entertainment Cards American Express, Diners Store Charge Cards Macy’s, Neiman Marcus

Pros of Using Credit Cards Fair Credit Billing Act gives several protections Limited liability if lost or stolen Especially if reported promptly Cash is usually unrecoverable One month free float

Cons of Using Credit Cards Painless ability to pay may induce one to buy more than can be paid for later Interest rates can run as hign as 19 percent Various fees can really be exhorbitant

How Banks Profit from Credit Cards Charge vendor for processing the transaction Charge vendor for verifying a transaction Charge interest Charge user annual fee and other fees

Features of bank credit cards (part 1 of 2) Annual fee (sometimes negotiable) Teaser rate Differential rates on advances and unpaid balances Over the limit fees Late payment fees

Features of bank credit cards (part 2 of 2) Fee for paying over the phone Transaction fee for a cash advance Lack of use fee How balance is computed on which interest is paid Average daily balance, Previous balance, Adjusted balance Length of grace period

Which card(s) to obtain? (part 1 of 2) Depends on style of use If carry a balance due on a regular basis, interest rate critical If incur fees, fee structure critical

Which card(s) to obtain? (part 2 of 2) Value of special benefits Frequent fly miles Cash rebates Special discounts at particular stores Affinity cards Strategy: Decide what features want and then seek best fit with search on the Internet

Debit Cards Online: ATM card Need Pin number Offline: like a check Direct charge against checking account Receipt is like a cancelled check Takes a few days for transaction to be processed

Debit vs. Credit Card Credit card Provides “float” Debit card: Cash substitute Spending constraint: Won’t clear if balances aren’t in checking account Great for college age children

Secured Cards Prepay for credit limit Option for people with poor credit records Critical for making reservations at hotels, etc.

Protections with Credit Cards Right to cancel Limit of $50 if card lost or stolen Covered by Fair Credit Reporting Act Right to refuse payment to merchants under certain conditions

Debt Consolidation Loans Attractive if can achieve at least one of the following: Lower effective interest rates Smaller monthly payments Tax deductibility of interest (if home equity or HELOC) Disadvantage: Can be locked into payment schedule for many years

Maximum size of home loan Start with appraised value of home Multiply this by the standard loan to value ratio of 80 percent Subtract all existing mortgage balances What is left over is the typical maximum amount for a new home equity loan or HELOC

Credit Doctor vs. Credit Counselor Credit doctor: Claims to resurrect your credit Schemes are usually expensive and sometimes fraudulent Credit Counselor: Focuses on getting spending under control Evaluates options such as debt cons. loans

FICO Score Score used by lenders to determine your credit worthiness Key elements of credit decision: Character Capacity Capital Collateral

Tips for improving FICO Score Stick at the same job Stick at the same address Own rather than rent Have a reasonable number of credit cards Keep oldest credit accounts open Avoid having people run credit checks on you

Credit Bureaus Big Three Experion TRW) Equifax TransUnion Corp. They only collect information

Protecting your Credit Record Regularly review your credit file normally involves a fee Fee waived under certain circumstances Apply for credit at least once per year to make sure you are able to get it Close out inactive credit accounts