Credit Cards and Other Forms of Credit Chapter 11 Credit Cards and Other Forms of Credit © 2010 Pearson Education, Inc. All rights reserved

Math for Personal Finance What are your financial Math Skills Problem 1 Jose just made a $532 credit sale in his uncle’s electronics store. The customer paid with a Visa card. Assume Jose’s uncle receives 98 percent of the sale after paying a 2 percent fee. How much will he actually receive from the sale? © 2010 Pearson Education, Inc. All rights reserved

Math for Personal Finance Solution: Jose’s uncle will get .98 x $532 = $521.36 © 2010 Pearson Education, Inc. All rights reserved

Math for Personal Finance What are your financial Math Skills Problem 2 Reese charged a pizza on her MasterCard. When she got her bill she was shocked. The pizza was only $11.39, but the charge put her over her credit limit. Assume the company charges her a $30 overdraft charge. How much did the pizza actually cost Reese? © 2010 Pearson Education, Inc. All rights reserved

Math for Personal Finance Solution: the pizza cost Reese $11.39 + $30 = $41.39. However, don’t forget that she probably incurred interest charges related to this purchase, since overdraft often triggers a higher interest rate on the balance she carries © 2010 Pearson Education, Inc. All rights reserved

Math for Personal Finance What are your financial Math Skills Problem 3 Twila used her credit card to get a $40 cash advance at a local ATM. She intended to pay the balance in full when the bill came in. Twila paid the $40 advance back and also paid $4 in fees ($2 for the ATM and $2 for the credit card company) when the credit card statement arrived 20 days later. What is the approximate annual interest rate that Twila paid for this advance? © 2010 Pearson Education, Inc. All rights reserved

Math for Personal Finance Solution: The $40 advance cost her $4 for 20 days. This amounts to 4/40 or 10 percent for 20 days use of the money. Assuming there are 18 twenty-day periods in a year, Twila would be paying 18 x 10 percent = 180 percent a year in interest if she did this same withdrawal every 20 days. © 2010 Pearson Education, Inc. All rights reserved

Learning Objectives Explain how credit cards work Describe different credit card features Explain how to use a credit card correctly Describe other risky credit arrangements © 2010 Pearson Education, Inc. All rights reserved

11-1 How Credit Cards Work Credit cards provide people with revolving open-end credit, which they can draw from repeatedly up to some preset limit Credit provider – such as a bank, agrees to make a certain amount of credit available to the cardholder A credit card can be a very useful financial tool Credit card are used at places of business that accept the credit card The cardholder receives a monthly bill listing all of the credit card purchases Explain that credit cards are a convenient method of paying for goods and services that require payment on a monthly basis © 2010 Pearson Education, Inc. All rights reserved

How Credit Cards Work The cardholder can use the card until reaching the credit limit A credit card can be very easy to abuse Pay off the balance every month or you could find yourself in financial trouble Discuss how credit cards are a useful and convenient tool but are easy to abuse and have been the major factor in the financial woes of millions of people. Explain that the failure to completely pay off credit cards may result in the change of terms to your credit contract that might be detrimental to your financial future. 0-4 © 2010 Pearson Education, Inc. All rights reserved

Ease of Availability and Use The easiest way to establish credit is to apply for a credit card You can receive credit card offers in the mail or apply for a card at a bank or website People use credit cards for lower priced convenience purchases such as gasoline, clothing, and air travel Take a look at Figure 11.1 for an example of a credit card statement Explain how credit cards are easy to apply for Explain that a credit card allows you to buy products and services wherever the card is honored © 2010 Pearson Education, Inc. All rights reserved

Figure 11.1 © 2010 Pearson Education, Inc. All rights reserved

Ease and Availability of Use Billing takes place monthly The credit card statement identifies purchases you made during the period The statement gives the total amount borrowed and the minimum payment you have to make Explain how the minimum payment works. It isn’t the full amount you owe. © 2010 Pearson Education, Inc. All rights reserved

Ease and Availability of Use Credit cards offer three advantages You can purchase products and services without carrying a large amount of cash or checkbook If you pay the balance in full at the end of each billing cycle, you do not incur any interest charges You receive a monthly statement that contains a list of your purchases for that month Tell the students that some cards provide annual statements that aids in preparing your taxes and helps you keep track your types of spending © 2010 Pearson Education, Inc. All rights reserved

Applying for a Credit Card To get a credit card, you must apply for it Applying for a credit card is like applying for a loan or other form of credit Your potential creditor will obtain personal information from you, such as cash inflows and current cash outflows. Refer to figure 11.2 for a sample credit card application Discuss how credit cards are easy to apply for but that require a credit check. Some will also evaluate your assets, such as savings or other financial assets and real property © 2010 Pearson Education, Inc. All rights reserved

Figure 11.2 © 2010 Pearson Education, Inc. All rights reserved

Applying for a Credit Card credit check is when creditors assess your credit report in order to examine your credit history and determine your ability to repay Potential creditors will perform a credit check Your credit report summarizes your existing lines of credit and past credit Creditors will be more likely to extend credit to people with high levels of cash inflows, low levels of cash outflows, and a good credit history Explain how credit cards can be helpful in establishing credit history Did you pay your bills on time or default on any loans? This information will show up on a credit check. Tell students that if they have no credit history, this can be interpreted as negative. © 2010 Pearson Education, Inc. All rights reserved

Types of Credit Cards Credit cards are recognized and accepted by most merchants in the United States and globally Credit cards help merchants, but they also cost them money Credit card companies receive a percentage of the purchase price in return for their services Tell students the most popular brands of credit card include MasterCard, Visa, American Express, and Discover. Explain that the credit card company makes money on your use of the card even if you pay off your balance every month © 2010 Pearson Education, Inc. All rights reserved

Types of Credit Cards Many financial institutions issue MasterCard and Visa credit cards to individuals. There are also numerous retail cards available. Retail stores such as Target and Sears issue cards Explain that retail store cards cannot be used at other retail outlets. © 2010 Pearson Education, Inc. All rights reserved

Check Your Financial IQ What can a consumer do with a credit card? © 2010 Pearson Education, Inc. All rights reserved

Check Your Financial IQ A consumer can purchase goods and pay for them later—even over time 0-17 © 2010 Pearson Education, Inc. All rights reserved

11-2 Credit Card Features Become familiar with credit cards different features and options The next few slides discuss some of the more common features and options Discuss the importance of being familiar with the features—both good and bad—of a credit card © 2010 Pearson Education, Inc. All rights reserved

Credit Limit Credit card companies will establish an individual credit limit for you The total amount of your outstanding debt to the credit card company cannot exceed the credit limit Creditors monitor how much of your limit you keep charged up. Keeping your card charged near the limit will negatively impact your credit score Recall, a credit limit is the maximum that you can borrow at any one time Discuss credit limits. Most cards will allow spending over the limit or apply fees that when you are near your limit causes it to be exceeded—it is never good to be over the limit. © 2010 Pearson Education, Inc. All rights reserved

Overdraft Protection Some credit cards have overdraft protection This will prevent you from attempting to use your credit card and having the charge denied because you are over the limit Only use this feature in emergency situations Overdraft often triggers higher interest rates on any balances you are carrying Overdraft protection is a credit card feature that allows you to “overdraw,” or exceed your credit limit Discuss the advantages and disadvantages of overdraft protection. You won’t be rejected at the point of sale, but the costs cam be high. Overdraft charge can be as high as $30 or more for each overdraft © 2010 Pearson Education, Inc. All rights reserved

Annual Fee Most credit card companies charge an annual fee of $20 to $70 Companies often waive the fees for people with good credit history and use their card frequently Other cards advertise charging no fee at all Read all offers carefully Annual fee a fee credit card companies charge you for using their card © 2010 Pearson Education, Inc. All rights reserved

Incentives to Use the Card Some credit cards offer bonus incentives to encourage people to use their credit cards such as: Cash-back bonuses Airline miles Gifts Incentives can be valuable for people who use of their credit cards often Discuss credit card incentives. Are incentives worth the cost of fees that might not exist on other cards? Some incentives sound great but come with an annual fee or slightly higher interest rate than a competing card. You should judge the value of the incentives to you. © 2010 Pearson Education, Inc. All rights reserved

Prestige Cards Financial institutions often issue prestige cards These cards are often called platinum or gold cards These cards provide additional benefits to cardholders, such as special warranties on purchased products or insurance on travel © 2010 Pearson Education, Inc. All rights reserved

Grace Periods Credit cards typically allow a grace period Grace periods are 20 days from the time the statement is “closed” If you pay the bill within the grace period, you will pay no interest on the amount borrowed. This is, in effect, a short-term free line of credit (see figure 11.3) Grace period is when you are not charged interest on your purchases Discuss grace periods and how they work. Grace periods are 20 days from the time the statement is “closed,” or your bill is calculated and mailed © 2010 Pearson Education, Inc. All rights reserved

Figure 11.3 © 2010 Pearson Education, Inc. All rights reserved

Cash Advances Many credit cards allow cash advances at banks or ATMs A cash advance is when you can use your card to get cash rather than just purchasing a good or service Many credit cards allow cash advances at banks or ATMs Most credit cards charge special transaction fees for this service and higher interest rates Cash advances do not have grace periods Discuss cash advances and how the fees can be extremely high. Is it worth it? © 2010 Pearson Education, Inc. All rights reserved

Financing or Interest Charges Most credit cards interest rates range between 15 and 22 percent Cardholders who make late payments may have late fees Many credit card companies make more money from late fees and other charges than they do from interest charges Discuss late fees and how costly it can be. While using credit cards as a type of financing is convenient, it is also extremely expensive when you carry a balance on it Keep track of your balance and when your payment is due. © 2010 Pearson Education, Inc. All rights reserved

Financing or Interest Charges Credit card companies sometimes offer low teaser rates These rates last for three to six months and encourage people to make charges and carry balances When teaser rates expire, the cards revert to the typical high interest rates Using a credit card as a type of financing can be convenient but it is also expensive with how high interest can be Discuss teaser rates and the importance of being cautious of them. Evaluate all these features when determining which card to apply for Be cautious about accepting too many offers Many consumers find themselves with 10 or more credit cards that they do not need or use © 2010 Pearson Education, Inc. All rights reserved

Prepaid Cash Cards Some companies allow you to purchase a card that you can “load” with cash. The purchase price is deducted from the amount the card was for when you use the card You can use the card until the amount is gone Other common prepaid cards are gift cards Discuss prepaid cash cards and how they are just like cash. Be careful with them. If you lose them, they are gone. Students might call these gift cards. © 2010 Pearson Education, Inc. All rights reserved

Check Your Financial IQ Identify five key features of a credit card. © 2010 Pearson Education, Inc. All rights reserved

Check Your Financial IQ Features include: the credit limit overdraft protection annual fee, incentives prestige cards grace periods cash advances finance or interest charges 0-35 © 2010 Pearson Education, Inc. All rights reserved

11-3 Tips on Using Credit Cards Credit cards are popular, widely available, and risky The Federal Reserve has a lot of information on credit cards. Go to www.federalreserve.gov and click “Consumer Help” to find out information © 2010 Pearson Education, Inc. All rights reserved

Use a Credit Card Only if You Can Cover the Bill Use a credit card only for convenience and not as a source of financing The cost of borrowing money beyond the grace period with a credit card is too high Save up for major purchases instead of using a credit card Remind students how costly it can end up being if you carry a balance. © 2010 Pearson Education, Inc. All rights reserved

Impose a Tight Credit Limit on Yourself Impose a strict standard on your own spending Your self-imposed maximum should equal the amount you can repay every month This will prevent carrying balances on your card For example, you may have a $5000 credit limit If you don’t have enough cash inflow to use that amount, you shouldn’t use it. © 2010 Pearson Education, Inc. All rights reserved

Pay Credit Card Bills First Pay off credit card balances as soon as possible Pay credit card balances before paying off less costly debt Pay off credit card debt rather than putting money into savings or investments Explain to students how it is important to pay off credit card bills first because they are more costly than most other debt. © 2010 Pearson Education, Inc. All rights reserved

Use Savings if Necessary Pay credit card debt with you savings if you need to You can replenish your savings later Credit card debt is costing you 15 to 22 percent Your money is much more wisely used to reduce that debt (see figure 11.4) © 2010 Pearson Education, Inc. All rights reserved

Figure 11.4 © 2010 Pearson Education, Inc. All rights reserved

If You Experience Credit Card Debt Problems Steps can be taken to deal with credit card debt Try to negotiate new terms. Credit card companies often lower interest rates or work out more favorable repayment terms Credit card companies prefer this type of arrangement to bankruptcy or default © 2010 Pearson Education, Inc. All rights reserved

If You Experience Credit Card Debt Problems Credit counseling agencies are another source of help for credit card debt They can help you negotiate better terms with your creditors As you try to lower your rates, limit your spending Take steps to increase cash inflow Tell students not to be afraid to try to negotiate better terms. It’s worth the try. © 2010 Pearson Education, Inc. All rights reserved

If You Experience Credit Card Debt Problems Debt consolidation means combining several small accounts into a one larger account that you may be able to finance at a lower rate at the bank Debt consolidation may be an option for credit card debt This option works best when you have assets you can pledge as collateral against the loan © 2010 Pearson Education, Inc. All rights reserved

If You Experience Credit Card Debt Problems For example, many people take a loan from a bank using the equity in their home as collateral This is a so-called home equity loan You replace the smaller loans with one larger loan and make one larger payment If the larger loan is at a lower rate, it can reduce the overall cost of your borrowing © 2010 Pearson Education, Inc. All rights reserved

If You Experience Credit Card Debt Problems There are risks with debt consolidation Too many people pay off their credit card debt with a home equity loan—and then run their credit card balances higher again Failure to pay off a home equity loan could have disastrous consequences—the loss of the home Discuss the importance of getting out of credit card debt and staying out of it. © 2010 Pearson Education, Inc. All rights reserved

If You Experience Credit Card Debt Problems Bankruptcy is the process in which the courts provide protection for a person who is unable to pay off his or her debts Personal bankruptcy is the last resort for credit card debt Most bankruptcy debt workouts involve a three to five year repayment plan Bankruptcy is reported to the credit bureau It is listed on the person’s credit report for seven years Discuss the importance of avoiding bankruptcy at all costs. Explain how bankruptcy works. The courts will help a bankrupt person propose a plan to repay at least a portion of his or her debts This will prevent the person from borrowing money during that period to ensure that the interest rate will be extremely high © 2010 Pearson Education, Inc. All rights reserved

Check Your Financial IQ What is the main rule for using credit cards wisely? © 2010 Pearson Education, Inc. All rights reserved

Check Your Financial IQ Do not borrow more than you will be able to pay off at the end of the billing period. © 2010 Pearson Education, Inc. All rights reserved 0-49

11-4 Other Risky Credit Arrangements There are other types of risky credit arrangements Among them are: payday lending, tax refund loans, and pawn shops It is important to understand the characteristics these credit options © 2010 Pearson Education, Inc. All rights reserved

Payday Lending Payday lending is a new form of credit Payday lending is when a lender provides cash advances at a high cost to customers who provide a check dated for some time in the future Payday lending is a new form of credit Payday lenders charge a very high fee for their service Loans are small and last for 7 to 14 days The fees amount to an interest rate that is equivalent to several hundred percent per year © 2010 Pearson Education, Inc. All rights reserved

Payday Lending Payday lending has other dangers too If the money you are expecting is delayed, the check to the payday lender will bounce The bounced check will result in additional fees It may also damage your credit report Go to www.paydayloaninfo.org/ to find out other dangers of payday lending Discuss payday loans. These are almost never the answer. These types of businesses prey on desperate people and know that most of their customers will be back. They know that when you get paid and payoff this loan, there are other bills that are due as well and money will need to be borrowed for those. It is a cycle these businesses know is hard to break. Nobody’s financial plan can survive and be healthy when relying on payday loans. © 2010 Pearson Education, Inc. All rights reserved

Tax Refund Loans People take short-term loans and plan on using their income tax refund to repay what they borrowed. This is called a tax anticipation loan A number of income-tax preparers offer this option during tax season When people use this service, the tax preparer may offer an instant refund based on the calculated income tax refund © 2010 Pearson Education, Inc. All rights reserved

Tax Refund Loans The typical fees for these loans are high They can be equal to an annual interest rate of over 100 percent Another danger is that some people find their refunds to be lower than expected In such a situation , the borrower would have a debt that is larger than the refund he or she receives Discuss the dangers of tax refund loans. Explain that tax refund loans and the fees associated are on the same scale as payday loans and carry a lot of risk. You can sometimes pay hundreds of percent interest rates for a loan you may not be able to repay—if your refund is less than you expected. These quick “refunds” are not refunds at all—they are high interest/fee loans against your money. You are paying high interest rates to someone else for your own money. © 2010 Pearson Education, Inc. All rights reserved

Tax Refund Loans Consumers need to be cautious of scams linked to tax refund advance lending In one common scam, victims receive a call offering to speed up their tax refund for a fee charged to their credit card The con artist uses the card to the available credit limit and the victim is left with a serious identity theft problem Tell students to be aware of these types of scams. © 2010 Pearson Education, Inc. All rights reserved

Pawn Shops Pawn shops used to be a popular source of short-term loans Pawnbroker is a pawn shop representative that receives and holds items in exchange for loans that run for 30 days to as much as three months Pawn shops used to be a popular source of short-term loans In many regions of the country, pawn shops still service this particular role Commonly pawned items are firearms, jewelry, and vehicles © 2010 Pearson Education, Inc. All rights reserved

Pawn Shops Pawned items serve as collateral for the loan The customer signs an agreement that allows the pawnbroker to sell the item if the customer does not repay the loan Customers may redeem their item if they repay the loan prior to the due date The cost of a pawnshop loan can be very high Discuss the dangers of pawn shops. It can end up costing you more money. © 2010 Pearson Education, Inc. All rights reserved

Cell Phone Leases Most cell phone providers require you to sign a 12-month lease This is a binding agreement to pay for one year’s service Plans typically charge a monthly fee ranging from $39.99 to $200 or more These plans vary based on the number of minutes you use, the services you have available, and on calling regions © 2010 Pearson Education, Inc. All rights reserved

Cell Phone Leases In most cases, per-minute charges apply if you use the phone more than the plan allows Some plans charge higher rates for other features such as text messages and interest access If you default on the payment, the service provider will report it to the credit bureaus Discuss the dangers of cell phone leases. These plans should be carefully considered and carefully understood—the penalties for ending a plan can be really expensive to end early and the cost to your credit report can be even higher if you decide to stay in a plan you cannot afford. Always compare features and buy the plan that best suites your usage pattern © 2010 Pearson Education, Inc. All rights reserved

Check Your Financial IQ What are some examples of other risky types of credit? © 2010 Pearson Education, Inc. All rights reserved

Check Your Financial IQ Payday lending, pawn broking, tax refund lending, and even cell phone plans are risky types of credit 0-61 © 2010 Pearson Education, Inc. All rights reserved

Summary Credit cards provide people with convenient and easy-to-use credit They are also easy to apply for and obtain A disadvantage of credit is that it is easier to obtain than to repay © 2010 Pearson Education, Inc. All rights reserved

Summary Key credit card features include: the credit limit the annual fee the interest rate a grace period the availability of cash advances Cards may offer “prestige” versions and also have incentives Some have overdraft protection © 2010 Pearson Education, Inc. All rights reserved

Summary Credit cards should be used with discipline Impose your own credit limits rather than spend up to the limit granted by the card Attempt to avoid financing costs Deal with any problems quickly © 2010 Pearson Education, Inc. All rights reserved

Summary There are several other examples of credit arrangements that meet a similar need to credit cards and carry similar risks These include: Payday lending Tax refund loans Pawnbroking Cell phone leases © 2010 Pearson Education, Inc. All rights reserved