Credit and Buying Necessities

Credit Credit: receiving funds, directly or indirectly, to buy goods and services today with the promise of paying for them in the future. (basically – taking goods and services and promising to pay for them later) Debt (amount owed from credit) = Principal + Interest Principal: amount originally borrowed Interest: cost for borrowing money (credit) Most common type of debt: Installment debt: loan paid back in equal payments over a specific amount of time Used for purchasing durable goods: items that have longer life span, usually over three years (cars, appliances) Longer payback times have lower payments, but more interest Mortgage: installment debt on houses, buildings, or property

Credit Why use Credit? Deciding to Use Credit To satisfy an immediate feeling of need (avoid waiting) or an actual need To spread payments over the life of the product (car or truck) As a necessity when making large purchases (house) Deciding to Use Credit Question comparing costs to benefits – interest payments vs. enjoyment times Be aware of costs of using credit Do you require the purchase now? What’s the opportunity cost of using cash? Will satisfaction be greater than interest amount? Is this the best credit available? Can I afford to use credit? You do not have to accept credit (offered a lot)

Sources of Credit Two main sources of credit: using credit cards and borrowing money directly from financial institutions Types of Financial Institutions: Commercial Banks: control largest amount of money and have widest range of services, checking, savings, individual loans, and transferring funds Savings and Loan Associations: accept deposits and lend money; make single family and multi-family dwelling mortgage loans, commercial mortgages, and car loans (usually at lower interest rate than commercial banks) Savings Banks: lend for home mortgages, personal and auto loans Credit Unions: Union member owned to offer savings accounts and low interest loans only to its members (primarily personal, auto and home improvement loans); offer higher interest rates on savings and charge lower interest rates on loans

Sources of Credit Finance companies: take over contracts from stores and add fee for collecting debts (in form of higher interest rates than before) Consumer finance companies: lend directly to consumer at high interest rate, usually because borrower cannot borrow elsewhere (bad credit) Charge Accounts: credit from a particular company for a consumer to buy goods or services there and to pay later Three types: Regular charge account: 30-day charge with credit limit (maximum amount of credit), must be paid in full to not accumulate interest Revolving charge account: allows consumer to make additional purchases without paying previous bill in full, but with interest added Installment charge account: equal payments over a period of time (part to interest, part to principal), at end of term, consumer owns product

Sources of Credit Credit Cards: allows consumer to buy something and pay for it later Can be used in variety of places High interest rates due to large number of delinquent loans Some offer lower rates with special terms to attract consumers Finance charge: cost of credit monthly in dollar amount (principal + interest + other charges Four methods of determining charges: (Figure 4.9 p. 93) Previous Balance Adjusted Balance Average Daily Balance Past Due Balance Annual Percentage Rate (APR): cost of credit as a yearly percentage Allows for easier credit comparisons (Figure 4.10 p. 94) Debit Cards: cashless purchases electronically transferring funds, not a loan

Applying for Credit Fill out a credit application Lending agency that hires a credit bureau to do a credit check. Credit bureau: private business that investigates a person to determine the risk in lending them money Credit check: investigation of a person’s income, debts, personal life, and history of borrowing and paying debts

Credit Rating Credit rating: rating of the risk in lending money to a specific person what credit bureau reports to creditor Factors to help checked for creditworthiness History Capacity to pay: income and debt Good character: reputation, trustworthiness, legal issues Collateral: size of personal capital (something of worth) Secured loans: backed up by collateral Unsecured loans: promise to repay money (sometimes require cosigner, who is responsible in non-payment) Responsibilities as a Borrower: pay on time repay all debts or suffer bad credit Keep records to not go over credit limit Concentrate on high-interest debts first, and pay more that minimum if debt is unmanageable

Government Regulations of Credit Truth in Lending Act first law to expand government’s role of protecting consumer credit ensures that consumer are fully informed of conditions of borrowing Equal Credit Opportunity Act Creditors cannot discriminate on basis of race, religion, nationality, gender, marital status or age Lender must give reasons for denying loan application State Usury Laws Restrict amount of interest that can be charged, setting maximum interest rates Interest ceilings can lead to shortage of credit if general rates rise, hurting lender and consumer

Personal Bankruptcy Bankruptcy: inability to pay debts based on income For people who absolutely cannot repay debts Debtors give up most of what they own to be distributed among creditors Creditors are forced to forgive entire debt Remains on a person’s credit history for 10 years (difficult to reestablish credit and borrow funds)

Buying Necessities Comparison Shopping: Making comparisons to decide what and where to shop Must consider time costs and transportation costs Advertisements and coupons can save time and money Trade-offs in Food Stores: Club warehouse stores: carries limited number of brands and items in large quantities and is less expensive Convenience stores: open most of the time, higher prices, but open more hours Brand-names are well known nationally or regionally. Private-labeled products are lower priced store-brand products carried by some supermarkets and warehouse stores (save almost 40%) Generic products have no brand name and are lower priced. Coupons are available to attract consumers to brand names.

Clothing Choices Comparing Clothing Value: Three factors that influence clothing value: Style: tend to be more expensive and change each year Durability: ability of an item to last a long time Service flow: amount of time you get to use the product and the value you place on that use. Cost of Care: require dry cleaning vs. machine washed More for Less: Clothing costs have decreased significantly over time. Clothing sales generally happen at the end of a season. Bargain fanatics buy items because they are on sale; if it is unnecessary, you may not be saving at all.

Housing Options Rent or Buy How much to spend? Buying a House Avoid spending more than you can afford Need cash for down payments and closing costs: fees involved in arranging a mortgage or in transferring ownership of property Be aware of points: fees paid to lenders and computed as a % of the loan (included in closing costs) each point = 1% of borrowed amount Buying a House Many different types of mortgages and finance options (Figure 5.9 p 124) Mortgages include down payments, interest, paid in monthly installments, and often property taxes, homeowners insurance, and mortgage insurance

Housing Options Renter Rights and Responsibilities: Most renters sign a lease: long-term contract describing terms of rented property (read carefully) Tenants have right to property under agreements in the lease, and a right to privacy, but must pay rent on time, take care of property, notify landlord for major repairs Some must place a security deposit (money held by landlord in case rent is not paid or to cover damages) down Tenants must give written notice if leaving before end of lease (may result in fees and fines for breaking lease) Landlords must supply minimum services (ex. Heat) and obey safety laws Rent-control laws limit the amount a landlord can charge in rent

Buying and Operating a Vehicle Trade-offs of deciding which vehicle: Smaller engines give better gas mileage, but less acceleration Newer vehicles cost more, but need les repairs Smaller vehicles are more energy efficient, but often less protection Registration fees are state fees paid each year Normal maintenance and repairs (oil and filter changes, tune-ups) Extended warranties covers future problems, but costs more Depreciation (decrease in value of the vehicle) as it ages States require liability insurance: to cover bodily injury and property damages (varies based on age, sex, and driving history)