Personal Finance Garman/Forgue Tenth Edition Chapter 6: Building and Maintaining Good Credit PPT slide program prepared by Amy Forgue and Ray Forgue.

Introduction Credit is any arrangement in which goods, service or money is received in exchange for a promise to repay at a later date. To succeed financially you need establish and maintain a good credit reputation. Copyright ©Cengage Learning. All rights reserved.

Your Next Five Years In the next five years: 1. Protect your credit reputation as carefully as you would safeguard your personal reputation. 2. Determine your own debt limits rather than rely on a lender before deciding to take on any debt. Copyright ©Cengage Learning. All rights reserved.

Your Next Five Years 3. Obtain copies of your credit bureau reports regularly and challenge all errors or omissions you find. 4. Never cosign a loan for anyone, including relatives. 5. Always repay your debts in a timely manner. Copyright ©Cengage Learning. All rights reserved. 6- 4

Learning Objective #1 Explain reasons for and against using credit. Copyright ©Cengage Learning. All rights reserved.

Reasons For and Against Using Credit Good uses of credit include emergencies, reservations, convenience, owning expensive items sooner, for protection against fraud, to obtain an education. Copyright ©Cengage Learning. All rights reserved. 6- 6 6

Reasons For and Against Using Credit The downside of credit: Use of credit reduces financial flexibility It Is tempting to overspend Interest is costly Interest, Finance Charge, Annual Percentage Rate (or APR) Copyright ©Cengage Learning. All rights reserved.

Concept Check 6.1 Which two good uses of credit seem most reasonable to you? Which do not? Explain the two downsides of credit that would be most worrisome for you. Distinguish between the APR and the finance charge on a debt. Copyright ©Cengage Learning. All rights reserved.

Learning Objective #2 Establish your own debt limit. Copyright ©Cengage Learning. All rights reserved. 6- 9

Setting Debt Limits Overindebted if the ratio is 15% or higher You should set your own debt limit. Debt payments-to-disposable income method uses your debt payments-to-disposable income ratio. Overindebted if the ratio is 15% or higher Copyright ©Cengage Learning. All rights reserved.

Setting Debt Limits Ratio of debt-to-equity method uses your Debt-to-Equity Ratio: Ratio of your consumer debt to your assets. Equity: Amount by which the value of a person’s assets exceeds debts. A ratio of 33% or higher is excessive. Copyright ©Cengage Learning. All rights reserved.

Setting Debt Limits Continuous-Debt Method: If you are unable to get completely out of debt every four years, you probably lean on debt too heavily. Dual-earner households should consider lower debt limits rather than a limit based on their combined incomes. Copyright ©Cengage Learning. All rights reserved.

Managing Student Loan Debt Choose the most advantageous repayment pattern allowed. Pay electronically. Make your repayments on time, every time. Consolidate your student loans. Copyright ©Cengage Learning. All rights reserved.

Concept Check 6.2 Distinguish among the debt payments-to-disposable income, ratio of debt-to-equity, and continuous-debt methods for setting your debt limit. Copyright ©Cengage Learning. All rights reserved.

Concept Check 6.2 What are the threshold levels for both the debt payments-to-disposable income and ratio of debt-to-equity methods that would indicate that a person is carrying too much debt? Copyright ©Cengage Learning. All rights reserved. 6- 15

Concept Check 6.2 Discuss how dual-earner households should consider their ability to carry additional debt. Copyright ©Cengage Learning. All rights reserved. 6- 16

Learning Objective #3 Achieve a good credit reputation. Copyright ©Cengage Learning. All rights reserved. 6- 17

Credit Approval Process 1. You apply for credit. Credit Application Credit History Copyright ©Cengage Learning. All rights reserved.

Credit Approval Process 2. The lender obtains your credit history. Credit Report Credit Bureau Credit Scoring (or Risk Scoring) System Copyright ©Cengage Learning. All rights reserved. 6- 19 19

Credit Approval Process 3. The lender decides whether to accept the application. Credit Agreement Promissory Note Tiered Pricing Copyright ©Cengage Learning. All rights reserved.

Unfair Credit Discrimination is Unlawful Equal Credit Opportunity Act (ECOA) Unfair discrimination is illegal. Copyright ©Cengage Learning. All rights reserved.

Making Sense of Your Credit Scores Copyright ©Cengage Learning. All rights reserved. 6- 22 22

Your Credit Reputation Building a credit history: Establish both a checking account and a savings account. Have your telephone and other utilities billed in your name. Copyright ©Cengage Learning. All rights reserved.

Your Credit Reputation Request, acquire, and use an oil-company credit card. Apply for a bank credit card. Ask a bank for a small short-term cash loan. Pay off student loans. Copyright ©Cengage Learning. All rights reserved.

Your Credit Reputation You can manage your credit bureau file for free only at annualcreditreport.com The Fair Credit Reporting Act (FCRA) allows you to challenge errors in your credit bureau files. Copyright ©Cengage Learning. All rights reserved.

Concept Check 6.3 Summarize the basic steps that occur when someone applies for credit. What is a credit history, and what role do credit bureaus play in the development f your credit history? Copyright ©Cengage Learning. All rights reserved.

Concept Check 6.3 What is a credit score, and what five major factors go into its calculation? Identify five actions you can take to build a good credit reputation. Summarize the protections provided under the Fair Credit Reporting Act. Copyright ©Cengage Learning. All rights reserved.

Learning Objective #4 Describe common sources of consumer credit. Copyright ©Cengage Learning. All rights reserved. 6- 28

Sources of Consumer Loans Depository institutions loan money to their banking customers. Sales finance companies loan money to buy consumer products. Consumer finance companies make small cash loans. Copyright ©Cengage Learning. All rights reserved.

Sources of Consumer Loans Stockbrokers loan money to their clients. Insurance companies loan money to their policyholders. Choose your source wisely as each tends to charge lower or higher interest rates. Copyright ©Cengage Learning. All rights reserved. 6- 30

Table 6.3: What It Costs to Borrow Money Lender APR Life insurance company 6 Sales finance company 8 Credit union 10 Commercial bank – S&L 12 Bank credit card 18 Consumer finance company 24 Copyright ©Cengage Learning. All rights reserved.

Figure 6.1: The Credit Pyramid Copyright ©Cengage Learning. All rights reserved.

Alternative Lenders Payday lenders Rent-to-own program Pawnshop Copyright ©Cengage Learning. All rights reserved.

Concept Check 6.4 List the four types of depository institutions that are sources of credit for consumers. Distinguish between a sales finance company and a consumer finance company. Copyright ©Cengage Learning. All rights reserved.

Concept Check 6.4 Summarize how stockbrokers and insurance companies serve as sources of consumer credit. Explain where you would go to obtain credit at the lowest cost. Copyright ©Cengage Learning. All rights reserved.

Learning Objective #5 Identify signs of overindebtedness and describe options available for debt relief. Copyright ©Cengage Learning. All rights reserved.

10 Signs of Overindebtedness Exceeding debt limits Not knowing how much you owe Running out of money Paying only the minimum amount due Copyright ©Cengage Learning. All rights reserved.

10 Signs of Overindebtedness Requesting new credit cards and increases in credit limits Paying late or skipping credit payments Using debt-consolidation loans Copyright ©Cengage Learning. All rights reserved.

10 Signs of Overindebtedness Taking add-on loans Experiencing garnishment Experiencing repossession or foreclosure Copyright ©Cengage Learning. All rights reserved.

Debt Collection Federal law regulates debt collection practices. Federal Fair Debt Collection Practices Act (FDCPA) Debt collection agencies Copyright ©Cengage Learning. All rights reserved.

Steps to Take to Get Out from Under Excessive Debt Determine your account balances and the payments required. Focus your budget on debt reduction. Contact your creditors. Copyright ©Cengage Learning. All rights reserved.

Steps to Take to Get Out from Under Excessive Debt Take on no new credit. Refinance. Avoid bad help. Find good help. Copyright ©Cengage Learning. All rights reserved.

Bankruptcy Bankruptcy is a last resort. When you file bankruptcy the court issues a stay on your debts. After bankruptcy all or a portion of your debts are discharged depending on the type of bankruptcy you receive. Copyright ©Cengage Learning. All rights reserved.

Bankruptcy Chapter 13 of the Bankruptcy Act: Wage earner or regular income plan whereby a portion of your debts are repaid over 3-5 years. Chapter 7 of the Bankruptcy Act: Straight bankruptcy whereby most of your assets are sold and applied to your debts. Copyright ©Cengage Learning. All rights reserved.

Concept Check 6.5 Identify four signs of overindebtedness. List the major provisions of the Fair Debt Collection Practices Act. Copyright ©Cengage Learning. All rights reserved.

Concept Check 6.5 What services are provided by a credit counseling agency and how might a debt management plan work to provide relief for someone who is having debt problems? Distinguish between Chapter 7 and Chapter 13 bankruptcy and explain who might be forced to use Chapter 13 rather than Chapter 7. Copyright ©Cengage Learning. All rights reserved.

The Top 3 Financial Missteps in Building and Maintaining Good Credit People slip up in building and maintaining good credit when they do the following: 1. Fail to regularly check the accuracy of credit bureau files. Copyright ©Cengage Learning. All rights reserved.

The Top 3 Financial Missteps in Building and Maintaining Good Credit 2. Let a lender’s willingness to grant credit be an indicator of its affordability. 3. Pay more than 14 percent of disposable income toward nonmortgage debt payments. Copyright ©Cengage Learning. All rights reserved. 6- 48

Do It NOW! Building and maintaining good credit is a must. Start today by: 1. Obtaining a free copy of your credit report (www.annualcreditreport.com) from one of the three national credit bureaus. 2. Confirming the accuracy of the report and if there are errors or omissions challenging them with all three bureaus. Copyright ©Cengage Learning. All rights reserved.

Do It NOW! 3. Repeating steps two and three every four months staggering the bureaus to ensure that each request is free. Copyright ©Cengage Learning. All rights reserved.