6-1 CHAPTER 6: BORROWING ON OPEN ACCOUNT

6-2 The Basic Concepts of Credit Why Borrow?  Avoid paying cash for large purchases (like a car)  Meet financial emergencies  Convenience  Investment purposes

6-3 Improper Uses of Credit  Meet basic living expenses  Make impulse purchases  Purchase non-durable goods (like restaurant meals)

6-4 Rule of Thumb!  THE PRODUCT PURCHASED SHOULD OUTLIVE THE CREDIT PAYMENTS Don’t let credit squash you!

6-5 Establishing Credit  Open checking and savings accounts.  Get one card and make small purchases.  Build a good credit history by: –Not getting overextended. –Fulfilling all terms of credit obligations. –Consistently paying on time. –Immediately notifying creditors if unable to pay. –Being truthful when applying.

6-6 How much credit can you stand? Total monthly consumer credit payments Monthly take-home pay Monthly consumer credit payments (excluding mortgage) should not exceed 20% of your monthly net income. DEBT SAFETY RATIO =

6-7 Steps for Women in Establishing Credit :  Consistently use your own legal name to build credit history. Ex: Mary Brown, not Mrs. John Brown  Have information reported to credit bureau in your name as well as your husband’s.  Consider retaining separate credit file when you marry.

6-8 Open Account Credit  Credit extended to a consumer in advance of any transaction.  Consumer can buy/borrow up to a specified amount, the credit limit.  Usually, interest can be avoided by paying balance in full.

6-9 Bank Credit Cards:  Issued by financial institutions  Features include: –Line of credit dependent upon applicant’s financial status and ability to pay –Cash advances and balance transfers –Other services or rebates –Interest rates and fees

6-10 Other Credit Cards & Charge Accounts:  Retail charge cards (ex: Sears)  30-day charge accounts  Travel & entertainment cards  Prestige cards  Affinity cards  Secured credit cards  Student credit cards

6-11 Debit Card:  Looks like a credit card but works like writing a check—accesses your checking account.  Does not provide line of credit.  Greater liability exposure in event of fraudulent use.  Prepaid card is a debit card with fixed amount available—does not access your checking account.

6-12 Revolving Credit Lines:  Open account credit offered by banks and other financial institutions.  Usually offer higher credit lines and lower interest rates than credit cards!  Money accessed by writing checks.

6-13 Forms of revolving credit:  Overdraft protection lines  Unsecured personal credit lines –Available on an as-needed basis  Home equity credit lines –Secured by the equity in owner’s home –Interest tax deductible (if you itemize deductions)

6-14 Obtaining and Managing Open Account Credit Steps in opening an account: 1. Complete and submit application. 2. Lender investigates creditworthiness. 3. Lender obtains credit bureau report. 4. Lender makes credit decision; may use credit scoring.

6-15 The Credit Application Applicant submits information on income, marital status, employment history, existing accounts, etc.

6-16 The Credit Application Applicant submits information on income, marital status, employment history, existing accounts, etc. The Lender Verifies application; turns it over to the Credit Bureau.

6-17 The Credit Bureau The Credit Application Applicant submits information on income, marital status, employment history, existing accounts, etc. The Lender Verifies application; turns it over to the Credit Bureau. Reporting agency that gathers and sells info about people. Gets information from: subscribing creditors creditors you use as reference public documents

6-18 The Credit Bureau The Credit Application Applicant submits information on income, marital status, employment history, existing accounts, etc. The Lender Verifies application; turns it over to the Credit Bureau. Credit Bureau submits report back to lender; lender then makes Reporting agency that gathers and sells info about people. Gets information from: subscribing creditors creditors you use as reference public documents The Credit Decision

6-19 Computing Finance Charges  Lenders must disclose –Annual percentage rate (APR), the true rate of interest paid over life of loan. –Method used in computing finance charges.  Balance to which interest rate applied generally determined using one of four variations of the Average Daily Balance (ADB) method.

6-20  ADB excluding new purchases The most consumer friendly!  ADB including new purchases Most frequently used—no grace period on new purchases if you carry a balance.  Two-cycle ADB excluding new purchases Calculated using last 2 billing cycles.  Two-cycle ADB including new purchases Least consumer friendly method!

6-21 Example: Calculate the finance charges on a credit card account which has an annual interest rate of 18% (or 1.5% per month) and uses the average daily balance method including new purchases. (Refer to Exhibit 6.8 in text.)

6-22 5$582$ 2, , , ,844 Total: 31$28,068 ADB = $28,068  31 = $ Monthly APR =.18  12 =.015 Finance charge = $ x.015 = $13.58 ADB Including New Purchases: # of Days BalanceWeighted (1) (2)Balance (1x2)

6-23 Refer to Exhibit 6.7 in text— What a difference the balance method makes! Examples shown below all have:  Same stated rate of 19.8%  Same account activity Method Finance Charges ADB including new purchases $ ADB excluding new purchases Two-cycle ADB including new purchases Two-cycle ADB excluding new purchases

6-24 Managing Your Credit Cards  Review statements promptly each month and verify each entry.  Pay at least the minimum monthly payment by due date.  Returned merchandise credited to your account.

6-25 Using Credit Wisely  Shop around, comparing: –Annual fees & other fees –APR –Length of grace period –Balance method

Short, interest-free loan + Simplified record keeping + Easier resolution to unsatisfactory purchases + Convenience and emergencies  Disadvantages of Credit Cards – Easy to overspend – High interest costs  Advantages of Credit Cards

6-27 Avoid credit problems by:  Using discipline when purchasing.  Reducing the number of cards you carry.  Being selective in accepting preapproved credit offers.  Not making new charges.  Paying more than the minimum.  Paying off cards with highest finance charges first.  Transferring balances to card with low introductory rate and paying off quickly.

6-28 Important Consumer Credit Legislation  Key legislation deals with –Credit discrimination. –Disclosure of credit information. –Billing procedures, errors, complaints, and recourse on unsatisfactory purchases. –Disclosure of finance charges, other fees, credit terms, and loss of credit card. –Protection against collector harassment.

6-29 Credit Card Fraud  Never give account number to someone who calls you—you must initiate the call.  Use only secure Internet sites.  Never put credit card info on checks or personal info on charge slips.  Keep your eye on your card!  Draw line through blank spaces on slip.  Destroy old cards and shred old statements and slips.  Report lost or stolen cards immediately!

6-30 Options if you’re getting into trouble...  File Bankruptcy –Chapter 13—debt restructuring. –Chapter 7—wipe the slate clean. –Other bankruptcy options.  Try credit counselors –Help you prepare a budget and repayment schedule. –Deal with creditors to possibly reduce some interest & fees.

6-31 THE END!