Going Into Debt Chapter 4

Americans and Credit Chapter 4, Section 1

Credit and Installment Debt Credit: receipt of funds to buy goods and services in the present with the promise to pay for them in the future Installment Debt: type of loan repaid with equal payments, or installments, over a specific period of time Examples are a car loan or a home mortgage Mortgage: installment debt on a house, land or building (real property) Durable goods: manufactured goods that have a lifespan longer than three years Examples: cars or appliances Often paid for with installment debt

Credit and Installment Debt Principle: amount originally borrowed Interest: amount the borrower must pay for the use of someone else’s money – this is the cost for borrowing The lender could be a bank, store, credit card company or finance company. A longer repayment period = smaller monthly payments A longer repayment period = larger total payments Debt Repayment InterestPrinciple

Why Use Credit? Allows the borrower to enjoy consumption NOW rather than later Spread the payments over the life of the item purchased The satisfaction of having the item purchased is greater than the interest cost. It’s an alternative to saving first. Opportunity cost of borrowing: What you could have bought instead The interest you could have earned by saving

Sources of Loans and Credit Chapter 4, Section 2

Two Major Types of Credit Using credit cards Borrowing directly from a financial institution

Types of Financial Institutions Commercial Banks: bank whose main functions are to accept deposits, lend funds and transfer funds among banks, individuals and businesses Savings & Loan Associations (S&L): depository institution that accepts deposits and lends funds Interest rates for loans are often slightly less than commercial banks. Savings Bank: depository institution originally set up to serve small savers overlooked by commercial banks Often lend funds for mortgages, auto loans and personal loans.

Types of Financial Institutions Credit Union: depository institution that is owned and operated by its members to provide savings accounts and low-interest loans only to its members Finance Company: company that takes over contracts for installment debts from stores and adds a fee for collecting the debt A consumer finance company makes loans directly to consumers at high rates of interest.

Charge Accounts Charge account: credit extended to a consumer allowing the consumer to buy goods or services from a particular company and pay them later Examples: Kohl’s charge, Macy’s charge Regular charge account: is a 30-day charge. It has a credit limit and is interest free if paid within 30 days. After 30 days the interest is high Revolving charge account: allows you to buy more even if you haven’t already paid what you owe Installment charge account: items are purchased then paid for in installments

Credit Cards Credit card: a credit device that allows a person to make purchases at many kinds of stores, restaurants and other businesses without paying cash Example: Visa, Mastercard You can even use a credit card to borrow cash (cash advance) although at a high interest rate Debit card: can be used to make purchases like a credit card, but it is not debt or a loan. A debit card deducts money directly from your checking account.

Cost of Credit Finance charge: the cost of credit expressed monthly in terms of dollars and cents Annual Percentage Rate (APR): cost of credit expressed as a yearly percentage

Applying for Credit Chapter 4, Section 3

Applying for Credit When you apply for credit, you have to complete a credit application. Credit bureau: private business that investigates a person to determine the risk involved in lending to that person – their credit-worthiness Experian, TransUnion, Equifax The credit bureau does a credit check: investigation of your income, debts, personal life and past history of borrowing and repaying debts This information determines your credit rating: rating of the risk involved in lending to a specific person

Credit Rating Very Poor (<580) Poor ( ) Fair ( ) Good ( ) Excellent (700+) Scoresrange from as low as 350 to over 800 Scores range from as low as 350 to over 800

What Hurts Your Credit Rating? Late Payments High Debt to Income Ratio Having Many Open Accounts Previous Bankruptcy UnemploymentLegal Trouble

Applying for Credit What lenders consider when deciding to given you a loan Credit Rating Your Capacity to Pay (Income) Your Character Collateral

Collateral Collateral: something of value that the borrower lets the lender claim if a loan is not repaid Secured loan: loan that is backed up by collateral Unsecured loan: loan guaranteed only by a promise to repay it (no collateral) Cosigner: another person who signs your loan and agrees to pay if you do not

Responsibilities of the Borrower When you get a loan you are responsible for paying it back. What happens when a borrower does not repay their loan? The lender can take your collateral if your loan was secured. You credit rating will go down and you may not be able to get loans in the future. Society has to repay your loan through higher interest rates and higher prices.

Government Regulation of Credit Chapter 4, Section 4

Laws Protecting Borrowers Truth in Lending Act (1968): requires creditors to keep consumers informed about the costs and conditions of borrowing Equal Credit Opportunity Act (1974): You cannot be denied credit based on race, religion, national origin, gender, marital status or age. You also cannot be denied credit just because you are on public assistance. Usury Laws: laws restricting the amount of interest that can be charged for credit

Bankruptcy Bankruptcy: legally having been declared unable to pay off debts owed with available income Should only be used as a last resort Will adversely affect your credit rating for 10 years Will make it difficult to get another loan or even to rent You must often give up the things you own to pay your creditors Just because someone offers you a loan doesn’t mean you can afford it Your debts may be erased, but you will still have to pay your tax debts.