1. 6-1 Chapter 6 Using Credit Cards: The Role of Open Credit

2. 6-2 Introduction Convenient, but if you’re not careful, credit cards will cost you. Some charge over 20% interest on unpaid balances. Most people don’t consider interest charges on purchases they have to have. Manage credit wisely to avoid high interest.

3. 6-3 A First Look at Credit Cards and Open Credit Credit involves receiving cash, goods, or services with an obligation to pay later. Open credit (revolving credit) is a line of credit extended before the purchase. Unpaid balance plus interest carries over to next month. As long as you pay the minimum, you will continue to have credit up to your line of credit.

4. 6-4 Interest Rates Annual Percentage Rate (APR) APR for all consumer loans must be disclosed. (Truth in Lending Act) Fixed APR vs. variable APR Teaser Rates Compound interest

5. 6-5 Calculating the Balance Owed The method of determining the balance (balance calculation method) Average daily balance method - most common Previous balance method – usually the highest interest Adjusted balance method – usually the lowest interest

6. 6-6 Figure 6.1 Calculation of Interest on Outstanding Balances

7. 6-7 Buying Money: The Cash Advance Cash advances at ATMs are just like taking out a loan. Higher interest rate charged immediately on cash advances Up-front fee of 2-4% of the amount advanced.

8. 6-8 Grace Period Grace period- 20-25 days from date of bill. Some credit cards have no grace period No grace period with cash advances. On most cards, the grace period is canceled if there is unpaid balance from previous month.

9. 6-9 Annual Fee A fixed annual charge imposed by a credit card. Over 70% of biggest credit card issuers do not charge an annual fee. Many don’t charge the fee if the card is used at least once a year. Merchant’s discount fee—the percentage of the sale that the merchant pays to the credit card issuer.

10. 6-10 Additional Fees Cash Advance Fee – fixed amount per transaction or a percentage Late Fee – capped at $25 (by the book) Over-the-Limit Fee – charging more than your limit Penalty Rate – not paying on time

11. 6-11 Pros and Cons of Credit Cards Advantages: Convenience Used as identification Phone and internet purchases Use product before paying for it Pay less today and earn interest elsewhere Extended warranties, travel insurance, and rewards.

12. 6-12 Pros and Cons of Credit Cards Disadvantages: Too easy to spend money Too easy to lose track of spending High interest rate Heavy budgetary problems with uncontrolled spending

13. 6-13 Figure 6.2 Undergraduates and Payment Behavior

14. 6-14 What the CARD Act Means for You http://www.foxbusiness.com/personal-finance/2013/09/11/card- act-pros-and-cons-3-years-later/ 1.Your credit card company has to tell you when they plan to increase your rate or other fees. 2.Your credit card company has to tell you how long it will take to pay off your balance. 3.No interest rate increases for the first year. 4.Increased rates apply to new charges.

15. 6-15 What the CARD Act Means for You 5.Restrictions on over-the-limit transactions. 6.Caps on high-fee cards. 7.Protections for underage consumers. 8.Standard payment dates and times.(mail 21 days before due) 9.Payments directed to highest interest balances first. 10.Your credit card company cannot charge you a fee of more than $25 in most cases. 11.No fees for inactivity on the card.

16. 6-16 Choosing a Source of Open Credit Bank Credit Cards— Bank Card Variations— –Premium or Prestige card – credit limits up to and over $100,000 –Affinity card – sponsored by an organization such as MADD (a percentage goes to them) –Secured credit card – backed by collateral

17. 6-17 Choosing a Source of Open Credit Travel and entertainment cards (T&E)— Interest-free grace period but requires payment in full each month. Issuers receive annual fee and merchant’s discount fee. American Express, Diners Club, and Carte Blanche are the primary issuers.

18. 6-18 Choosing a Source of Open Credit Single-Purpose Cards— Companies issue their own cards to avoid merchant’s discount fees. Terms vary, some offer revolving credit. Typically, no annual fee.

19. 6-19 Choosing a Source of Open Credit Traditional charge account — Offered by businesses (LG&E) Convenient for both issuer and payee. Pay monthly bill in full or pay interest/fee.

20. 6-20 The Choice: What’s Best for You Credit user—carries an unpaid balance from month to month. Convenience user—pays off the credit card balance each month (avoids interest). Convenience and credit user—generally pays off all the balance

21. 6-21 Getting a Credit Card Emergency funds. Build solid credit history if used prudently. First step is to apply.

22. 6-22 Credit Evaluation: The Five C’s of Credit Character – having a record of timely repayment of past debt Capacity – current income (total debt payments should be less than 36% of gross pay Capital – investment portfolio Collateral – value of property to be used as security Conditions – impact of current economic conditions (possibility of being laid off)

23. 6-23 The Key to Getting Credit: Your Credit Score A credit bureau—gathers information on consumers’ financial history, including payment history and sells to customers. Credit bureaus compile credit report and assign a credit score. FICO vs. VantageScore Credit report—information on financial situation and dealings. Credit information impacts whether you get a loan, it affects your interest rate.

24. 6-24 Determining Creditworthiness Credit scoring—numerical evaluation of “scoring” of applicants based on their credit history. Reduces the lender’s uncertainty Lender able to make credit available to good risk customers at lower interest rates. You may check any time, free and secure, at www.creditkarma.comwww.creditkarma.com

25. 6-25 Your Credit Score Affects rates you pay on credit cards Affects size of credit line Affects insurance rates Affects mortgage rate Strong credit score—lower interest rate

26. 6-26 How Your Credit Score is Computed Based on models developed by Fair Isaac Corporation. FICO Score but name and your score varies with bureau. Scores range from 300-850. Visit www.myfico.com/ficocreditscoreestimator to get an estimate of your score.www.myfico.com/ficocreditscoreestimator

27. 6-27 Figure 6.5 National Distribution of FICO Scores

28. 6-28 How Your Credit Score is Computed What is a good score? A good credit score doesn’t just mean that you’ll get a loan, it also means you’ll pay less for it through lower rates. Creditworthiness also based on employment history, job history, and amount of debt you currently have.

29. 6-29 Table 6.1 Representative Rates and Monthly Payments for Different FICO Scores

30. 6-30 What’s in Your Credit Report? Identifying Information Trade Lines or Credit Accounts – type of accounts, balances, payment, etc. Inquiries – over the last 2 years Public Record and Collection Items – bankruptcies, foreclosures, liens, etc.

31. 6-31 Factors That Determine Your Score Your Payment History (35%) Amount You Owe and Your Available Credit (30%) Length of Credit History (15%) Types of Credit Used (10%) New Credit (10%)

32. 6-32 Figure 6.6 Factors That Determine Your Credit Score

33. 6-33 Monitoring Your Credit Score The Fair and Accurate Credit Transactions Act (FACT) Check for errors in credit report. Get free copy of your credit report each year from the three major credit bureaus at www.annualcreditreport.com www.annualcreditreport.com Check all information correct, all accounts on report are yours.

34. 6-34 Table 6.3 National Credit Bureaus

35. 6-35 If Your Credit Card Application is Rejected Apply for a card with another financial institution. Find out why you have been rejected. Set up an appointment with credit card manager. Address the problem.

36. 6-36 Controlling and Managing Your Credit Cards and Open Credit Reducing your balance Protecting against fraud Trouble signs in credit card spending If you can’t pay your credit card bills

37. 6-37 Table 6.5 How Long It Can Take to Eliminate Credit Card Debt

38. 6-38 Checklist 6.1