1.  2006 McGraw-Hill Ryerson Ltd. Kapoor Dlabay Hughes Ahmad Prepared by Cyndi Hornby, Fanshawe College Chapter 6 Choosing a Source of Credit: The Costs of Credit Alternatives 6-1

2.  2006 McGraw-Hill Ryerson Ltd. Learning Objectives - Chapter 6 1.Analyze the major sources of consumer credit. 2.Determine the effective cost of borrowing by considering the quoted rate, the number of compounding periods, the timing of interest payments & other service charges. 3.Develop a plan to manage your debt. 4.Evaluate various private & government sources that assist consumers with debt problems. 5.Assess the choices in declaring personal bankruptcy. 6-2

3.  2006 McGraw-Hill Ryerson Ltd. Learning Objective # 1 Analyze the major sources of consumer credit. 6-3

4.  2006 McGraw-Hill Ryerson Ltd. Sources of Consumer Credit Credit costs money Weigh benefits of buying an item on credit versus waiting until you have saved enough money to pay cash Ask yourself Do I need a loan? Can I afford a loan? Can I qualify for a loan? 6-4

5.  2006 McGraw-Hill Ryerson Ltd. Sources of Consumer Credit Inexpensive loans. Parents and family members. Loans based on assets, such as a GIC. Medium-priced loans. Chartered banks, trust companies and credit unions. Expensive loans. Finance companies. Retailers such as car or appliance dealers. Bank credit cards and cash advances. 6-5

6.  2006 McGraw-Hill Ryerson Ltd. Learning Objective # 2 Determine the effective cost of borrowing by considering the quoted rate, the number of compounding periods, the timing of interest payments & other service charges. 6-6

7.  2006 McGraw-Hill Ryerson Ltd. The Cost of Credit Effective Annual Interest Rate depends on; Quoted annual percentage rate How frequently interest is compounded Interest charged up front Other charges such as service charges, credit-related insurance premiums, and appraisal fees 6-7

8.  2006 McGraw-Hill Ryerson Ltd. The Cost of Credit The annual percentage rate (APR) is the percentage cost of credit on a yearly basis. The APR provides the true rate of interest for comparison with other sources of credit. This rate lets you compare like with like when shopping for rates. 6-8

9.  2006 McGraw-Hill Ryerson Ltd. Annual Percentage Rate (APR) R = approximate APR n = number of payment in one year I = total dollar cost of credit P = principal or net amount of loan N = total number of payments scheduled to pay off the loan R = 2 x n x I P (N +1) 6-9

10.  2006 McGraw-Hill Ryerson Ltd. Trade-Offs of Financing Choices Term (length of loan) versus interest cost. A longer term allows lower monthly payments, but you pay more in interest. Lender risk versus interest rate. To reduce the lender’s risk you can... Accept a variable interest rate. Provide collateral to secure the loan. Make a large down payment up front. Have a shorter loan term. 6-10

11.  2006 McGraw-Hill Ryerson Ltd. Calculating Your Loan Payments Fixed Rate Installment Loan Pay off over a pre-determined period of time Payment represents blend of interest and principal Floating Rate Personal Line of Credit Variable interest rate tied to lender’s prime rate Compounded daily Payments not fixed At risk if interest rates rise Takes longer to repay if only paying minimum required 6-11

12.  2006 McGraw-Hill Ryerson Ltd. Cost of Carrying Credit Card Balances Adjusted balance method The assessment of finance charges after payments made during the billing period have been subtracted. Previous balance method Method of computing finance charges that gives no credit for payments made during the billing period. Average daily balance method Uses a weighted average of the account balance throughout the current billing period. If you carried over a balance new purchases may be included in your average daily balance calculation. 6-12

13.  2006 McGraw-Hill Ryerson Ltd. The Cost of Credit Expected Inflation borrowers and lenders are concerned about the goods and services their dollars can buy - its purchasing power inflation erodes the purchasing power of money the expected rate of inflation is added to the interest rate charged by lenders to protect their purchasing power 6-13

14.  2006 McGraw-Hill Ryerson Ltd. The Cost of Credit Avoid the minimum monthly payment trap minimum monthly payment is the smallest amount you can pay and still be a cardholder in good standing is not the total amount due the longer you take to repay the more interest you will incur Credit Insurance ensures the repayment of your loan in the event of death, disability or loss of property pays lender directly 6-14

15.  2006 McGraw-Hill Ryerson Ltd. Learning Objective # 3 Develop a plan to manage your debt. 6-15

16.  2006 McGraw-Hill Ryerson Ltd. Managing Your Debts A sudden illness or loss of job may make it impossible to repay your debts Contact your creditors at once to work out a modified payment arrangement Your vehicle can be repossessed if you default on your payments and you could incur added costs so it is better to sell yourself and repay the debt Debt counseling services are available but be sure to investigate the company 6-16

17.  2006 McGraw-Hill Ryerson Ltd. Warning Signs of Debt Problems Emotional problems such as the need for instant gratification. The use of money to punish. The expectation of instant comfort among those who overuse the installment plan to get what they want now Keeping up with the Joneses. Overindulgence of children. Lack of communication among family members. The amount of finance charges is too high. 6-17

18.  2006 McGraw-Hill Ryerson Ltd. Warning Signs of Debt Problems You continually go over your credit limit You use your credit card as a necessity rather than a convenience You borrow money to make it from one pay cheque to the next Your wages have been garnished to pay outstanding debts You pay only interest or service charges monthly and don’t reduce your total debt You are pressured or threatened by creditors Utility services are cut off for unpaid bills 6-18

19.  2006 McGraw-Hill Ryerson Ltd. The Serious Consequences of Debt Loss of job due to garnishment of wages Neglecting health and educational needs of family members Alcoholism or drug abuse Marital difficulties Neglect of children 6-19

20.  2006 McGraw-Hill Ryerson Ltd. Learning Objective # 4 Evaluate various private & government sources that assist consumers with debt problems. 6-20

21.  2006 McGraw-Hill Ryerson Ltd. Consumer Credit Counseling Service If you are having problems paying your bills you can; contact your creditors and work out a repayment plan go to a non-profit financial counseling program for assistance Credit counseling activities include; aiding families by helping them manage their money, setup a realistic budget and plan for expenditures helping people to avoid future debt problems 6-21

22.  2006 McGraw-Hill Ryerson Ltd. Learning Objective # 5 Assess the choices in declaring personal bankruptcy. 6-22

23.  2006 McGraw-Hill Ryerson Ltd. Declaring Personal Bankruptcy Increasing number of bankruptcy filers are well-educated, middle-class baby boomers with an overwhelming level of credit card debt Usually between 40-44 years of age Increasingly likely to be female In last 9 years bankruptcy has increased almost 8% annually 6-23

24.  2006 McGraw-Hill Ryerson Ltd. Fending off Bankruptcy Consolidation Loans advantages are single interest rate on all your debts and ability to extend them to allow you to make smaller payments disadvantages are higher interest rates as you represent a higher risk to the lender a longer term means more accumulated interest 6-24

25.  2006 McGraw-Hill Ryerson Ltd. Bankruptcy & Insolvency Act 6-26 A federal law initiated in 1992 and amended in 1997 Regulates bankruptcy (a straight declaration of insolvency) and proposal (a wage earner plan) proceedings You are allowed to declare insolvency either through a consumer proposal or through an assignment in bankruptcy

26.  2006 McGraw-Hill Ryerson Ltd. Consumer Proposal A consumer proposal is a maximum 5 year plan for paying creditors all or a portion of a debt owed must be insolvent and less than $75,000 in debt (excluding home mortgage) both court and creditors must approve your proposal may save you from bankruptcy 6-26

27.  2006 McGraw-Hill Ryerson Ltd. Bankruptcy First step is the assignment of your assets to a licensed trustee Until you are released from your debts by a court you will be considered a discharged bankrupt Secured creditors are paid first Remaining assets distributed with cost of bankruptcy administration taking precedence Once completed court will grant you a discharge 6-27

28.  2006 McGraw-Hill Ryerson Ltd. Effects of Bankruptcy Obtaining future credit will be difficult Easier for those who file a consumer proposal and repay some of their debt than those who make no effort to repay A bankruptcy remains on your credit file for 7 years 6-28

29.  2006 McGraw-Hill Ryerson Ltd. Summary of Learning Objectives Analyze the major sources of consumer credit Banks, trust companies, credit unions, finance companies, life insurance companies, family and friends Each has unique advantages and disadvantages Parents or family members are least expensive source of loans May only charge you interest they would have earned on savings May complicate family relationships 6-29

30.  2006 McGraw-Hill Ryerson Ltd. Summary of Learning Objectives Determine the cost of credit by calculating interest using various interest formulas Determine the effective cost of borrowing by considering the quoted rate, the number of compounding periods, the timing of interest payments and other service charges Financial institutions quote an annual percentage rate (APR) on installment loans and lines of credit Effective cost of borrowing will rise of compounded more than once a year or loan is made on a discount basis with service fees added 6-30

31.  2006 McGraw-Hill Ryerson Ltd. Summary of Learning Objectives Develop a plan to manage your debt Serious consequences if debt not properly managed Following are common reasons for indebtedness; Emotional problems Use of money to punish Expectation of instant comfort Keeping up with the Joneses Overindulgence of children Misunderstanding or lack of communication among family members Amount of financial charges 6-31

32.  2006 McGraw-Hill Ryerson Ltd. Summary of Learning Objectives Evaluate various private and government sources that assist consumers with debt problems If you cannot meet obligations contact creditors immediately Investigate debt consolidation companies thoroughly before signing up Or better yet contact a credit counselling service or other debt counselling organization 6-32

33.  2006 McGraw-Hill Ryerson Ltd. Summary of Learning Objectives Evaluate various private and government sources that assist consumers with debt problems Such organizations help people manage money better by setting up a realistic budget and planning for expenditures Also help prevent debt problems by teaching necessity of family budget planning and providing education to people of all ages 6-33

34.  2006 McGraw-Hill Ryerson Ltd. Summary of Learning Objectives Assess the choices in declaring personal bankruptcy Last resort is to declare bankruptcy Consider financial and other costs first Can declare insolvency through consumer proposal or an assignment in bankruptcy Obtaining credit more difficult after filing bankruptcy May be easier because relieved of prior debt or creditors know they cannot file another case for a period of time 6-34

35.  2006 McGraw-Hill Ryerson Ltd. Key Formulas Calculating the Effective Annual Interest Rate (1 + APR/m) m - 1 Calculating an Installment Loan Payment Calculating monthly interest in a line of credit Interest = B x APR x (n/365) 6-35