Chapter 6: Intro to Consumer Credit

Consumer credit

the use of credit for personal needs, except a home mortgage, by individuals and families, in contrast to credit used for business purposes E.g. cars, credit cards, student loans, appliances

Open-End Credit

Loans are made on a continuous basis and you are billed periodically for at least partial payment Use as needed until reaching line of credit maximum (line of credit: the maximum dollar amount of credit the lender has made available to you) Credit cards, departments store cards, bank credit cards, incidental credit, home equity You pay interest and finance charges if you do not pay the bill in full when due The creditors make money planning that consumers will be paying interest at hefty rates

Types of Credit: Home Equity Loans

Based on the difference between current market value of your home and the amount owed on the mortgage Borrow up to 85% of the value of the home It is set up like a revolving line of credit Can be very useful and very dangerous Example $300K house appreciates to $500K and $200K mortgage exists. What is maximum Home Equity Loan? What happens to debt service on house? What happens if value decreases to $400K and maximum was borrowed?

Components of Fico

Provides a snapshot of risk that banks and other institutions use to help make lending decisions - Number generally between 300 and 850. You need about a 760 score to get the best mortgage rates, and a score of 720 to get the best deal on an auto loan Factors taken into account in a person's financial history to assess their FICO score: 35%: Payment history (pay bills on time?) 30%: Credit utilization (amounts owed) 15%: Length of credit history (don't close old accounts unless you have to. May hurt credit score) 10%: Types of credit used (installment, revolving, consumer finance & mortgage) - consumers can benefit by having a history of managing different types of credit 10%: Recent searches for credit (don't apply for new credit cards and loans unless absolutely necessary as each credit inquiry will lower credit score)

Advantages of Credit

Provides for immediate use of current goods and services. (Food, books, etc.) Permits purchase even when funds are low A cushion for financial emergencies Could help one save money by purchasing something earlier "on-sale" Easier to return merchandise Convenient when shopping, don't have to carry cash Tracking One monthly payment Safer than cash and arguable debit cards Normally needed for hotel, car reservations and shopping online Can take advantage of float time/grace period May get rebates, airline miles, or other bonuses Indicates financial stability

FICO Score Range

There are several FICO scores. The classic FICO score is between 300 and 850 with 60% of people falling between approximately 650 and 799. According to FICO the median score in Aug 2015 was 695. Each individual actually has three credit scores for FICO scoring because each of three national credit bureaus, Equifax, Experian and TransUnion, has its own database. Data about an individual consumer can vary from bureau to bureau.

Laws that protect you if you have a complaint about consumer credit

Truth in Lending and Consumer Leasing - If creditor fails to disclose information required, gives inaccurate information, or does not comply with the rules regarding credit cards or the right to cancel them, you pay sue for actual damages, that is, any loss you suffer Equal Credit Opportunity Act - If you can prove that a creditor has discriminated against you for any reason, you may sue Fair Credit Billing Act - A creditor that fails to comply with the rules applying to the correction of billing errors automatically forfeits the amount owed on the item in question and any finance charges on it, up to a combined total of $50, even if the bill was correct Fair Credit Reporting Act - May sue for violating rules regarding access to your credit records and correction of errors in your credit file Consumer Credit Reporting Reform Act - An unfavorable credit report can force you to pay a higher interest rate on a loan or cost you a loan, an insurance policy, an apartment rental, or even a job offer. This act places burden of proof for accurate credit information in the credit reporting agency rather than on you Credit Card Accountability, Responsibility and Disclosure Act (Credit CARD act) - Places new restrictions on credit card lending and eliminates certain fees

NEW CREDIT CARD RULES

your credit card company has to tell you: When they plan to increase your rate or other fees. Your credit card company must send you a notice 45 days before they can : - increase your interest rate; - change certain fees (such as annual fees, cash advance fees, and late fees) that apply to your account; - make other significant changes to the terms of your card. How long it will take to pay off your balance: - Your monthly credit card bill will include information on how long it will take you to pay off your balance if you only make minimum payments - It will also tell you how much you would need to pay each month in order to pay off your balance in three years.

Pecore's Planning Principles

1. Establish good credit early 2. If possible, pay credit cards in full monthly; don't carry a balance 3. Minimize or avoid fees 4. If you have a consumer loan, get the lowest rate 5. Take your credit rating seriously 6. Use minimal number of credit cards

Credit

An arrangement to receive cash, goods, or services now and pay for them in the future. Receive now, pay later

Managing Credit Capacity

Before you take out a loan, ask yourself Can you afford the loan? - Add up all basic monthly expenses and then subtract this total from your take-home pay. If the difference will not cover the monthly payment and still leave funds for other expenses, you cannot afford the loan What do you plan to give up in order to make the payment? - If you currently save a portion of your income that is greater than the monthly payment, you can use these savings to pay off the loan. But if you do not, you will have to forgo spending on entertainment, new appliances, or perhaps even necessities Are you prepared to make this trade-off? What is the opportunity cost? (Example on 84)

Debt payments-to-income ratio

Calculated by dividing your monthly debt payments (not including house payment, which is a long-term liability) by your net monthly income (total monthly payments/after tax income) - Ratio should not exceed a maximum of 20% of your net income

Closed-End Credit

One-time loans for a specific purpose and specific amount that you pay back in a specified period of time, and in payments of equal amounts Mortgage, automobile, and installment loans for furniture, appliances and electronics An agreement, or contract, lists the repayment terms: the number of payments, the payments, the payment amount , and how much the credit will cost.

Disadvantages of Credit

Temptation to overspend Hard to see and feel the outflows like cash, checks or debit cards. Failure to repay loan may lead to loss of income. Income garnishment. Credit costs money - interest and fees Compounding works hard and never stops working against you at normally very high rates

What creditors look for when you apply for credit

The 5 Cs: - Character: do you pay bills on time? - Capacity: Can you repay the loan? Based on income - Capital: What are your assets and net worth? Based on assets - Collateral: What property do you have to pledge that the lender can repossess if you default on the loan? - Conditions: What economic conditions could affect your ability to repay the loan?

FICO Score

The FICO score is the best-known and most widely used credit score model in the United States and is calculated with information from a consumer's credit files. The score is sold by the: Fair Isaac Company. It provides a snapshot of risk that banks and other institutions use to help make lending decisions. Applicants with higher FICO scores might be offered better interest rates on mortgages or automobile loans as well as higher credit limit amounts.

Co-signing A Loan

The creditor will give you a notice that tells you... You are being asked to guarantee the debt, so consider if you can afford it if the borrower defaults. If the borrower does not pay, you may have to pay up to the full amount and also any late or collection fees. If a payment is missed the creditor can collect the debt from you without first trying to get it from the borrower. Be careful! If you do co-sign, consider: - Can you afford to pay the loan? If not, your credit rating could be damaged - Liability for this debt may prevent you from getting other credit that you want - If you put up collateral, pledged assets, you could lose the assets if the loan goes into default

Fair Credit Reporting Act

This act regulates the use of credit reports. Credit card companies must correct inaccurate or incomplete information. Only authorized persons have access to your report. Adverse data can be reported for seven years; bankruptcy for ten years. Bankruptcy - inability to pay obligations and is a formal and legal "reset" with creditors.