Finance 8 Personal Finance - Ch 5 Consumer Credit: Advantages, Disadvantages, Sources, and Costs
Bankruptcy
A legal process in which some or all of the assets or a debtor are distributed among the creditors because the debtor is unable to pay debts.
What is a FICO Score
Rates how risky a borrow is Fair Isaac Co (Corporation)
Risk-Base Pricing
Seeks to differentiate customers based on their credit information and charge higher rates for more risky customers
Suppose you borrow $1,000 at 6 percent and will repay it in one payment at the end of one year. Use the simple interest formula to determine the amount of interest you will pay
Simple Interest Formula I = P x r x T 1,000 x 6% x 1 = $60.00
Fair Credit & Charge Card Disclosure Act
Covers solicitation for credit cards in the mail, over the phone, in print, or online, it requires they must provide the necessary terms of the account.
What are the major sources of finance charge?
Credit cards
What are the major sources of interest?
Credit cards
If Joshua paid the $500 in 12 equal monthly payments, what is the APR?
Formula: 2 x n x I / P(N+1) 2 x 12 x 50 / 500(12 +1) = 1,200 / 6,5000 = .185 or 18.5%
Credit Report / Credit File
The record of your complete credit history
What is a credit bureau?
A credit bureau is an agency that collects information on how promptly people and business pay their bills. The three major credit bureaus are: 1 Experian 2 TransUnion 3 Equifax
Borrowers
Cardholders who do NOT pay off their balances every month
Open-End Credit
A line of credit in which loans are made on a continuous basis and billed periodically for at least partial payment. i.e. Department stores & bank cards (Visa, MasterCard) Travel & Entertainment (American Express Diners Club) Overdraft Protection
Installment Sales Credit
A loan that allows you to receive merchandise, usually high-priced items i.e. large appliances or furniture Down payment is required, sign contract to repay the balance, plus interest and service charges, in equal installments over a specified period.
Single Lump-Sum Credit
A loan that must be repaid in total on a specified day, usually w/in 30 - 90 day. Usually used to purchase a single item.
Debtor
A person who files for relief under the bankruptcy code
Capacity
The borrower's financial ability to meet credit obligations.
Indebtedness
The condition of being deeply in debt.
Interest
A periodic charge for the use of credit.
What two key concepts to remember when borrowing money?
The two key concepts to remember when borrowing money are: 1 Finance Charge 2 Annual Percentage Rate
What inquiries about your credit history are not counted as applications for credit?
When you request a copy of your own credit report Creditors are monitoring your account or look at credit reports to make prescreened credit offers
Affordable Loan Calculation
Add up all basic monthly expenses and then Subtract this total from take-home pay.
Character
The borrower's attitude toward his/her credit obligations.
Distinguish between Chapter 7 and Chapter 13 bankruptcy.
The difference between Chapter 7 and Chapter 13 bankruptcy is: Chapter 7 is a straight bankruptcy - not all debts are forgiven. Chapter 13 is a wage earner plan bankruptcy - the debtor with a regular income proposes a plan for using future earnings or assets to eliminate the debts over a period of time.
What are the disadvantages of using consumer credit?
The disadvantages of using consumer credit are: Credit costs money Encourages overspending Ties up future income
How might you protect your credit information on the internet?
You might protect your credit information on the internet by: 1 Use a secure browser. 2 Keep records of your online transactions. 3 Review your monthly bank and credit card statements. 4 Read the privacy and security policies of websites you visit. 5 Keep your personal information private 6 Never give your password to anyone online 7 Don't download files sent to by strangers.
Revolving Check Credit
A prearranged loan from a bank for a specified amount Also called: Bank line of Credit
The Equal Credit Opportunity Act (ECOA)
Age, sex, race, nationality, marital status, may not be used to discriminate against you in any part of the credit dealing. You get to know why you were declined for credit.
Home Loan Value Formula
Approx. Market Value of home Multiply by .75 Subtract balance due on mortgage Approx. credit line available
How do you reduce your lender's risk?
By accepting conditions that reduce lender's risk i.e: Variable Interest Rate - based on fluctuating rates in the banking system i.e. Prime Rate. - Sharing the interest rate risk w/lender. Lender may offer a lower initial interest rate than a fixed-rate loan. Secured Loan - Pledge property or other assets as collateral - to receive a lower interest rate Up-Front Cash - Pay cash for a large portion of what is financed. May give you a better chance to getting the other terms you want. Shorter Term - The shorter the time for which you borrow, the smaller chance something will prevent you from repaying and the lower the risk to the lender. Maybe lower interest rate by accepting shorter term BUT PAYMENTS will be higher.
Louise McIntyre's monthly gross income is $2,000. Her employer withholds $400 in federal, state, and local income taxes and $160 in Social Security taxes per month. Louis contributes $80 each month for her IRA. Her monthly credit payments for Visa and MasterCard are $35 and $30, respectively. Her monthly payment on an automobile loan is $285. What is Louise's debt payment-to-income ratio? Is Louise living within her means?
Debt payment-to-Income Ratio = Debt payment / Income 35 + 30 + 285 = 350 Payments 2,000 - 400 - 160 - 80 = 1,360 Income 350/1,360 = .26 (26%) No Louise is not living within her means.
Why is consumer credit important to our economy?
Consumer credit is important to our economy because any forecast or evaluation of the economy includes consumer spending trends and consumer credit as a sustaining force.
What is consumer credit?
Consumer credit is the use of credit for personal needs (except a home mortgage).
What can you do to improve your credit score?
Pay bills on time Lower balances Use credit wisely
The Consumer Credit Protection Act
Protects you against illegal use of your credit card and what rights & responsibility you have in the handling of the credit card.
What are some warning signs of debt problems?
Some warning signs of debt problems are: 1 You make only the minimum monthly payment on credit cards 2 You're having trouble making even the minimum monthly payment on your credit card bills. 3 The total balance on your credit cards increase every month. 4 You miss loan payments or often pay late. 5 You use savings to pay for necessities i.e. food and utilities. 6 You receive second and third payment due notices from creditors. 7 You borrow money to pay off old debts 8 You exceed the credit limits on your credit cards 9 You've been denied credit because of a bad credit bureau report.
What steps might you take if there is a billing error in your monthly statement?
The steps that you might take if there is a billing error in your monthly statement are: 1 Notify your creditor in writing include any information that might support your case. 2 Pay the portion of the bill that is NOT in question
What steps would you take if someone stole your identity?
The steps that you would take if someone stole your identity are: 1 Contact the credit bureaus - flag your file with a fraud alert including a statement that creditors should call you for permission before they open any new accounts in your name. 2 Contact the creditors - Any accounts that have been tampered with or opened fraudulently - follow up in writing. 3 File a police report - keep a copy of police report in case creditors need proof.
Float
The time between when making a purchase and when lender deducts balance from checking account when payment is due Can provide up to 50-day Includes a grace period of 20 - 25 days No finance charges are assessed on current purchases if balance is paid in full w/in 25 days after billing.
What are the two general rules of measuring credit capacity? How is it calculated?
The two general rules of measuring credit capacity are: 1 Debit Payments-to-Income Ratio - Debt payments (not including house payment / net monthly income 2 Debit-to-Equity Ratio - Total liabilities / net worth Do not include the value of your home and the amount of its mortgage.
P-1 A few years ago, Simon Powell purchased a home for $110,000. Today, the home is worth $150,000. His remaining mortgage balance is $50,000. Assuming that Simon can borrow up to 80 percent of the market value, what is the maximum amount he can borrow?
$150,000 x .80 = $120,000 $120,000 - 50,000 = $70,000
Joshua borrowed $500 for one year and paid $50 in interest. The bank charged him a $5 service charge. What is the finance charge on this loan?
$50 + $5 = $55.00
What are the three major trade-offs you should consider as you take out a loan?
1 Term vs. Interest Costs 2 Lender risk vs. Interest Rate 3 Cost of Credit
What to do if your identify is stolen?
1-Contact the credit bureaus - to flag file w/a fraud alert 2-Contact the creditors - that have been tampered w/or opened fraudulently & follow-up in writing. 3-File a police report - keep copy of police report
Fair Credit Reporting Act (FCRA)
1971 Regulates the use of Credit reports
Sidney took a $200 cash advance by using checks linked to her credit card account. The bank charges a 2 percent cash advance fee on the amount borrowed and offers no grace period on cash advances. Sidney paid the balance in full when the bill arrived. What was the cash advance fee? What was the interest for one month at an 18 percent APR? What was the total amount she paid? What if she had made the purchase with her credit card and paid off her bill in full promptly?
200 x 2% = $4.00 Cash Advance Fee 200 x 18% = 36 / 12 = $3 Interest for One Month $200 + $4 + $3 = $207.00 Total Amount Paid $200 Paid with credit card and pad in full
Installment Cash Credit
A direct loan of money for personal purposes, home improvement or vacation expenses. NO down payment Make payments in specified amounts over a set period
Cash Advance
A loan billed to your credit card
Chapter 7 Bankruptcy
A straight bankruptcy in which many, but not all, debts are forgiven. Most assets are sold to pay off creditors Certain assets receive protection i.e.: Social Security payments Unemployment compensation, Net value of home, vehicle, household goods & appliances, tools used at work & books.
Collateral
A valuable asset that is pledged to ensure loan payment
Credit
An arrangement to receive cash, goods, or services now and play for them in the future.
Convenience Users
Cardholders who pay off their balances in full each month
Credit Card Accountability Responsibility & Disclosure Act of 2009 (Card Act)
Credit card companies must provide 45 days' notice of rate increases. The time between receiving statement and the payment due date is 21 days. Credit card companies must apply payments first to the debts that carry the higher interest rates I.e cash advances. Also provide more detailed statement that includes the time and total interest amount to pay off the balance
Truth in Lending Law
Creditors are required to state the cost of borrowing so that consumer can compare credit costs and shop for credit.
Debit Cards vs. Credit Cards
Debit card electronically subtracts money from savings/checking account to pay for goods or services. Also used at ATMs Credit card extends credit and delays payment.
Suppose that your monthly net income is $1,500. Your monthly debt payments include your student loan payment and a gas credit card, and they total $200. What is your debt payments-to-income ratio
Debt payments-to-income ratio formula: Monthly debt payments / Monthly net income 200 / 1,500 = .13 or 13%
Robert Sampson owns a $140,000 townhouse and still has an unpaid mortgage of $110,000. In addition to his mortgage, he has the following liabilities: Visa $565 MasterCard 480 Discover card 395 Education loan 920 Personal bank loan 800 Auto loan 4,250 Total $7,410 Robert's net worth (not including his home) is about $21,000. This equity is in mutual funds, an automobile, a coin collection, furniture, and other personal property. What is Robert's debt-to-equity ratio? Has he reached the upper limit of debt obligations?
Debt-to-Equity ratio = Liabilities / net worth 7,410 / 21,000 = .35 No, he has not reached the upper limit of debt obligations
Madeline Rollins is trying to decide whether she can afford a loan she needs in order to go to chiropractic school. Right now Madeline is living at home and works in a shoe store, earning a gross income of $820 per month. Her employer deducts a total of $145 for taxes from her monthly pay. Madeline also pays $95 on several credit cards debts each month. The loan she needs for chiropractic school will cost an additional $120 per month. Help Madeline make her decision by calculating her debt-to-income ratio with and without the college loan. (Remember the 20 percent rule.)
Debt-to-Income ratio = Debt Payments/Income Ra 820 - 145 = 675 95 / 675 = .14 14% without college loan 95 + 120 = 215 215 / 675 = .32 32% with college loan
Chapter 13
Debtor with regular income proposes a plan for using future earnings or assets to eliminate debts over a period of time. Debtor keeps all or most of property. A plan for a debtor with a regular income to eliminate his debts over a period of time. Normally keeping most of the property. Can be as long as 5 years
Truth in Lending & Consumer Leasing Act
Disclosing all fees & interest & requirements for loans & leases.
Chapter 7
Eliminating almost all debts, assets are sold off to pay creditors. Some assets are protected, Social Security payments, Unemployment compensation, the value of your home, vehicle, household goods, appliances, tools for work & books
The U.S. Bankruptcy Act of 1978
Establishing the legal right to eliminate the debts of an individual. Bankruptcy on your record for 10 years Can file bankruptcy every 8 years
In problem 5, Joshua borrowed $500 on January 1, 2014, and paid it all back at once on December 31, 2014. And paid an interest of $50. What was the APR?
Formula: 2 x n x I / P(N+1) 2 x 1 x 50 / 500(1 +1) = 100 / 1,000 = .10 or 10%
Calculating simple interest on the Declining Balance
I (interest (in dollars)) = P (Principal borrowed) x r (Interest rate) x T (Length of loan in yrs) i.e. Principal $1,000, Interest 5%. 2 payments 1st Payment: = 1,000 x .05 x 1/2 = 25 interest + 500 = $525 2nd Payment = 500 x .05 x 1/2 = 12.50 interest + remaining balance 500 = $512.50 Total Payment on the loan: $525 + $512.50 = $1,037.50
Simple Interest
Interest computed on principal only and without compounding. Formula: Interest = Principal x Rate of Interest x Time I = P x r x T
Teaser Rates
Introductory rates are good for a short period of time 6 - 12 months Rates may rise significantly after the introductory period
Expensive Loans
Loans from finance companies, retail stores charge high-interest rates 12 - 25% Easiest to obtain and the most expensive
Medium-Priced Loans
Loans w/moderate interest from commercial banks, savings & loan associations, & credit unions.
What are the major sources of medium-priced loans?
Loans with moderate interest - from commercial banks, savings and loan associations, and credit unions
Brooke lacks cash to pay for a $600 washing machine. She could buy it from the store on credit by making 12 monthly payment of $52.74 each. The total cost would then by $632.88. Instead, Brooke decides to deposit $50 a month in the bank until she has saved enough money to pay cash for the washing machine. One year later, she has saved $642, $600 in deposits plus interest. When she goes back to the store, she finds that the washing machine now costs $660. Its price has gone up 10 percent - the current rate of inflation. Was postponing her purchase a good trade-off for Brook?
No, because if she would have purchased the washing machine for $632.88 she would have saved $27.12. $660 - $632.88 = $27.12
What to do if your credit card is lost or stolen?
Notify the credit card company immediately. The max. amount that must be paid IF someone uses your card illegally is $50. If the company was informed before the card was used illegally - you have NO obligation to pay
Closed-End Credit
One time loans Paid back in a specified period of time and in payments of equal amounts. i.e. Mortgages Automobile Instalments Loans
What are the major sources of inexpensive loans?
Parents or other family members
Inexpensive Loan
Parents or other family members often the source of the least expensive loans - loans w/ or w/o low interest. Inexpensive loans can complicate family relationships.
What are the five categories in a credit report
Payment History 35% Amounts Owed 30% Length of Credit History 15% Types of Credit Used 10% New Credit 10%
The Bankruptcy Abuse Prevention & Consumer Act of 2005
Requires payback when applicable, to pay back at least a portion of the debt, Requiring financial management training, Curriculum to educate individual debtors & that curriculum test be evaluated for effectiveness.
Fair Credit Billing Act (FCBA)
Sets procedures for promptly correcting billing mistakes, refusing to make credit card payments or defective goods, and promptly crediting payments
What are the interest cost and the total amount due on a six-month loan of $1,500 at 13.2 percent simple annual interest?
Simple Annual Interest = Principal x Rate x Time Rate = 13.2% = .132 Years into months 6/12 =.5 1,500 x .132 x .5 = 99 SAI = 99
Mobile Commerce
The ability to purchase using a mobile device
What are the advantages of using consumer credit?
The advantages of using consumer credit are: Purchasing goods when they are needed and paying them gradually Meeting financial emergencies Achieving convenience in shopping Establishing a credit rating
Capital
The borrower's assets or net worth
What is the difference between a credit and a debit card?
The difference between a credit and a debit card is: A credit card extends credit and delays your payment. A debit card electronically subtracts money from your savings or checking account to pay for goods and services.
Electronic Fund Transfer Act
The disclosure & regulatory handling of ATM's ACH, & wire transfers
Line of Credit
The dollar amount, which may or may not be borrowed, that a lender makes available to a borrower.
What are the major sources of expensive loans?
The easiest loans to obtain - from finance companies, retail stores, and banks through cash advances
What are the factors a lender cannot consider according to the law when offering credit?
The factors a lender cannot consider according to the law when offering credit are: 1 Age 2 Public assistance 3 Housing loans
Conditions
The general economic conditions that can affect a borrowers' ability to repay a loan
What are the major sources of consumer credit?
The major sources of consumer credit are: Commercial banks Savings and Loan Associations Credit Unions Finance Companies Life Insurance Companies Family and Friends
What is the maximum amount that must be paid if someone uses your ard illegally?
The max. amount that must be paid IF someone uses your card illegally is $50.
Annual Percentage Rate (APR)
The percentage cost (or relative cost) of credit on a yearly basis. The APR yields a true rate of interest for comparisons with other sources of credit.
Redlining
The practice of denying or limiting financial services to certain neighborhoods based on racial or ethnic composition without regard to the residents' qualifications or creditworthiness.
Skimming
The recording of the data on the magnetic strip on a credit or debit card.
What is the most common method of calculating interest?
The simple interest formula Interest = Principal x Rate of Interest x Time Other variations methods: Simple interest on the declining balance Add-on interest
Minimum Monthly Payment
The smallest amount you can pay and remain a borrower in good standing.
Finance Charge
The total dollar amount paid to use credit
Finance Charge
The total dollar amount paid to use credit.
List two good reasons to borrow and two unnecessary reasons to borrow.
The two good reasons to borrow are: 1 Enables people to enjoy goods and services now 2 Provides shopping convenience and the efficiency of paying for several purchases with one monthly payment. The two unnecessary reasons to borrow are: 1 The temptation to overspend 2 Does not increase total purchasing power
What are two types of consumer credit?
The two types of consumer credit are: 1 Close-end 2 Open-end
Consumer Credit
The use of credit for personal needs (except a home mortgage).
Calculating Annual Percentage Rate (APR)
There are two ways to calculate APR; 1-by using the APR table or 2-Formula - only approx the APR Formula: r = APR n = number of payment periods in 1yr 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) 2 x # of Pay. periods in 1 yr x Dollar cost of credit / Loan Amt (Total # of pay. to pay off the loan + 1
True / False - Inflation reduces the buying power of money
True
Simple Interest on the Declining Balance
When simple interest is paid back in more than 1 payment. Pay interest only on the amount of principal that has not yet repaid. More payments - the lower the interest paid. Most credit unions use this method.
What is in a credit file?
Your & Spouse's Name Current/Previous Address Your & Spouse's SSN Your Birthdate Your Current /Previous employer Position Your & Spouse's Income Spouse's employer
After visiting several automobile dealerships, Richard selects the car he wants. He likes its $10,000 price, but financing through the deal is not a bargain. He as $2,000 cash for a down payment, so he needs an $8,000 loan. In shopping at several banks for an installment loan, he learns that interest on most automobile loans is quoted at add-on rates. This is, during the life of the loan, interest is paid on the full amount borrowed even though a portion of the principal has been paid back. Richard borrows $8,000 for a period of four years at an add-on interest rate of 11 percent.
a. What is the total interest on Richard's loan? $8,000 x 4 (yrs) x 11% rate $3,520.00 Total Interest b. What is the total cost of the car? 3,520.00 + 8,000 + 2,000 = $13,520.00 $13,520.00 Total cost of the car c. What is the monthly payment? 13,520 - 2,000 = 11,520 11,520 / 48 = 240 Monthly Payment d. What is the annual percentage rate (APR)? R = 2 x n x I / P(N + 1) 2 x 12 x 3,520 / 11,520(48+1) = .1496 or 14.96% APR
