Chapter 5 first half
- 1. 5A Consumer Credit #1 Credit – An arrangement to receive cash, goods, or services now and pay for them in the future. Types of credit ???
- 2. Objective 1 Analyze Advantages and Disadvantages of Using Consumer Credit • Credit – Based on trust in people’s ability and willingness to pay bills when due • Consumer Credit – Use of credit by individuals for personal needs, except a home mortgage – Dates back to colonial times; exploded after invention of cars (installment loans; traveling) – A major force in our economy 5-2
- 3. Uses and Misuses of Credit Before you use credit for a major purchase, ask: – Do I have the cash for the down payment? – Do I want to use my savings for this purchase? – Does the purchase fit my budget? – Could I use the credit I’ll need in some better way? – Can I postpone this purchase? – What are the opportunity costs of postponing this purchase? – What are the dollar and psychological costs of using credit for this purchase? 5-3
- 4. Advantages of Credit • Current use of goods and services • Permits purchase even when funds are low • A cushion for financial emergencies • Advance notice of sales • Easier to return merchandise • Convenient when shopping • Provides a record of expenses 5-4
- 5. More Advantages of Credit • One monthly payment • Safer than carrying cash • Needed for hotel reservations, car rentals, and shopping online • Take advantage of “float” time/grace period • Rebates, airline miles, cash-back rewards, or other “perks” • Credit indicates financial stability 5-5
- 6. Disadvantages of Consumer Credit • Temptation to overspend • Can create long-term financial problems and slow progress toward financial goals • Potential loss of merchandise due to late or non-payment • Ties up future income • Credit costs money - more costly than paying with cash 5-6
- 7. Objective 2 Assess the Types & Sources of Consumer Credit Two Basic Types of Consumer Credit • Closed-End Credit – One-time loans for a specific purpose paid back in a specified period of time • Open-End Credit – Use as needed until line of credit max reached 5-7 Examples of each?
- 8. Closed-End Credit • One-time loans for a specific purpose 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 • 3 most common types of closed-end credit 1.Installment sales credit- loan for high-priced items 2.Installment cash credit- loan of cash for personal use 3.Single-lump credit- loan repaid on a specific day 5-8
- 9. Open-End Credit • Use as needed until line of credit max reached – Credit cards – Department store cards – Home equity loans • You pay interest and finance charges if you do not pay the bill in full when due • Revolving Check Credit (Bank Line of Credit)- pre-arranged loan for a specified amount; can be accessed with special checks 5-9
- 10. Sources of Consumer Credit Loans – Borrowing money with an agreement to repay, along with interest, within a certain amount of time (e.g., 3 years) • Inexpensive loans – Parents or family members • Medium-priced loans – Commercial banks, savings and loan associations, and credit unions • Expensive loans – Finance and check cashing companies – Retailers (e.g., department store credit cards) – Bank credit cards and cash advances 5-10
- 11. Sources of Consumer Credit • Home Equity Loans – Loan based on home equity • Current market value of your home minus the amount you still owe on the mortgage – Interest is tax-deductible – Should only be used for major purchases • Credit Cards – Average cardholder has > 9 credit cards – Convenience users vs. borrowers – Finance charge = total amount paid to use credit 5-11
- 12. Sources of Consumer Credit • Debit Cards – Debit cards electronically subtract money from savings or checking accounts – Most commonly used at ATMs – Widely accepted at stores also • Stored Value Cards – Gift cards – Prepaid cards 5-12
- 13. Sources of Consumer Credit • Smart Cards – Plastic card equipped with a computer chip that can store 500 times as much data as a normal credit card (e.g., health info) • Travel and Entertainment (T&E) cards – Not really “credit cards”; balance is due in full each month – Diners Club; American Express – You don’t pay for goods or services at the time of purchase 5-13
- 14. Objective 3 Determine Whether You Can Afford a Loan and How to Apply for Credit Before you take out a loan, ask yourself... Can you meet all your essential expenses and still afford the monthly loan payments? – Add up basic monthly expenses and subtract from take-home pay; will the difference cover the monthly payment? (NO? Can’t afford it!) – What do you plan to give up in order to make the payment? 5-14
- 15. General Rules of Credit Capacity *Not including a house payment, which is a long-term liability Debt Payments-to-Income Ratio Monthly Debt Payments* Net Monthly Income Consumer credit payments should not exceed a maximum of 20% of your net income. 5-15
- 16. General Rules of Credit Capacity Debt To Equity Ratio Total Liabilities Net Worth* = Should be < 1 *Excluding home value 5-16 The lower the ratio, the better; e.g., 0.5 or 0.25
- 17. The Five C’s of Credit • Character - Do you pay bills on time? • Capacity - Can you repay the loan? • Capital - What are your assets and net worth? • Collateral - What assets do you have to secure the loan? • Conditions- Lenders will review how general economic conditions will affect your ability to repay your loan 5-17
- 18. FICO & VantageScore • FICO Credit Score – 350 to 850 – Higher score = less risk – Available from http://www.myfico.com for a fee; can sometimes get for free from lenders • VantageScore – New scoring technique – Developed collaboratively by 3 credit agencies – Range = 501 to 990 5-18
- 19. Credit Scoring Factors • Bill payment history, weighted to emphasize past 12 months (35%) • Proportion of outstanding debt to available credit limits (30%) • Length of credit history (15%) • Number of recent credit inquiries (10%) • Mix of types of credit used (10%)
- 20. Factors of Creditworthiness ECOA (Equal Credit Opportunity Act) – Gives all applicants the same rights. – Credit providers may not discriminate based on: • Age • Social Security or public assistance • Housing loans (redlining) – If you are denied credit, you have the right to know the reasons • You can request a copy of your credit report within 60 days if you are denied credit based on what is in your files 5-20
- 21. Your Credit Report • Credit Reports – Record of your complete credit history • Credit Bureaus – Agencies that collect information on how promptly people and businesses pay their bills – Experian, Trans Union and Equifax are the 3 major credit bureaus – Credit Bureaus obtain information from banks, finance companies stores, credit card companies and other lenders 5-21
- 22. Four Main Parts to a Credit Report • Identifying Information: name, SS Number, current/previous addresses, birthdate, employer • Public Record Information from Local Courthouse: liens, foreclosures, bankruptcy • Other Credit History Information: list of loans and credit cards, timeliness of payments, defaults and negative information (7 years) • Inquiries: Usually 2 years; self-initiated and promotional (for marketing purposes)
- 23. Your Credit Report • Who can obtain a credit report? – Only authorized persons have access to your report for approved legitimate business purposes – Examples??? • Time Limits on Unfavorable Data – Adverse data can be reported for 7 years – Bankruptcy can be reported for 10 years 5-23
- 24. Wrap Up • Concept Check 5-1- Reasons to Borrow and Advantages/Disadvantages • Concept Check 5-2- Definition of Terms; Difference Between Credit and Debit Cards • Concept Check 5-3- Definition of Terms
Editor's Notes
- #20: This slide lists seven factors that affect credit scoring models: Previous Payment History- On-time payments enhance a person’s credit score while late payments subtract points. The more bills that are late (e.g., 3 creditors versus 1) and the later the payments (e.g., 90 days instead of 30 days), or charged-off debts, the worse a credit score. A borrower’s previous payment history accounts for 35% of his or her credit score (Kiplinger’s Personal Finance, “The Secret Mix,” September 2000, p. 104). Amount of Money Currently Owed- Potential lenders don’t like to see high amounts of debt. In addition, scoring models take points away from people who have a lot of open credit lines with zero balances (e.g., credit cards they don’t use) because they could go out tomorrow and borrow against them. Proportion of Balances to Credit Limits- “Maxing out” credit lines (i.e., borrowing up to the credit limit) can decrease your credit score. How Long You’ve Been a Borrower- Credit scoring models give more weight to people who have successfully used credit for longer periods of time. Number of Recent Credit Inquiries- Scoring models take points away from people who have applied for a number of new credit lines within a short time period (e.g., six months to a year). Inquires made by lenders in advance of “pre-approved offers” are ignored and do not count against you. Types of Credit Used- Credit scores can increase with a mix of credit (e.g., mortgage, car loan, credit cards) instead of just one type of credit. Stability of Job and Home Address- Scoring models give more weight to “stability” as indicated by length of time at current job and current address.