CREDIT BASICS What to know and understand before you obtain credit…

CREDIT IS…A Contractual Agreement — In which a borrower receives something of value now and agrees to repay the lender at some later date

“Buy Now, Pay Later” Includes terms and conditions agreed upon between the parties to the

contract about what is to be done, how it will be done and under what circumstances

A Privilege – It can be damaged or taken away… but if used wisely, can be of great benefit to the borrower

Important to Understand – It can have great impact on your financial future

Your Present Self Impacts Your Future Self

The Importance of Having Good Credit

How Does Credit Affect Everyday Life:Employers are reviewing credit reports of prospective employees as part of a standard background checkInsurance companies review credit reports when you apply to insure your carWithout good credit, it is very difficult to obtain a credit card or loanLandlords may check credit rating of potential renters

Credit Terms & Vocabulary

Lender/Creditor An organization or person that lends money to borrowers

Principal The total dollar amount borrowed or the amount still owed on

a credit card or loan, separate from interest

Interest The amount paid for the use of borrowed money

Interest Rate The cost of borrowing money, expressed as a percentage

(Annual Percentage Rate-APR), usually over a period of one year

Credit Terms & Vocabulary

5 C’s of Credit Worthiness This is determined before you are given credit Character-Willingness to repay the borrowed money; lender may

investigate your payment history (credit report) Capacity-Can you comfortably manage payments based on

income, employment history and debt-to-income ratio Condition- Economic conditions, interest rate and payment

amounts Capital-Represents other income besides employment income

such as savings, investments and other assets that can be used to repay the loan

Collateral-Property that can be pledged to back the loans if the borrower fails to repay the loan

Credit Can Be…

An effective tool IF managed responsibly

Create financial stress and negatively impact quality of life and financial well-being IF NOT managed responsibly

Credit Sources

There are many sources

of credit including…

Private Mortgage

Companies Depository Institutions

Automobile Dealerships

Government/Colleges

Credit Card Companies

Insurance Agents

Pawn Shops

Retail Stores

Managing Credit Responsibly Evaluate

the Purpose

Ask Yourself:Does the loan/credit provide long-term benefits?

Is the item a want or a need?

Investing in your human capital with an education loan

Purchasing a vehicle to get to and from work with an automobile loan

Having a credit card to securely make online purchases and for emergencies

Managing Credit Responsibly

Consider Your OptionsAsk Yourself:

• Is using money you already have in a saving or investment account a better option?

Ask Yourself:

• Can you wait to purchase the item until you have enough money saved?

No ContractNo Added Interest or

Fees

You’re Not Spending

Future Income

Benefits:

When You Borrow You Are Spending Future

Income

$1,280.96 Paid in Interest

$10,000 Loan

8% Annual Interest

RateMonthly

Payments for 3 Years

Interest is typically paid for the convenience of using credit

Automobile Loan

Managing Credit Responsibly

Evaluate the Contract

Are the terms (such as interest rate) favorable?

Is the loan feasible both in the present and in the future?

Are the terms consistent for the life of the loan?

Contract: How and When Money Will Be Paid Back

Types of Credit

INSTALLMENT LOANClosed-End Credit

Borrowed money is paid back in specified equal monthly paymentsFixed interest rate that does not change during the life of the loanBuyer signs a legally binding contract with lenderSecured loan means the creditor owns product (collateral) until paid in full

Installment loans are typically used for large purchases such as vehicles, homes, education, etc.

REVOLVING CREDITOpen-End Credit

Borrower may use or withdraw funds up to a pre- approved (maximum) limitThe amount of available credit decreases and increases as funds are borrowed and then repaidCredit may be used repeatedlyBorrower makes payments based only on the amount they’ve actually used or withdrawn, plus interestThe borrower may repay over time, or in full at any time

Bank cards and store/retail cards are examples of revolving credit.

Rent-To-Own Loan•Also known as rental-purchase, is a • Type of legally documented transaction under which

tangible property, such as furniture, consumer electronics, motor vehicles and home appliances, is leased in exchange for a weekly or monthly payment, with the option to purchase at some point during the agreement

Refund Anticipation Loan•A Refund Anticipation Loan (RAL) • is a loan made by a lender that is based on and usually

repaid by an anticipated federal income tax refund. They are offered starting in January through the end of the tax season in April. Taxpayers are generally charged fees and interest to obtain a RAL

Title Loan In the United States, a car title loan, is a type of secured loan where borrowers can use their vehicle title as collateral

Borrowers who get title loans must allow a lender to place a lien on their car title, and temporarily surrender the hard copy of their vehicle title, in exchange for a loan amount

When the loan is repaid, the lien is removed and the car title is returned to its owner

If the borrower defaults on their payments then the lender is liable to repossess the vehicle and sell it to repay the borrowers’ outstanding debt

Pawn Loan Pawn loans are a quick and easy way to borrow money without a credit check or hassle

Loans are based on the value of your collateral, not your credit rating or pay schedule. Subject to individual state laws, a typical pawn loan may have a term length of 30 days/one month, plus a 30-day/one month grace period

If you cannot pay back your pawn loan in full, including any applicable grace period, we offer extensions/renewals (where permitted by state law) to give you extra time

You may also choose to surrender your collateral as payment in full

Pay Day Loan Short term loan that ‐provides immediate cash by securing a borrower’s written check or receiving authorization for automatic withdrawal from the borrower’s depository institution account

Good Debt vs. Bad Debt

GOOD DEBT

• The purchase outlasts the debt.

• The ratio of debt to income does not exceed 36%.

BAD DEBT

• Financial obligations last longer than the purchase.

• The ratio of debt to income exceeds 36% or jeopardizes financial security if payments cannot be made.

Debt to Income Ratio (DTI)The Debt to Income Ratio is a simple but useful measure of a person’s finances

Percentage of consumer’s monthly gross income that goes toward paying debts

Lenders look at this ratio when they are trying to decide whether to lend you money or extend credit and they like this number to be low, generally keep around 36%

Add up all of your monthly debt obligations -- often called recurring debt -- including your mortgage (principal, interest, taxes and insurance) and home equity loan payments, car loans, student loans, your minimum monthly payments on any credit card debt, and any other loans that you might have and divide by gross income

Example: $725 recurring monthly debt/$2000 gross monthly income = 36%

Figuring Debt To Income Ratio

1. Add up total net monthly income1. Wages/Salary2. Overtime pay3. Commissions or Bonuses4. Allowance5. Part-time pay

2. Add up your monthly debt obligations1. Credit card bills2. Loans3. Rent4. Student loans

3. Divide total monthly debts by total monthly income1. 650/1000 = 65%2. 200/1000 = 20%3. 650/3000 = 22%

Figuring the InterestIt’s important to know how much money you will pay when using credit

(when you’re not paying off your balance in full each month)

Here’s an easy way to understand compound daily % (interest)

Current Credit Balance ___ x APR% ___ = ______

Divide by 365 (days/year) = $_______ (daily rate)

Daily rate x 30 (days in month) = $____ (monthly interest)Example:

$2000.00 x 24% (.24) = $480$480 / 365 = $1.32 (interest accumulating each day)

$1.32 x 30 = $39.42 in additional interest paid/due in the next month’s billing cycle

= $2039.42 (if no other charges are made the next month)

Benefits of Using CreditUse of product or service before you “own” it

Free loan if you pay bill in full every month

Convenient, no-hassle shopping

More secure than cash – report to the bank that issued the card within two business days and you are not liable for more than $50

Useful in emergencies

Universal acceptance – global

Necessary for rental car and hotel reservations

Use for catalog/Internet shopping

Establish a good credit score

Disadvantages of Using Credit“Too convenient” – can lead to overspending

Finance charges add to the purchase price

Predetermines future income

(Debt accrued predicts what you need to bring home in net pay)

Can hurt your credit score

Tips To Help Dump Debt Write it down

◦ Make a list of how much money you owe and the interest rate

Start the SNOWBALL rolling◦ Start with the smallest balances first while paying minimum payment on

larger debts◦ Once the smallest balance is paid in full move to the next slightly smaller

debt above that, so on and so forth

Stack (Highest Interest Rate) Method◦ Pay off balances with the highest interest rate first

Cut it out◦ Select an activity and stop it for a month or two, put it toward the debt. Sell some assets.

Debt Management Worksheet

Federal Law Protects Your Use of Credit

Truth in Lending Law (TILA) ◦ The lender MUST disclose ALL lending costs and terms of the loan at the time

the offer is made.

Fair Credit Billing Act (FCBA) ◦ You may dispute billing errors and unauthorized use of your account. ◦ You may dispute charges for goods and services charged but not delivered

satisfactorily. You may withhold payment on that amount while the charge is being investigated.

Equal Credit Opportunity Act (ECOA) You cannot be denied credit based on race, creed or gender.

◦ You must be given a reason if you are denied credit.

Federal Law Protects Your Use of Credit

Fair Credit Reporting Act (FCRA)◦ Requires that the lender notify you if you are denied a loan or credit because

of information in your credit report

Fair Debt Collection Practices Act (FDCPA)◦ Helps eliminate abusive debt collection practices: Contact at unusual times,

contact at work, threats of violence, deceptive or misleading methods to collect debt

Lending Laws Worksheet