Unit 4 - Good Debt, Bad Debt: Using Credit Wisely

NEFE High School Financial Planning ProgramNEFE High School Financial Planning ProgramUnit 4 – Good Debt, Bad Debt: Using Credit Wisely

Unit 4 - Good Debt, Bad Debt:Unit 4 - Good Debt, Bad Debt:Using Credit WiselyUsing Credit Wisely


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Credit FactsCredit Facts• Nearly Nearly 33%33% of teens owe money to either a person or of teens owe money to either a person or

company, with an average debt of company, with an average debt of $230$230..

• About About 26%26% of teens ages 16-18 already have more than of teens ages 16-18 already have more than $1,000 in debt.$1,000 in debt.

• 30%30% of teens say they understand how credit card interest of teens say they understand how credit card interest and fees work.and fees work.

• 36%36% of teens say they know how to establish good credit. of teens say they know how to establish good credit.


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10 Questions to Ask10 Questions to Ask

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• Do I really need this item right now, or can I wait?Do I really need this item right now, or can I wait?• Can I qualify for credit?Can I qualify for credit?• What is the interest rate (APR) on this card?What is the interest rate (APR) on this card?• Are there additional fees?Are there additional fees?• How much is the monthly payment, and when is it due?How much is the monthly payment, and when is it due?• Can I afford to pay the monthly payments?Can I afford to pay the monthly payments?• What will happen if I don’t make the payments on time?What will happen if I don’t make the payments on time?• What will be the extra cost of using credit?What will be the extra cost of using credit?• What will I have to give up to pay for it?What will I have to give up to pay for it?• All things considered, is using credit worth it for this purchase?All things considered, is using credit worth it for this purchase?


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The Language of CreditThe Language of Credit• Credit - is the amount of money or something of value that is

loaned on trust with the expectation it will be repaid later to lenders.

• Types of Credit– Borrow up to a predetermined limit (i.e., credit card)

– Borrow cash to be repaid by a specific date

– Borrow money for a major purchase to be repaid in regular payments over time, typically monthly (i.e., car loan, home mortgage)

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The Language of CreditThe Language of Credit• Debt is the entire amount of money you owe to lenders.

• APR (Annual Percentage Rate) is the total cost to use credit in a year.

• Term is how long you have to repay a loan, often expressed in months.

• Fees are charged to use credit. Examples: Annual Credit Card Fee, Loan Origination Fee, Over-the-Limit Fee

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The Language of CreditThe Language of Credit

• Credit History is a record of your behavior related to borrowing and repaying loans.

• Credit Report is a detailed record of your personal credit and financial transactions.

• Credit Score is a rating used by credit reporting companies to help lenders decide whether and/or how much credit can be extended to a borrower.

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The Language of CreditThe Language of Credit

• Universal Default allows a credit card company to increase your interest rate if you make just one late payment.

• Bankruptcy is a legal process to get out of debt when you can

no longer make all your required payments.

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Types of CreditTypes of CreditInstallment CreditInstallment Credit• Fixed paymentsFixed payments• Set period of time to repaySet period of time to repay• Set or varying interest ratesSet or varying interest rates• Car loans and home loans Car loans and home loans

are typical examples.are typical examples.

Revolving CreditRevolving Credit• No stated payoff timeNo stated payoff time• Limit to creditLimit to credit• Minimum monthly Minimum monthly

paymentspayments• Interest rates vary or notInterest rates vary or not• Finance chargesFinance charges• Credit cards most typical Credit cards most typical

exampleexample


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Sources of CreditSources of Credit• BanksBanks• Credit UnionsCredit Unions• Department StoresDepartment Stores• Automobile DealersAutomobile Dealers• Oil Companies (for gas stations)Oil Companies (for gas stations)• Federal Government (for student loans)Federal Government (for student loans)• Others?Others?


Basics of Credit• Pay off balance monthly

to avoid interest• Always pay on time

(builds strong credit)• Shop around for low

interest rates• Know grace period-

number of days with no interest

• Pay more than the minimum payment


Credit Benefits• Access cash in

emergency• Ability to use it now• Safety & Convenience• Bonus Points or

Reward Points


College Students & Credit Cards

o College students average credit limit is $5000

o 1/5 undergrads carry 4 or more cardso Average revolving balance for college

student $2500


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A little bit of credit card mathA little bit of credit card math

You buy $500 worth of “STUFF” with your credit card.You buy $500 worth of “STUFF” with your credit card.

Your APR is 18%.Your APR is 18%.

You plan to pay $10 a month to pay it off.You plan to pay $10 a month to pay it off.

You will pay $431 in interestYou will pay $431 in interest

Final cost of your purchases = $931.40Final cost of your purchases = $931.40

And it will take SEVEN YEARS and NINE MONTHSAnd it will take SEVEN YEARS and NINE MONTHS

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How long it takes

APR = 18%APR = 18%

Payment: 4% of current balancePayment: 4% of current balance

You owe $3,000.You owe $3,000.

Finance Charge $1715.69Finance Charge $1715.69

Total cost of original Total cost of original $3,000 loan = $4715.69$3,000 loan = $4715.69

And it will And it will take take

nearly nearly 11 YEARS 11 YEARS to pay off!to pay off!

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The Cost of Using Credit

APR = 24%APR = 24%


$700 for a Game System$700 for a Game System

Finance Charge $550.04Finance Charge $550.04

Your CD player REALLY Your CD player REALLY cost $1,250.04cost $1,250.04

And it will And it will take overtake over7 years 7 years

to pay off!to pay off!

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The Cost of Using CreditThe Cost of Using CreditInterest Rate = 24%Interest Rate = 24%

Payment = 4% of Current BalancePayment = 4% of Current Balance

BALANCEBALANCE TIME TO TIME TO PAY OFFPAY OFF

INTEREST INTEREST CHARGEDCHARGED

TOTAL TOTAL COSTCOST

$2,000$2,000 11 YEARS11 YEARS6 MONTHS6 MONTHS $1,850$1,850 $3,850$3,850

$6,000$6,000 16 YEARS16 YEARS1 MONTH1 MONTH $5,850$5,850 $11,850$11,850

$10,000$10,000 18 YEARS18 YEARS2 MONTHS2 MONTHS $9,850$9,850 $19,850$19,850

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APR = 21%APR = 21%


$3,000 Charged to Credit Account$3,000 Charged to Credit Account

Finance Charges $2,220.57Finance Charges $2,220.57

You Owed You Owed $3,000$3,000

butbutYou PaidYou Paid$6,065+$6,065+

Includies annual feesIncludies annual fees

Annual Credit Card Fee: $65Annual Credit Card Fee: $65

Paying the minimum, it will Paying the minimum, it will take you 11 YEARS and 11 take you 11 YEARS and 11 MONTHS to pay off your debt.MONTHS to pay off your debt.

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Financial Consequences of Debt• Could put you in a state of overspending and perpetual debt,

where you get used to carrying a balance and paying extremely high interest rates.

• Could adversely affect your credit rating, making it harder to get loans when you really need them.

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• What if you took the $120 monthly payment in the last example and INVESTED $120 a month for the 12 years it took to pay off the $3,000 debt, and your investment got an 8% rate of return?

• Instead of $6,000 paid out for $3,000 worth of “stuff”, your $120 monthly investments would amount to $28,799 in your pocket!

Saving instead of spending

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How to get out of debt….• Spend less than you earn!

• Stick to budget

• Pay all loans- even if it is minimum

• Prioritize- highest interest rate first

• Look for ways to cut costs


Chapter 7- allows to erase debt, may require filer to be unemployed or low income. Must seek counseling; Also a liquidation type of bankruptcy that wipes out most debts in exchange for giving up most assets

Chapter 13- allows pay back portion of debt with more time (3-5 years), court oversees repayment plan; allows people to keep their assets

Lenders must absorb loan loss

Responsible borrowers have to pay higher rates to recover

Bankruptcy remains on credit report 10 years

Bankruptcy


Truth in Lending Act (1968)• Also called Consumer Credit Protection Act• Consumers can comparison shop for credit

– 1. Lenders must disclose in writing total cost of using their credit

– 2. Lenders must be truthful in their advertising about costs of their credit

– 3. Gives rights to cancel credit within 3 business days– 4. Limits liability of credit card holder to $50 for

unauthorized use


Fair Credit Reporting Act (FCRA) 1971

• Provides access to personal credit information on file with credit bureau

• Credit bureau must investigate errors & correct report

• Borrower’s have 30 days to review file without charge if denied credit


New CARD Act of 2009• Creditors have to tell you:

– How long it will take to pay off your balance.– When they plan to increase your rate or other fees.

• No interest rate increases for the first year.• Increased rates apply only to new charges.• Restrictions on over-the-limit transactions.• Caps on high-fee cards.• Protections for underage consumers.• CARD Act Rules


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The Four “The Four “CCs” of Credits” of Credit

CollateralCollateralCapitalCapital

CapacityCapacityCharacterCharacter


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How Credit Scores Are DeterminedHow Credit Scores Are Determined

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•Your payment historyYour payment history–Information about how you make your payments on credit Information about how you make your payments on credit cards, store accounts, car loans, finance companies, mortgagescards, store accounts, car loans, finance companies, mortgages

–Accounts in collection or past due, and how long past dueAccounts in collection or past due, and how long past due

–Information in public records, such as bankruptcy, judgments, Information in public records, such as bankruptcy, judgments, liens, wage attachments or child supportliens, wage attachments or child support



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•Your overall debtYour overall debt–How much you owe on all your accountsHow much you owe on all your accounts–How much credit you have available to useHow much credit you have available to use

•Your credit account historyYour credit account history–When you opened and used each of your accountsWhen you opened and used each of your accounts–How recently you applied for new creditHow recently you applied for new credit–Recent good credit history following past payment Recent good credit history following past payment problemsproblems



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•Types of CreditTypes of Credit–The different types of credit accounts you haveThe different types of credit accounts you have–The total number of accounts you haveThe total number of accounts you have


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Get and Keep a Good ScoreGet and Keep a Good Score• (FICO) Highest Score: 850 Average Score: 680(FICO) Highest Score: 850 Average Score: 680

•Make sure your credit report is accurate.Make sure your credit report is accurate.

•Pay all your bills on time.Pay all your bills on time.

•Apply for credit only when you need it.Apply for credit only when you need it.

•Lower the balances on all your credit accounts.Lower the balances on all your credit accounts.

•Pay off debt rather than moving it around.Pay off debt rather than moving it around.


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Protect Yourself: Inaccurate Credit ReportsProtect Yourself: Inaccurate Credit Reports

• Get a copy of your free credit reports from all credit rating Get a copy of your free credit reports from all credit rating agencies.agencies.

• If you find something that is incorrect, ask the agency to If you find something that is incorrect, ask the agency to investigate the information.investigate the information.

• If that doesn’t resolve the issue, you can attach a short If that doesn’t resolve the issue, you can attach a short statement to your credit report.statement to your credit report.


Free Credit Report Annually• Equifax• Experian• Trans Union Corporation• Go to

annualcreditreport.com

• Against the law to obtain anyone’s credit score without their permission

• By law, people are entitled to a free copy of their credit report from each of these companies once every 12 months.


70%70%Living ExpensesLiving Expenses

10%10%Pay Pay Off Off

DebtDebt

20%20%Save or InvestSave or Invest

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Rule of ThumbRule of Thumb


(the 20-10 rule)

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•Never borrow more than 20% of your yearly net income

•If your net income (money after taxes) is $400 a month, then your net income in one year is:

12 x $400 = $4,800

•Calculate 20% of your annual net income to find your safe debt load.

$4,800 x 20% = $960

•So, you should never have more than $960 of debt outstanding.

–Note: Housing debt (i.e., mortgage payments) should not be counted as part of the 20%, but other debt should.


(The 20-10 rule)•Monthly payments shouldn’t exceed 10% of your monthly net income

•If your take-home pay is $400 a month:$400 x 10% = $40

•Your total monthly debt payments shouldn’t total more than $40 per month.

–Note: Housing debt (i.e., mortgage payments) should not be counted as part of the 10%, but other debt should be included, such as car loans, student loans, and credit cards.


comparing credit cards

• Type of account

• Annual fee

• Grace period

• Annual Percentage Rate (APR)

• Credit limit

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• Minimum monthly payment

• Finance charge calculation method

• Late payment fee, other fees

• Other features


if you’re denied creditif you think the reasons for the denial are valid:• Ask the creditor if you can provide additional information or arrange alternate credit terms.• Apply to another creditor whose standards may be different.• Do the things you need to do to improve your creditworthiness (pay bills on time, increase income, reduce spending, obtain a secured card, etc.) and then reapply.

if you are not sure whether the reason for the denial is valid:• Ask the creditor to explain why you were denied.• Review your credit history.• If you find your credit history contains errors, take steps to correct the errors.

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If you believe the reason for the denial is invalid and that the creditor has discriminated against you:

• Notify the federal enforcement agency whose name you were given by the creditor. The federal enforcement agency will investigate and report back to you.

• If you can afford it, hire an attorney to file suit against the creditor. If the court determines the creditor did discriminate, the creditor will be required to pay you actual damages plus punitive damages.

Cont..


other credit card protectionsprompt credit for payment

• A card issuer must credit your account on the day the issuer receives your payment, unless the payment is not made according to the creditor’s requirements.

refunds of credit balances

• When you return merchandise or pay more than you owe, you have the option of keeping the credit balance on your account or receiving a refund.

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unauthorized charges

• If you report your card lost before it is used, you cannot be held responsible for any unauthorized charges.

• If your card is used before you report it lost, you are liable for $0 if reported within two business days. After that, you’re liable for no more than $50.00.

disputes about merchandise or services

• In some circumstances, you have the right to withhold payment for unsatisfactory merchandise or services.

Cont.


credit card tipsshop around• Look at various sources.

read and understand the contract• Read the contract carefully.• Don’t rush into signing anything.• Once a contract is signed, get a copy of it.• Know the penalties for missed payments.

know your cost• Figure out total price when paying with credit.• Make the largest payments possible.• Know the penalties for missed payments.• Buy on installment credit only after you have evaluated all other possibilities.• Don’t be misled into thinking small payments will be easy.

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Unit 4 - Good Debt, Bad Debt: Using Credit Wisely

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