USING CREDITUnit 7

The Importance of Consumer Credit

Terms:

1. Creditor – an entity (bank, finance co., credit union, business or individual) to which money is owed2. Consumer Credit – the use of credit for personal needs, dates back to colonial times.

Uses & Misuses of Credit

• FACTORS TO CONSIDER BEFORE USING CREDIT• Do you have the cash you need for the down payment?• Do you want to use your savings instead of credit?• Can you afford the item?• Could you use the credit in some better way?• Could you put off buying the item for a while?• What are the costs of using credit?

Advantages & Disadvantages of Credit

• ADVANTAGE:• Lets you enjoy goods and services NOW• Credit may be the only acceptable method of payment• If used wisely, other lenders will view you a responsible

person.• DISADVANTAGES:• It COSTS money!• Does not increase your total purchasing power.

Types of Credit

• Closed-End Credit• You receive a one-time loan that you will pay back over a

specified period of time and in payments of equal amounts.• Used for specific purpose and involves a definite amount of

money• Open-End Credit• You borrow money for a variety of goods and services.• Company issues a credit card with a certain limit on the amount

of money you can borrow.• Line of Credit – the maximum amount of money the creditor

makes available to borrow.

Sources of Consumer Credit

• LOANS:• Inexpensive loans – parents or family members• Medium-priced loans – commercial banks, credit unions• Expensive loans – finance co., retail stores• Home equity loans – loan based on the equity in your home

(the difference between the current market value of your home and the amount you still owe on the mortgage.

• CREDIT CARDS• Terms:• Grace period – a time period during which no finance charge will be

added to your account.• Finance charge – total dollar amount you pay to use credit.

• Debit Cards – DON’T confuse with credit card!!!• Electronically subtracts money from your checking account

• Smart Cards - a new kind of credit card. • Equipped with a computer chip that can store 500 times as much data as

a credit card. CC balances, drivers license, health care id., medical history,etc.

• Travel & Entertainment Cards – not really credit cards.• Balance is due at the end of every month!

Can You Afford a Loan?

• Debt Payments-to-Income Ratio• % of debit you have in relation to your net income (take

home pay)• Suggested no more than 20% of net income on debt

The Cost of Credit

• The Finance Charge and the Annual Percentage Rate (APR)• APR – how much credit costs you on a yearly basis in %

• Calculating the Cost of Credit• Simple Interest – interest added to the principal• Cost of Open-End Credit• Truth In Lending Act requires creditors to inform consumers how

finance charge and APR affect costs.• Cost of Credit and Expected Inflation – inflation reduces

purchasing power• Avoid Minimum Monthly Payment Trap• Smallest amount you can pay to stay in good standing

APPLYING FOR CREDIT

The 5 Cs of Credit

• 1. Character• 2. Capacity• 3. Capital• 4. Collateral• 5. Credit History

Character

Will you repay the loan???What kind of person are you? Stable? Trustworthy?

• Have you used credit before?• How long have you lived at your present address?• How long have you held your current job?

Capacity

Can you repay the loan?Your income and current debt.

What is your job, and how much is your salary?Do you have other sources of income?What are your current debts?

Capital

What are your assets and net worth?

The amount of your assets (what you have) that exceed your liabilities (what you owe)

What are your assets?What are your liabilities?

Collateral

What if you don’t repay the loan?

Property or savings you already have. If fail to repay loan…the take property/savings.

What assets do you have to secure the loan (such as a car, your home, or furniture)?Do you have any other valuable assets (such as bonds or savings)?

Credit History

What is your credit history?

Used credit responsibly in the past?

Do you pay your bills on time?Have you ever filed for bankruptcy?

Credit rating – a measure of a person’s ability and willingness to make credit payments on time

What CAN NOT be considered….

• Age (although must be at least 18 or 21)• Public Assistance (social security or state assistance)• Housing Loans (neighborhood where you live or want to

live)

If Denied?

Credit Bureaus

• They report your credit report.

• 3 Major Credit Bureaus:• Experian Information Solutions• Trans Union Credit Information Company• Equifax Services, Inc.

What’s on your credit file?

• Your employer, position, and income• Your previous address• Your previous employer• Your spouse’s name, social security number, employer

and income• Whether you rent or own your house• Checks returned for insufficient funds

PROTECTING YOUR CREDIT