5B

Consumer Credit #2
Covered so far…
 Advantages and disadvantages of credit
 Types and sources of credit
 Credit capacity (how much you can afford)
 Credit reports and scores

Still to cover…
 The cost of credit
 Protecting your credit
 Consumer credit protection laws
 Debt problems and bankruptcy
5-1
Objective 4
Determine the Cost of Credit by
Calculating Interest Using Various
Interest Formulas
• Finance charge
– Total dollar amount you pay to use credit
– Includes interest costs and fees, such as service
charges, credit-related insurance premiums, or
appraisal fees
• Annual Percentage Rate (APR)
– Percentage cost of credit on a yearly basis
– Key to comparing costs when shopping for rates
It is important to shop around for credit
5-2
Tackling the Trade-Offs
• Term (length of loan) versus interest cost
– Longer loan: higher interest rate; total cost
• Lender risk versus interest rate
– Fixed rate: increases lender risk
• To reduce the lender’s risk and thus the
interest rate you can:
– Accept a variable interest rate
– Provide collateral to secure a loan
– Provide up-front cash
– Take a shorter term loan
5-3
Secured Credit Cards
Secured Credit Card (or Collateralized
Credit Card) – Backed by collateral in the
form of a savings account opened at the
financial institution that issues the card.
Example:
Deposit $1,000 with
creditor to borrow $1,000
Calculating the Cost of Credit
• Simple interest
– Computed on principal only without compounding
– The dollar cost of borrowing
– Interest = Principal x Rate x Time
• Simple interest on the declining balance
– Interest is paid only on the amount of original
principal not yet repaid
• Add-on interest
– Interest calculated on full amount of principal
– Interest added to original principal
– Payment = Total divided by number of payments to
be made
5-5
Calculating the Cost of Credit
• Avoid minimum monthly payment trap
– The longer to pay bill, the more interest you pay
• Avoid credit card fees
– Annual Fee- fee charged each year just to have a
credit card (many are increasing; why?)
– Transaction Fee- fee charged to use a credit card, get
cash advances, or make transfers
– Late Fee- fee assessed for making a late payment
– Bounced Check Fee- fee for NSF check payment
– Over-the-Limit Fee- fee charged (with cardholder’s
permission) to exceed credit card limit
5-6
Objective 5
Develop a Plan to Protect Your Credit
and Manage Your Debts
Fair Credit Billing Act (FCBA, 1975)
• Notify creditor of error in writing within 60 days
• Pay the portion of the bill not in dispute
• Creditor must respond within 30 days
• Credit card company has two billing periods, but
no longer than 90 days, to correct your account
or tell you why they think the bill is correct
5-7
Protecting Your Credit
Fair Credit Billing Act (FCBA, 1975)
• Disputed item won’t affect your credit rating
while in dispute
• Can withhold payment on damaged or shoddy
goods or poor services if purchased with a
credit card
• Must make sincere attempt to resolve problem
with creditor
– Contact merchant first and document it
Has anybody ever used FCBA procedures?
5-8
Co-signing a Loan
Co-signing means guaranteeing a debt
– Lender would not require a co-signer if borrower
were a good risk
– Can you afford it if the borrower defaults?
• If borrower doesn’t pay, cosigner is liable for
the full amount plus any late or collection fees
• If payment is missed, creditor can collect from
the cosigner first
• Unpaid debts will appear on the cosigner’s
credit report
5-9
Complaining About Consumer Credit
• First: Try to solve the problem
directly with the creditor
• If that fails: Use formal complaint
procedures
• Federal government administers
laws and assists with complaint
procedures
– Federal Reserve Board
– Federal Trade Commission (FTC)
5-10
Consumer Credit Protection Laws
• Truth in Lending and Consumer Leasing Acts
– Requires disclosure of the cost of credit (APR)
• Equal Credit Opportunity Act (ECOA)
– Prohibits discrimination in credit-granting decisions
• Fair Credit Billing Act
– Provides rules for correcting billing errors
• Fair Credit Reporting Act
– Provides rules for accessing/correcting credit reports
Your Rights Under Consumer Credit Laws
– Complain to the creditor
– File a complaint with the government
– If all else fails, sue the creditor
5-11
Managing Your Debts
Warning Signs of Debt Problems
• Paying only the minimum balance each month
• Trouble even paying the minimum balance
• Total balance increases every month
• Missing loan payments or paying late
• Using savings to pay for necessities
• Getting second or third payment notices
• Borrowing money to pay old debts
• Exceeding the credit limits on your credit cards
• Denied credit due to a bad credit report
5-12
Managing Your Debts
Debt Collection Practices
The FTC enforces the Fair Debt Collection
Practices Act (FDCPA)
– Prohibits certain practices by debt collectors
(e.g., early or late calls, calls at work, profane language)
– Does not eliminate legitimate debts; just
controls the way that debt collectors work
– Does not apply to first-party debt collectors
(original creditors); only to third-party
collectors (independent companies)
5-13
Managing Your Debts
Consumer Credit Counseling Services
(CCCS)
– Non-profit and supported by contributions
from banks, merchants, etc.
– Provides education about credit
– Provides help with spending plan
– Provides debt counseling services for
those with serious financial problems
– Can develop a debt repayment plan and
negotiate reduced interest rates
5-14
Declaring Personal Bankruptcy
U.S. Bankruptcy Act of 1978
Chapter 7 = straight bankruptcy
Chapter 13 = wage earner plan
Personal bankruptcy is a legal process to distribute
some or all assets among a person’s creditors due
to an inability to repay debts.
Bankruptcy should be the last resort, because of the
damage to your credit rating; stays in a person’s credit
report 10 years vs. 7 years for other negative information
5-15
Chapter 7 Bankruptcy
•
Submit a petition to the court that lists
assets and liabilities, and pay a filing fee
•
Many, but not all, debts are forgiven
•
Assets surrendered to pay creditors
•
Can keep some assets (home, vehicle,..),
depending on state/federal exemptions
•
Intent = “A Fresh Start”
•
Most bankruptcies are this type
5-16
After Chapter 7
• You May No Longer Owe:
– Retail store charges
– Bank credit card charges
– Unsecured loans
– Unpaid hospital or physician bills
• You Still May Owe...
– Certain taxes and fines
– Child support and alimony
– Educational loans
– Debts from willful or malicious acts
5-17
Bankruptcy Abuse Prevention and
Consumer Protection Act of 2005
– Makes it more difficult for consumers to file a
Chapter 7 bankruptcy (means test)
– Debtors must wait 8 years from their last
bankruptcy to file again
– Clamps down on “bankruptcy mills” that seek
to game the system
– Includes provisions for consumer education on
debt management and financial planning
5-18
Chapter 13 Bankruptcy
• Debtor with regular income proposes a plan
to eliminate his debts over time
• Debtor normally keeps most of property
• Information provided to the court the same as
under Chapter 7
• Plan may last up to five years
• Debtor makes payments to a court-appointed
trustee
5-19
Obtaining Credit after Bankruptcy
• May be more difficult
• But, creditors may consider the inability to
file bankruptcy again for 8 years
• Could be easier for Chapter 13 filers (who
have repaid some debt) versus Chapter 7
filers who made no effort to repay
• Likely to pay high interest rates (lower credit
score)
5-20
CARD Act Regulations
• 45 days’ notice before key changes in account
terms (up from previous 15 days)
• Minimum payment illustrations on credit card
bills (payoff cost and payment to repay in 36 months)
• “Universal default” practice was banned
• Two-cycle balance billing was banned
• “Teaser rates” must last at least 6 months
• Consumers must “opt in” for over-the-limit fees
• Bills must be mailed 21 days before due date
• No more “late fee traps” (e.g., weekends, 8 am)
College Students and Credit Cards
(CARD Act)
• Credit card companies are prohibited from
offering free merchandise in exchange for credit
card applications (on campus, campus events)
• No credit cards under age 21 unless cosigner or
proof of income to make payments
• Maximum amount of credit < 21: greater of $500
or 20% of annual gross income in most recently
completed calendar year
• Aggregate limit for ALL credit cards held by
someone <21: 30% of annual gross income in
most recent completed calendar year
Alternatives to Credit Cards for
College Students
• “Authorized user” on parent’s credit cards and
reimburse parents
– Parents see everything you charge; may be fees
– Does not boost students’ credit much; parent is user
• Joint account with parents
– Credit history reported to credit bureaus; builds credit
• Secured credit cards
– Still need to follow CARD Act cosigner/income rules
• Prepaid debit cards
– Not “credit”; use will not build credit history; high fees
– Less protection than credit cards if lost or stolen
Wrap Up
• Chapter Quiz
• Concept Check 5-4- Two Key Concepts
and Credit Terms
• Concept 5-5- Correcting a Billing Error
• Helpful Advice for Others