Consumer Credit: Credit
Cards and Student Loans
CHAPTER PLAYLIST SONGS:
“One Piece at a Time” by Johnny
Cash and June Carter Cash
“Ring of Fire” by Johnny Cash
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objectives
• LO 5-1 Explain the responsibilities, importance,
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and cost of credit as well as the options
available for accessing credit.
LO 5-2 Evaluate the features, benefits, and
disadvantages of many different types of
credit cards.
LO 5-3 Describe the mechanics of obtaining and
repaying student loans.
LO 5-4 Assess the benefits and drawbacks of
payday loans, title loans, and rent-to-own
credit options and identify alternatives.
5-2
Credit
 A contractual agreement in which a borrower
receives something of value now and agrees to repay
the lender at some date in the future, generally with
interest
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Family and Friends
General Purpose Credit Card
 Secured
 Unsecured
Store Credit Cards
Depository Institutions
Finance Companies
5-3
Friends and Family
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Advantages
Friendly money
No credit application
No credit check
Low/no interest rate
Common Uses
 First car
 Down payment on first
home
 Money when needed
quickly
Disadvantages
 Can ruin family
relationships through
jealousy and nonpayment
 Can cause financial hardship
on the lender
 Does not build credit record
Advice
 Have everything in writing
 Treat it as one of your most
important payments
 Refinance with a traditional
lender as soon as possible
5-4
General Purpose Credit Cards
(i.e., Visa, Discover, MasterCard, American Express)

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Advantages
Widely accepted
Builds credit record
Buyer protection
Recordkeeping
Miles or cash back
Common Uses
Household items
Auto repair
Auto rental
Airline and hotel
reservations
Online purchases

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Disadvantages
High interest rate
Fees and charges
Easy to overspend
Once in credit card debt it is
hard to get out of debt
Advice
 Only use credit card for
emergencies
 Always repay the full
balance
 Pay on time every time
5-5
General Purpose Credit Cards
Secured Credit Cards
 Require a deposit to be
held by the credit card
company
 Credit limit is the
amount on deposit
 Good for starting a credit
file or rebuilding a credit
file after bankruptcy
Unsecured Credit Cards
 No deposit required
 Credit limit and interest
rate depends on your
income, credit score
 No collateral required
5-6
Store Credit Cards
(i.e., Sears, Best Buy, BP, Home Depot, Macy’s)
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Advantages
Special Promotion
Recordkeeping
Builds credit record
Buyer protection
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Common Uses
 Household items
 Home repair
 Auto repair and fuel
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Disadvantages
Only accepted at specific store
High interest rate
Fees and Charges
Easy to overspend
Once in credit card debt, it is
hard to get out of debt
Advice
Always repay the full balance
Pay on time every time
5-7
Depository Institutions
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Advantages
Builds relationship with local
lender
Builds credit record
Generally lower interest rates
Oldest form of credit
Common Uses
 Automobile
 Home improvement
 Major purchases
Disadvantages
 Higher credit standards
and harder to get the loan
 Loans hard to get if under
$1,000
Advice
 Build a relationship with
your banker so he/she
knows you
 Only take out a loan if you
really need it
5-8
Finance Companies
Advantages
 Ease of credit
 Some specialize in
specific areas
 Will finance lower loan
amounts
Common Uses
 Automobile
 Home furniture
 Major appliances
Disadvantages
 Higher interest rates
 Fees and charges
Advice
 Shop for your best rate and
terms
 Only take out a loan if you
really need it
5-9
Characteristics of the Differing Credit Options
5-10
Revolving Line of Credit
Revolving Lines of Credit: You pay a commitment fee and can take and repay
funds at will
Credit Limit: $1,000
Charge: - $300
Balance: $700
How much more you can borrow: $700, Owe: $300
Previous Balance: $700
Payment: $200
Balance: $900
How much more you can borrow: $900, Owe: $100
Previous Balance: $900
Payment: $100
Balance: $1,000
How much more you can borrow: $1,000, Owe $0
5-11
Applying for Credit
Sections of the credit application
 Demographics
 Income
 Assets and liabilities
 Contacts
 Attest and authorization
5-12
Five Cs of the Credit Decision
 Character
 Responsibility in repaying loan
 Capacity
 Enough income minus expenses to pay loan
 Collateral
 Something of value to secure the loan
 Capital
 Net worth, other assets that could be sold to pay the loan
 Conditions
 Economic conditions for specific industries
5-13
Risk and Interest Rates
 The higher the risk of not being repaid, the higher
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the interest rate charged to offset the risk
Risk determined by your 5 Cs of credit and credit
score
If you have high income, your risk decreases
If you have collateral, your risk decreases because
the lender can sell collateral
If you have a lot of capital (high net worth), your
risk decreases and rates are lower
5-14
Credit Cards
 First credit card was in 1950s with Diners Club
 1957: American Express and BankAmericard (now
Visa) enter market
In 2010…
 Average household credit card debt > $10,000
 Average undergraduate credit card debt > $3,000
 Average college senior credit card debit > $4,000
5-15
Advantages of Credit Cards
 Arbitration
 Interest-free loans
 Automatic bill
 Purchase
payments
 Identity theft
safeguards
 Credit builder
 Extended
warranties
protection
 Rental car coverage
 Rewards
5-16
Features of Credit Cards
 Credit limit – The amount you can borrow without
penalties and fees for over-the-limit transactions
 Grace period – The time you have to pay your bill
before finance charges are activated. Not all credit
cards have a grace period
 Interest rate – The charge you have for borrowing
money
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Can be fixed or variable based on an index rate
Can be very high for some credit cards
5-17
Credit Card Charges and Fees
 Finance Charges
 Adjusted balance method – Payments or credits received
during the current billing period are subtracted from the
balance at the end of the previous billing period.
 Average daily balance method – Most common method.
Every day your balance reflects any charges and/or payments.
 Minimum finance charge – The minimum interest that is
charged per billing cycle.
5-18
Doing the Math 5.2
5-19
Fees
 Annual - Charge for the privilege of having the card
 Cash Advance
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A flat fee for the advance
A percentage fee for the amount of money taken
 Late-Payment – A penalty fee charged for paying late
 Over-Limit – A penalty fee for charging over your credit
limit
 Return-Item – A penalty fee for a bounced check
 Balance Transfer – A percentage fee for transferring
balance from one card to another
5-20
Errors on Your Statement
According to the Fair Credit Billing Act:
 Contact credit card company in writing within 60
days after statement date on the bill with the error
 Send letter to “billing inquiries” address on
statement
5-21
Errors on Your Statement, ctd.
 Include your name/account number and state the
error, why it is an error, and the date of the error–
and include copies of any supporting documents
 Keep a copy; the credit card company will investigate
the complaint and if the charge is found to be in
error, you will not have to pay any interest on the
disputed amount
5-22
Household Use of Credit/Economy Impact
Credit Picture Different for Rich, Poor Households
http://www.npr.org/player/v2/mediaPlayer.html?action=1&t=1&islist=false&i
d=90112615&m=90127338
5-23
Choosing a Credit Card
CC1:
Credit Card Features
Priority
Rank
Rank
CC1 Score
(Priority
Rank*CC1
Rank)*
CC2:
Rank
CC2 Score
(Priority
Rank*CC2
Rank)*
CC3:
Rank
CC3 Score
(Priority
Rank*CC3
Rank)*
APR: purchases
APR: cash advances
APR : balance transfers
APR if you pay late
Interest Rate: fixed, variable or tiered
Grace Period: balance paid off
Grace Period: carry a balance
Grace Period for cash advances
Finance charge calculation: 1 or 2 cycles
Finance charge include/exclude new purchases
Ave or Adjusted finance charge calculation:
Minimum finance charge
Fee: annual
Fee: late payment
Fee: over credit limit
Fee: set-up
Cash Advance: Transaction fee
5-24
Tips for keeping credit card rates and fees low
 Select a card based on how you plan to use it
 Pay on time
 Don’t charge over your credit limit
 Maintain balance < 30% of your credit limit
 Look out for new fees
 Be judicious about all your personal finance activity
 Complain if your rates or fees increase
5-25
Student Loan Categories
 Federal student loans made directly to the student
 Federal student loans made to the parents (PLUS)
 Private student loans made to students or parents
Application: Free Application for Federal Student Aid
(FAFSA) www.fafsa.ed.gov.
5-26
Subsidized vs. Unsubsidized Federal Student Loans
Comparison Table
5-27
Student Loan Payments
 Student Loan Consolidation and Refinancing
 One rate for all your student loans
 One lender
 Deferment
 Delays the repayment of the loan
 No interest is accrued for subsidized loans
 Forbearance
 Can postpone or reduce payments for a specific period of time
 Interest continues to accrue
 Alternate Payment Options
5-28
Student Loan Payments
 Standard Repayment
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10 year repayment
$50 minimum payment
 Extended Repayment
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Not to exceed 25 year repayment
Minimum loan amount of $30,000
 Graduated Repayment
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Start out low and increase every two years
Up to 10 year repayment
 Income-Based Repayment (IBR)
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Based on income and family size
Monthly payment less than 10-year standard repayment
Must submit annual documentation to set payment
5-29
Calculating Payments
 PVA = PMT ({1 – [1/(1 + i)n]}/i) where
 PVA = Present Value of an Ordinary Annuity
 PMT = Payment
 i = Interest Rate per Period
 n = Number of periods
Example: Financing $1,000 at 12% interest annually (or 1%
monthly) for 1 year making monthly payments:
PVA = $1,000
i = .01
n = 12
5-30
Calculating Payments Formula Example
$1,000 = PMT ({1 – [1/(1 + .01)12]}/.01)
$1,000 = PMT {[1 – (1/1.0112)]/.01}
$1,000 = PMT {[1 – (1/ 1.126825)]/.01}
$1,000 = PMT (1 - 0.887449)/.01
$1,000 = PMT (0.112551/.01)
$1,000 = PMT (11.25508)
Next solve for PMT by dividing both sides by 11.25508
$1,000/11.25508= PMT (11.25508)/11.25508
PMT = $88.85
5-31
Example: Amortization Table $1,000, 1 year, at 12% APR
5-32
Costly Cash
 Payday Loans
 Title Loans
 Rent-to-Own
 Usury Law: State laws that specify the maximum legal
interest rate at which loans can be made
 Predatory Lending: Act of lending money at an
unreasonably high interest rate, making repayment
excessively difficult or impossible for the borrower
5-33
Payday Lenders
 Short-term loans
 Write the payday lender a check for the amount you
want to borrow plus a fee
 If you don’t pay off the loan on the specific date,
there is a roll-over fee
 Annual percentage rate, including the fees, can be
250% or higher
5-34
Title Loans
 Title of an automobile is collateral for the loan
 Typically for no more than 25% of the value of the
automobile
 Short-term loan
 Could lose your vehicle if you don’t repay the loan
 High interest rate
5-35
Rent-to-Own
 Make purchases with low weekly payments
 Effective interest rates very high
5-36
Alternatives to Payday Loans
5-37