MGT 12: Personal Financial Management
Tues & Thurs 11:00AM–12:20PM
Rady School of Mgt, Room 1N108
Tues & Thurs 5:00PM–6:20PM
Center Hall 216
Professor: Joe Pecore
Spring 2018
http://www.bloomberg.com/live
Agenda 5/10/18
•
Announcements
•
Lecture
–
Chapter 7 – Cost of Credit
Announcements
1.
Keep up with your Tracker – bring a hard copy to class for a
potential spot check for credit.
2.
IPA will kick-off on Thursday May 17
3.
We will review Article 3 next week
Midterm – Top Line Results
•
Nice work!
Average =
•
Remember, this will count 25% . Final is not cumulative
•
If you want to see your exam, please visit mine or the TA’s office hours.
1-4
Article 2
Purchase Vehicle
Monthly Payment
$
Annual Payment
$
Car 1
500 $
6,000 $
Car 2
Car 3
Car 4
750 $ 1,000 $ 1,200
9,000 $ 12,000 $ 14,400
Lease Vehicle
Monthly Payment
Annual Payment
Car 1
300 $
3,600 $
Car 2
400 $
4,800 $
Year
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
$
$
Purchase
Payment
$ 6,000
$ 6,000
$ 6,000
$ 6,000
$ 6,000
$
$
$
$
$
9,000
9,000
9,000
9,000
9,000
$
$
$
$
$
12,000
12,000
12,000
12,000
12,000
$
$
$
$
$
14,400
14,400
14,400
14,400
14,400
Lease
Payment
$ 3,600
$ 3,600
$ 3,600
$ 3,600
$ 3,600
$ 4,800
$ 4,800
$ 4,800
$ 4,800
$ 4,800
$ 6,000
$ 6,000
$ 6,000
$ 6,000
$ 6,000
$ 7,200
$ 7,200
$ 7,200
$ 7,200
$ 7,200
$ 8,400
$ 8,400
$ 8,400
$ 8,400
$ 8,400
$ 9,600
$ 9,600
$ 9,600
$ 9,600
$ 9,600
$ 10,800
$ 10,800
$ 10,800
$ 10,800
$ 10,800
$ 12,000
$ 12,000
$ 12,000
$ 12,000
$ 12,000
Car 3
500 $
6,000 $
Annual
Difference
$ (2,400)
$ (2,400)
$ (2,400)
$ (2,400)
$ (2,400)
$ 4,800
$ 4,800
$ 4,800
$ 4,800
$ 4,800
$ (3,000)
$ (3,000)
$ (3,000)
$ (3,000)
$ (3,000)
$ 7,200
$ 7,200
$ 7,200
$ 7,200
$ 7,200
$ (3,600)
$ (3,600)
$ (3,600)
$ (3,600)
$ (3,600)
$ 9,600
$ 9,600
$ 9,600
$ 9,600
$ 9,600
$ (3,600)
$ (3,600)
$ (3,600)
$ (3,600)
$ (3,600)
$ 12,000
$ 12,000
$ 12,000
$ 12,000
$ 12,000
Total $ 207,000 $ 312,000 $ 105,000
Car 4
600 $
7,200 $
Car 5
700 $
8,400 $
Car 6
Car 7
Car 8
800 $
900 $ 1,000
9,600 $ 10,800 $ 12,000
Cumulative
Difference
$ (2,400)
$ (4,800)
$ (7,200)
$ (9,600)
$ (12,000)
$ (7,200)
$ (2,400)
$ 2,400
$ 7,200
$ 12,000
$ 9,000
$ 6,000
$ 3,000
$
$ (3,000)
$ 4,200
$ 11,400
$ 18,600
$ 25,800
$ 33,000
$ 29,400
$ 25,800
$ 22,200
$ 18,600
$ 15,000
$ 24,600
$ 34,200
$ 43,800
$ 53,400
$ 63,000
$ 59,400
$ 55,800
$ 52,200
$ 48,600
$ 45,000
$ 57,000
$ 69,000
$ 81,000
$ 93,000
$ 105,000
5-5
Dave Ramsey
FICO scores and Getting out of Debt
FICO Score
http://www.youtube.com/watch?v=eBxn22X835A
Paying off debts if you are trouble
(at 8:24 to 10:30)
https://www.youtube.com/watch?v=gIAESsAHOR8
5-6
How to get a perfect 850 FICO Score Automatically
Stacy Johnson 4/27/16
http://www.moneytalksnews.co
m/how-get-perfect-850-ficocredit-score-automatically/
5-7
Chapter 7
Choosing a Source of Credit:
The Costs of Credit Alternatives
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
6-8
Chapter 7 – The Cost of Credit
Pecore’s Planning Principles
1.
Make sure credit is necessary before committing
2.
Shop around and get the lowest cost credit
3.
Pay credit cards in full each month; don’t carry a balance
4.
Know what happens when you are late and early with
payments
5-9
Chapter 7
Learning Objectives
1.
Analyze the major sources of consumer credit
2.
Determine the cost of credit by calculating interest using
various interest formulas
3.
Develop a plan to manage your debts
4.
Evaluate various private and governmental sources that assist
consumers with debt problems
5.
Assess the choices in declaring personal bankruptcy
5-10
Sources of Consumer Credit
Objective 1: Analyze the major sources of consumer credit
Consumer Credit does not include a home mortgage
WHAT KIND OF LOAN SHOULD YOU SEEK?
• It depends on the situation.
7-11
Sources of Consumer Credit
• Inexpensive loans (in terms of interest rates)
– Parents or family members (could be zero %)
– Loans based on assets- e.g. using CD as collateral
– Loans to finance education (from the U.S. Department of
Education)
• around 4-7%
7-12
Sources of Consumer Credit
• Medium-priced loans
– Commercial banks, savings and loan associations, and
credit unions (11.75% at mine)
• Expensive loans
– Finance and check cashing companies
– Retailers such as car or appliance dealers
– Bank credit cards and cash advances
7-13
The Cost of Credit
Objective 2: Determine the cost of credit by calculating
interest using various interest formulas and different
variables that can influence the cost of credit.
7-14
The Cost of Credit
• Truth in Lending Law is the federal law that requires
creditors to disclose the annual percentage rate (APR) and
the finance charge as a dollar amount.
• Finance charge is the total dollar amount you pay to use
credit. It includes interest costs, service charges, creditrelated insurance premiums, or anything else.
7-15
The Cost of Credit
Annual Percentage Rate
• The annual percentage rate (APR) is the percentage cost of
credit or finance charges on a yearly basis
• A standardized rate for comparison purposes
• APR: True rate of credit so you can compare rates with
other sources of credit. It is important to shop for credit.
• Annual Percentage Rate – APR definition :
The annual rate that is charged for borrowing expressed as a
single percentage number that represents the actual yearly cost
of funds over the term of a loan. This includes any fees or
additional costs associated with the transaction.
7-16
The Cost of Credit
ARITHMETIC OF THE ANNUAL PERCENTAGE RATE (APR)
The formula, given below, calculates the APR:
r= (2*n*I)/(P*(N+1))
Where :
– r = Approximate APR
– n = Number of payment periods in one year (12, if payments are
monthly; 52, if weekly)
– I = Total dollar cost of credit
– P = Principal, or net amount of loan
– N = Total number of payments scheduled to pay off the loan
7-17
The Cost of Credit
ARITHMETIC OF THE ANNUAL PERCENTAGE RATE (APR)
Let us compare the APR when the $100 loan is paid off in one lump sum at
the end of the year and when the same loan is paid off in 12 equal monthly
payments. The stated annual interest rate is 10 percent for both loans.
Using the formula, the APR for the lump-sum loan is 10 percent. (one
payment)
r= (2*n*I)/(P*(N+1)) or r=(2*1*10)/(100*2)=20/200=0.10 or 10%
Using the formula, the APR for the monthly payment loan is (12 payments)
r= (2*n*I)/(P*(N+1)) or r=(2*12*10)/(100*13)=240/1300=0.185 or 18.5%
Interest rate and APR can be very different. Look for APR.
7-18
The Cost of Credit
CALCULATING THE COST OF CREDIT
• Simple interest on the declining balance or unpaid
balance
– Fixed payment for closed end credit includes both principal
and interest
– Interest is paid only on the amount of beginning unpaid
principal for that period
– The interest would be part of the minimum payment for a
credit card or open end credit
– Show $1,000 example
7-19
The Cost of Credit
TACKLING THE TRADE-OFFS
• Length of loan term or how many years is the loan?
– Longer term loans - lower payments, more total interest
paid and usually a higher interest rate
– Shorter term loans – higher payments, less total interest
paid and usually a lower interest rate.
– Balance is unpaid longer for longer terms vs shorter
terms.
– This is why car dealers ask – what do you want your
payments to be?
7-20
The Cost of Credit
TACKLING THE TRADE-OFFS
• Lender risk and interest rate risk.
– Some ways to reduce the lender’s risk:
•
•
•
•
Accept a variable interest rate
Provide collateral to secure the loan
Make a large down payment up front
Have a shorter loan term
• Its about balancing risk between lender and borrower
and the lender making money
• This is why there are so many flavors in getting a loan
or consumer lending.
7-21
The Cost of Credit
Car Loan example
A COMPARISON
Even when you understand the terms a creditor is offering, it's easy
to underestimate the difference in dollars that different terms can
make. Suppose you're buying a $7,500 used car. You put $1,500
down, and you need to borrow $6,000. Compare the following
three credit arrangements:
Show model in Excel
for $20K car loan
7-22
The Cost of Credit - $20K Car Loan example
PMT Function
principal
rate
term
payment
Total
22,108 $
4 year
Payment
4 years
Higher
payment by
$84/month
Total
Payments
= $22,108
Total
Difference between 4 and 5 year loans
principal
rate
term
payment
20,000
5.0%
48 months
461
$
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
=PMT(rate, number of payments, present value)
2,108 $
4 year
Interest
20,000
4 year
Principal
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
461
83
82
80
79
77
75
74
72
71
69
67
66
64
62
61
59
57
56
54
52
51
49
47
45
44
42
40
39
37
35
33
31
30
28
26
24
22
21
19
17
15
13
11
9
8
6
4
2
377
379
380
382
384
385
387
388
390
392
393
395
397
398
400
402
403
405
407
408
410
412
413
415
417
419
420
422
424
426
427
429
431
433
435
436
438
440
442
444
446
447
449
451
453
455
457
459
22,108
2,108
20,000
$
537
20,000
5.0%
60 months
377
$ 22,645 $ 2,645 $ 20,000
4 year
Balance
Principal Paid
20,000
19,623
1.9%
19,244
3.8%
18,864
5.7%
18,482
7.6%
18,098
9.5%
17,713
11.4%
17,326
13.4%
16,938
15.3%
16,548
17.3%
16,156
19.2%
15,763
21.2%
15,368
23.2%
14,971
25.1%
14,573
27.1%
14,173
29.1%
13,772
31.1%
13,368
33.2%
12,964
35.2%
12,557
37.2%
12,149
39.3%
11,739
41.3%
11,327
43.4%
10,914
45.4%
10,499
47.5%
10,082
49.6%
9,663
51.7%
9,243
53.8%
8,821
55.9%
8,397
58.0%
7,971
60.1%
7,544
62.3%
7,115
64.4%
6,684
66.6%
6,251
68.7%
5,817
70.9%
5,380
73.1%
4,942
75.3%
4,502
77.5%
4,060
79.7%
3,617
81.9%
3,171
84.1%
2,724
86.4%
2,274
88.6%
1,823
90.9%
1,370
93.1%
915
95.4%
459
97.7%
(0)
100.0%
5 year
Payment
5 year
Interest
5 year
Principal
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
377
83
82
81
80
78
77
76
75
73
72
71
70
68
67
66
64
63
62
60
59
58
56
55
54
52
51
50
48
47
46
44
43
41
40
39
37
36
34
33
32
30
29
27
26
24
23
21
20
18
17
15
14
12
11
9
8
6
5
3
2
294
295
297
298
299
300
302
303
304
305
307
308
309
310
312
313
314
316
317
318
320
321
322
324
325
326
328
329
330
332
333
335
336
337
339
340
342
343
344
346
347
349
350
352
353
355
356
358
359
361
362
364
365
367
368
370
371
373
374
376
22,645
2,645
20,000
5 year
Balance Principal Paid
20,000
19,706
1.5%
19,411
2.9%
19,114
4.4%
18,816
5.9%
18,517
7.4%
18,217
8.9%
17,915
10.4%
17,613
11.9%
17,309
13.5%
17,003
15.0%
16,697
16.5%
16,389
18.1%
16,080
19.6%
15,769
21.2%
15,458
22.7%
15,145
24.3%
14,830
25.8%
14,515
27.4%
14,198
29.0%
13,879
30.6%
13,560
32.2%
13,239
33.8%
12,917
35.4%
12,593
37.0%
12,268
38.7%
11,942
40.3%
11,614
41.9%
11,285
43.6%
10,955
45.2%
10,623
46.9%
10,290
48.6%
9,955
50.2%
9,619
51.9%
9,282
53.6%
8,943
55.3%
8,603
57.0%
8,261
58.7%
7,918
60.4%
7,574
62.1%
7,228
63.9%
6,881
65.6%
6,532
67.3%
6,182
69.1%
5,830
70.8%
5,477
72.6%
5,122
74.4%
4,766
76.2%
4,409
78.0%
4,050
79.8%
3,689
81.6%
3,327
83.4%
2,964
85.2%
2,598
87.0%
2,232
88.8%
1,864
90.7%
1,494
92.5%
1,123
94.4%
750
96.2%
376
98.1%
(0)
100.0%
5 years
Total
Payments
= $22,645
7-23
The Cost of Credit
Payday loans
Borrowing against forthcoming paycheck
7-24
The Cost of Credit
Payday loans for bi-weekly paychecks
Payday loan
$ 100.00 $ 255.00
Fee
$ 17.50 $
45.00
17.50%
17.65%
Effective Interest Rate
Annual finance charges
Annual Percentage Rate
$ 455.00 $ 1,170.00
455%
459%
Biweekly paydays analyzed above (26/year)
7-25
The Cost of Credit
COST OF OPEN-END CREDIT – CREDIT CARDS
• Average daily balance method
– Creditors
1) add your balances for each day in the billing period
2) divide this total by the number of days in the billing period
3) multiply this average by the monthly interest rate.
– New purchases may be excluded from the average daily
balance calculation, but generally are included if you carry
over a balance.
• Including or excluding purchases will impact interest payment
– Incentive to pay early in cycle
7-26
The Cost of Credit
COST OF OPEN-END CREDIT
• Adjusted balance method
– Finance charges are calculated after payments made in
the billing period have been subtracted
– Most generous
7-27
The Cost of Credit
COST OF OPEN-END CREDIT
• Previous balance method
– Method of computing finance charges that gives no
credit for payments made during the billing period
– Least generous
7-28
The Cost of Credit – Example Calculations
7-29
The Cost of Credit – Other considerations
• Inflation: Borrowers and Lenders are concerned about the
purchasing power of dollars, rather than the actual credit used.
• Taxes: Interest paid on consumer credit is not tax deductible.
• Minimum Payment: Avoid the minimum monthly payment trap.
• Early repayment: Constant payments like a mortgage or car
payment favor lender. Prepayments limit their profit. Could also
be prepayment penalties or fees.
• Credit insurance: Loan paid off if insured dies or becomes
disabled--Expensive.
7-30
The Cost of Credit
EXAMPLE : Minimum Monthly Payment Trap
• You purchase a $2,000 stereo system using a credit card with
19 percent interest and a 2 percent minimum payment. If
you pay just the minimum every month, it will take you 265
months—over 22 years—to pay off the debt and will cost
you nearly $4,800 in interest payments.
• Doubling the amount paid each month to 4 percent of the
balance owed would allow you to shorten the payment time
to 88 months from 265 months—or 7 years as opposed to 22
years—and save you about $3,700.
– However, you are still paying much more than $2,000 for a
$2,000 stereo.
7-31
The Cost of Credit
• Credit Card Accountability, Responsibility, and
Disclosure Act of 2009 (The Credit CARD Act)
– Limits increases in the APR in the first year
– Restricts issuers from charging higher interest rates on existing
balances
– Teaser rates must be for at least 6 months
– Issuers must mail statements at least 21 days before payment
is due
– Disclosure statement must be clear and timely
– Card issuers must post card agreements on the internet
7-32
The Cost of Credit
• Credit Card Accountability, Responsibility, and
Disclosure Act of 2009 (The Credit CARD Act)
– Requires statements to report the due dates, potential late
fees, and total costs of making only the minimum payments
– Sets a consistent due date for card payments each month
– Restricts the penalties for over the limit fees
– Prohibits card issuers from issuing card to consumers under 21
with out a cosigner or independent means to repay debt.
7-33
The Cost of Credit
Minimum Monthly Payment Trap – the good news
• The new Credit CARD law requires creditors to include the
minimum payment warning in their monthly statements.
Here is an example:
7-34
Managing Your Debts
Objective 3: Develop a plan to manage your debts
• Notify creditors if you can’t make a payment.
7-35
Managing Your Debts
Why consumers don't pay (Exhibit 7-4)
• Excessive use of credit and loss of income due to unemployment are
the major reasons consumers don't pay.
• Source: Consumer Credit Counseling Service of the Gulf Coast Area,
www.nfcc.org, April 12, 2005.
Arguably, over 50% is poor personal financial habits.
7-36
Managing Your Debts
Over indebtedness is the nation's #1 family financial
problem - Warning Signs of Debt Problems (Exhibit 7-5)
•
Paying only the minimum balance each month
•
Increasing the total balance due each month
•
Missing or alternating payments or paying late
•
Intentionally using overdraft protection or taking frequent cash
advances
•
Using savings to pay routine bills such as food
•
Getting second or third payment notices
•
Not talking to your partner about money or talking only about money
•
Depending on overtime to meet routine expenses
7-37
Warning Signs of Debt Problems
Warning Signs of Debt Problems (Exhibit 7-5) (continued)
•
Using up your savings
•
Borrowing money to pay old debts
•
Not knowing how much you owe
•
Going over your credit limit on credit cards
•
Having little or no savings for the unexpected
•
Being denied credit due to a credit report
•
Getting a credit card revoked by the issuer
•
Putting off medical or dental visits because you can’t afford
them now
7-38
Consumer Credit Counseling Services
Objective 4: Evaluate various private and governmental
sources that assist consumers with debt problems
** If you can’t pay your bills, postpone further credit purchases,
talk with your creditors, or seek help from a non-profit credit
counseling service
7-39
Consumer Credit Counseling Services
• Consumer Credit Counseling Service (CCCS) is a non-profit
which is supported by contributions from banks, merchants,
etc.
– Provides education about credit and budgeting
– Provides help with spending plan
– Provides debt counseling services for
those with serious financial problems
– Can develop a debt consolidation
plan and negotiate reduced interest rates
7-40
Consumer Credit Counseling Services
• Universities, local agencies, credit unions, military bases, and
state and federal housing authorities provide nonprofit
counseling services.
• You can check with your financial institution or consumer
protection office to see if it has a listing of reputable, low-cost
financial counseling services.
• Avoid those service providers with large fees.
• www.consumercredit.com is the website of the nonprofit
American Consumer Credit Counseling
• Bankruptcy is a last resort
7-41
Declaring Personal Bankruptcy
Objective 5: Assess the choices in declaring personal
bankruptcy
• Bankruptcy is a legal process in which some or all of the
assets of a debtor are distributed among the creditors
because the debtor is unable to pay his or her debts.
– Liabilities far outweigh assets
7-42
Declaring Personal Bankruptcy
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 are sold to pay creditors
–
Can keep some assets
–
Fresh start
–
Most filed used to be this type
7-43
Declaring Personal Bankruptcy
After Chapter 7 You May No Longer Owe...
• Retail store charges
• Bank credit card charges
• Unsecured loans
• Unpaid hospital or physician bills
7-44
Declaring Personal Bankruptcy
After Chapter 7 Bankruptcy You Still May Owe...
• Certain taxes and fines
• Child support and alimony
• Educational loans
• Debts from willful or malicious acts
7-45
Declaring Personal Bankruptcy
Chapter 13 Bankruptcy… (Bankruptcy lite)
• A voluntary plan proposed to the bankruptcy court for those
to want to pay a portion of their debt over a period up to
five years
–
–
–
–
–
Must have a regular income
Can’t have more than $250,000 unsecured debt or $750,000
in secured debt
Payments are made to a trustee
Trustee distributes money to your creditors
Court may allow you to keep property & pay less than full
amount of debts
• Costs to the debtor include court costs, attorney’s fees and
trustee’s fees and costs
7-46
Group Exercise
http://www.myfico.com/crediteducation/cal
culators/loanrates.aspx
5-47
Investment Portfolio Analysis (IPA)
• Students will :
– Be given $1,000,000 to invest
– Three out of four portfolio options will be given. You will
select the fourth from a given list
– Track Investments from May 18 (starting point) through
June 1 (9 business days)
– Analyze portfolio
– Bring a print out of the IPA each time you attend class
– Earn an extra 2 course points if they have “winning
portfolio”
Investment Ideas for fourth IPA item
We will narrow it down to 3 or 4 for each class
We will select from this list on 5/15 to round our your
portfolio
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Chapter 7
Chapter Summary – We learned about…
1.
Analyzing and assessing the major sources of consumer
credit
2.
Determining the cost of credit by using various interest
formulas
3.
Developing a plan for debt management
4.
Listing and evaluating various private and governmental
sources that assist consumers with debt problems
5.
The choices in declaring personal bankruptcy
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Backups
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Cancelling/Not Using Credit Cards
Stacy Johnson 2/3/14
http://www.moneytalksnews.com/2014/01/28/a
sk-stacy-will-canceling-credit-cards-hurt-mycreditscore/?utm_source=newsletter&utm_campaign
=email-2014-02-03&utm_medium=email
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