Chapter 6:
Credit Use and Credit Cards
Objectives
• Compare and contrast installment and
non-installment credit and discuss the
costs of credit.
• Discuss reasons for and against using
credit.
• Describe the types of charge accounts.
Objectives
• Describe the process of opening a credit
account and the procedures lenders use
to evaluate credit applicants.
• Manage your credit card and charge
accounts properly.
What is Consumer Credit?
Receiving products, services or cash now, and
paying for them in the future.
Before you use credit, think about...
• Could I pay cash or make a down payment?
• Do I want to use savings for this purchase?
• Does purchase fit with my goals and budget?
6-2
What is Consumer Credit?(continued)
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•
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Does purchase fit with my goals and budget?
Could I use the credit I’ll need another way?
Can I wait to buy it?
What are the opportunity costs of postponing
the purchase?
• What are the economic & psychological costs
of using credit for the purchase?
6-3
Credit Use and Credit Cards
A RECENT SURVEY OF U.S.
HOUSEHOLDS:
•1:3 fear credit over-extension
•1:2 are concerned about payments
•Most people use installment credit 12+ times during
their life.
•Yet, only 1:3 shop for credit terms!
Credit Use and Credit Cards
•Credit is any situation in which goods,
services or money are received in exchange
for a promise to pay a definite sum of
money at a future date.
Credit Use and Credit Cards
• Consumer
• Installment
• Non-installment
• Open-ended
Closed vs. Open-End Credit
Advantages of Credit
•
•
•
•
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Current use of goods and services
Demonstrates financial stability
Use for financial emergencies
Convenience when shopping
Safer than cash
Reasons For Using Credit
• Convenience
• Emergencies
• Identification
• Reservations
Reasons For Using Credit
• Consume expensive products earlier
• Enjoy the good life
• Take advantage of free credit
• Consolidate debts
• Protection against ripoffs and frauds
Volume of Consumer Credit
Charting the Economy
Consumer Credit – Student Loans
Total Consumer Credit
Disadvantages of Consumer Credit
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Purchases are more expensive
Temptation to overspend
Possible financial difficulties
Possible loss of merchandise
due to late or non-payment
• Ties up future income
Credit Card Circulation
• 176.8 million credit cardholders in 2008.
• 159 million credit cardholders in the U.S. in 2000
• 173 million credit cardholders in the U.S. in 2006
• Average credit cardholder has 3.5 credit cards.
• Only 2% of undergraduates have no credit history.
• 50% of college undergraduates have 4 or more credit
cards.
• 76% of undergraduates have credit cards.
• Average undergrad has $2,200 in credit card debt.
• Average undergrad will amass about $20,000 student
debt.
http://www.creditcards.com/credit-card-news/credit-card-industry-facts-personal-debt-statistics-1276.php
Helpful Tips About Credit
•Always budget your credit spending carefully.
•Shop around for the lowest credit rates.
•Use credit only when doing so is to your advantage.
•Buy items on credit that will last at least until the last payment is due.
•Pay your bills on time
•Understand the credit contract before signing it.
•Notify the creditor if, for any reason, you can not make your payment.
•Keep an eye on your credit card when you give it to a salesperson.
•Tear up any carbons after you sign the receipt.
•Never give your credit card to anyone over the phone unless you initiated the call.
•Keep your receipt after you make charges. Compare them with your monthly statement.
•Keep a list of your credit card numbers and the issuers’ phone number in a safe place.
•Report stolen cards at once.
•After reporting a stolen card via telephone, follow up with a telegram or registered letter.
Reasons Against Using Credit
• Interest is costly
• Additional fees
• High-priced add-ons
• Liability for lost credit cards
Reasons Against Using Credit
• Tempting to overspend
• Privacy is a concern
• Reduces financial flexibility
Establishing a Debt Limit
• Debt-payments-to-income method
• Ratio of debt-to-equity method
• Continuous-debt method
How to Calculate Debt Paymentsto-Income Ratio
Credit Capacity Indicators
Debt To Equity Ratio
total liabilities
=
Should be < 1
net worth*
*Excluding home value
6-10
Fair Credit Reporting Act
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Is your credit report accurate?
If you are denied credit based on your
report, you can get a copy of your credit
report free within 60 days of your request
Obsolete information must
be deleted
Only authorized persons
have access to your report
Adverse data can be reported
for seven years or bankruptcy for ten
Sample Dispute Letter
Open-Ended Charge Accounts
PROCESS FOR OPENING:
• Application
• Investigation
• Credit ratings and risk scoring
Build and Maintain Your Credit Rating
• Establish a steady work record
• Pay all bills promptly
• Opening a checking account and don’t
bounce checks
• Get a cosigner on a loan and pay back the
loan as agreed
• Open a savings account and make regular
deposits
• Check to see what is in your file
Avoiding and Correcting Credit Mistakes
Fair Credit Billing Act
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Notify creditor of error in writing in 60 days
Send it to the correct address
They must respond within 30 days
Credit card company has 90 days to resolve
the problem
• Won’t affect your credit rating while in dispute
• You can withhold payment on shoddy goods
Managing a Charge Account
CREDIT STATEMENTS:
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•
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Billing date/Due date
Transaction/Posting dates
Grace period/Minimum payments
Credit for merchandise returns/Errors/
Correcting errors
Managing a Charge Account
COMPUTATION OF FINANCE CHARGES:
• Annual Percentage Rate (APR)
• Periodic Rate
• Average Daily Balance
What Should You Do
If You are Denied Credit?
• You have the right to know the
specific reason why
• Ask yourself if you can afford the item
• Check your credit report
• You are entitled to have errors in your
credit report corrected
• You have the right to provide a 100 word
explanation
What If You Are Denied Credit?
Protecting Against
Credit/Debit Card Fraud
• Sign new cards as soon as they arrive
• Treat the cards like money
• Shred anything with your account number
on it
• Don’t give your number over the phone
unless you make the call
• Get a receipt after every transaction
• Check your statements for errors
Measuring Your Credit Capacity
• Ask yourself.....
• can you afford the loan?
• what do you plan to give up in order to
make the payment?
• Cosigning a loan
• if the person doesn’t pay,
you will have to
• co-signers often have to pay
• it can affect your credit report
Criteria Used
to Grant Credit
5 C’s of Credit
• Character
• Capital
• Capacity
• Collateral
• Conditions
What Creditors Look For
• Character - do you pay bills on time?
• Capacity - can you repay the loan?
• Capital - what are your assets and net
worth?
• Collateral - what if you don’t repay?
• Conditions - what economic conditions
would affect your repayment of the loan?
Minimum Payments
Equals Permanent Debt
•Credit card issuers often require a
minimum monthly repayment as low as 1/36
or 1/48 of the outstanding balance. Such a
payment is mathematically guaranteed to
keep the user in “perma-debt.”
Bank Card
Competition
• Fixed or variable interest rates
• Introductory/teaser rate
• Co-branded card
• Rebates
www.e-wizdom.com/cc/index.html
www.bestcreditoffers.com
www.bankrate.com/brm/rate/cc_home.asp
Establish a
Credit History
• Establish both checking and savings
accounts
• Install telephone and bill to home address
• Request, acquire, and use an oil-company
card
• Apply for bank credit card
• Ask bank for small short-term cash loan
• Pay off student loans
Five Primary Areas of Interest in
Calculating FICO Score
What Your FICO Score Looks At
Payment History (35%)
Do you pay your bills on time.
Amount Owed (30%)
Debt ratio
Length of Credit History (15%)
How long have your accounts been established?
Types of Credit (10%)
Credit cards, retail accounts, installment loans,
mortgage loans, etc.
New Credit (10%)
It’s OK to request and check your own credit
report.
Credit Score Breakdown
Credit Score
499 and Below
500-549
550-599
600-649
650-699
700-749
750-799
800+
Percentage
2%
5%
8%
12%
15%
18%
27%
13%