C
5
Consumer Credit
“Borrowing money is like wetting your bed in the middle of the night. At first all you feel is warmth and release. But very, very quickly comes the awful, cold discomfort of reality.”
– Elizabeth Gilbert
1

2
 Credit is an arrangement to receive cash, goods or services now, and pay for them in the future
 Consumer credit is the use of credit for personal needs (excludes home loans, home improvement loans and higher education loans)
 It is a major force in the American economy
 There are three ways consumers can finance current purchases


Take money from savings
Use present earnings
 Borrow against future income
 Trade-offs are involved in using credit

Does consumer credit increase or decrease your purchasing power?
A.
Consumer credit increases your purchasing power
B.
Consumer credit decreases your purchasing power
C.
Consumer credit has no effect on your purchasing power
The correct answer is (B). Sounds like a test question, huh?
3

 The finance charge is the total dollar amount you pay for the loan
 Includes interest and fees, such as service charges or credit-related insurance
 The annual percentage rate (APR) is the percentage cost of credit on a yearly basis
 The APR provides the true rate of interest for comparison with other sources of credit
 This rate lets you compare “like with like” when shopping for rates
 Mandated by the Truth in Lending Act
4

The Truth In Lending Act requires creditors to provide you with accurate and complete credit costs, terms, and APR
Creditors must disclose credit terms and information...
 In a clear and conspicuous manner
 In a form you can keep

But often in a font you can not possibly read
 And that is where they put all the information they do not want you to read such as what happens if you miss a single payment – Your interest rate goes up to 1000% and they come and take your house and your first born and you will be in debt to them for the rest of your life which will not be that long since you will work yourself to death trying to pay the interest but they do not care because they will have made enough money off you to buy one or maybe even two yachts and brand new gas bar-bq and a trip around the world and …
5

 Simple interest
 Computed on principal only and without compounding – The dollar cost of borrowing
 Interest = Principal x Rate x Time
 Note: Time needs to be expressed in years
 Used for most installment loans (closed-end loans)
 Average daily balance method
 Most credit cards use this method
 Uses a weighted average of the account balance
 throughout the current billing period
If you carried over a balance, new purchases will be included in your average daily balance calculation
 So you do not get to take advantage of the “float”
6

(continued)
 Adjusted balance method
 New purchases are not taken into account and all payments are deducted from your previous balance before interest is added
 This is the most favorable to credit card holders
 But – Surprise!
– is the least common method
 Previous balance method
 More costly than average balance method, less costly than adjusted balance method
 Two cycle average daily balance method
 The worst method for card holders
 Luckily, not very common
7 http://www.asapcreditcard.com/articles/interest-calculation-methods.html

 It cost us almost two times more than $299 because of the taxes
 What if we had purchased it with a credit card and only paid the minimum payments?


19.9% APR
2.2% minimum
 That is right – The Price Just Doubled Again!
 It will cost us twice as much if we purchase it on credit and only make the minimum payments
 And since those are all after-tax dollars, the true cost of the $299 stereo is almost $1,200
8

9




10
Well, all right. In case of emergency…

11
100% Down!

 Before you use credit for a major purchase, ask yourself some questions:
 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?
Could I use the credit I will need in some better way?
 Can I postpone this purchase?
 What are the opportunity costs of postponing this purchase?
 What are the dollar and psychological costs of using credit for this purchase?
12

 Current use of goods and services
 Permit purchase even when funds are low
 Convenient when shopping
 Safer than cash
 Can take advantage of float time
 May get rebates, airline miles or other bonuses
 Demonstrates financial stability
 Use For Financial Emergencies
13

14



Gotta’ love this one!


 (Unlikely in case of credit cards)

 Closed-End Credit
 For a specific purpose and amount
 Mortgage loans
 Automobile loans
 Installment loans
 Open-End Credit – a.k.a. line of credit
 Used as needed until limit of credit is reached


You pay interest and finance charges if you do not pay the bill in full when due
Revolving credit – prearranged loan
 Credit cards / Home equity loans
15

“The bubonic plague of personal finance” – Jonathan Clements
16
 Nearly eight out of ten American households carry one or more credit cards
 One-third are convenience users
 They pay their balance off in full each month
 Often to take advantage of points, miles, etc.
 The other two-thirds are borrowers
 Co-branding –
GM, Shell, etc.
 Linking a credit card with a business offering rebates on products and services

(continued)
 Debit Cards versus Credit Cards
 They are not the same
 Laws and regulations differ
 Credit Card Fraud
 $50 limit on credit card fraud
 Debit Card Fraud
 $50 limit if reported within 2 days


$500 limit if reported within 6 months
Unlimited loss after 6 months!
 Most banks and credit unions will waive the above limits
17

(continued)

“But aren’t credit cards a good way to save money? As long as you pay the total amount each month, you are essentially getting a free loan. Plus they are so convenient,” said Cathy.
“Not so fast,” said Roy. “By taking advantage of the ‘float’ as it is called, you may save a few dollars a year. But the pennies you save each year are swamped by the hundreds or even thousands of dollars you spend because of the very same convenience you speak so highly of. How many times have you rationalized the purchase of items simply because you told yourself you wouldn’t have to pay for it until next month? And then when the bill came the next month, you ask yourself, ‘How did I spend $500!?’ The cost of that convenience is very high.”
18

How Many Credit Cards Do You Have?
A.
Zero, zilch, nada, no way. Forget it.
They ain’t gettin’ their hooks in me!
B.
Only one! I swear it! I only use it to buy gas.
C.
Okay. I have two. I use one to pay off the other …
D.
More than two and I lost count a long time ago. Plus I would not tell you even if I did know!
19

20
And How Much Do You Owe?
A.
Nothing! I am serious! I do not owe a cent!
B.
Less than $1,000
C.
Between $1,000 and $5,000
D.
More than $5,000 (You can lie if you do not want us to know…)

(continued)



21
Notice that I use the singular instead of the plural?
Do not have more than one credit card!
There simply is not any valid reason to have more than one.
(Well, actually, there might be one or two.)

 Based on the current market value of your home less the amount still owed on the mortgage (asset – liability = equity)
 a.k.a. 2 nd mortgage, 2 nd trust deed, HELOC
 Will be much cheaper than a credit card


Interest is normally tax-deductible (Schedule A)
Danger!
¡Peligro!
 Do not pay your credit cards and you can destroy your credit rating
– bad, but not a big deal
 Do not pay your home equity loan and you can lose your home – Big Deal!
22

(continued)
 Example:


Home currently worth $200,000
Still owe $150,000 on the mortgage
 Home Equity = $50,000 ($200,000
– $150,000)
 A reputable lender would let you borrow up to 75% or 80% or even maybe 90% of the current value of your home


 80% of $200,000 = $160,000
$160,000 – $150,000 mortgage = $10,000
You would be eligible for a $10,000 home equity line of credit
23

(continued)
 But some unscrupulous lenders will let you borrow more than the available equity in your home!
24
 Have you heard or seen the ads?
 “Get a 125% Home Equity Loan!”
 “Consolidate your car loans and credit card bills into one easy monthly payment!”
 “Run up your credit card bills all over again!”
 “Lose your house to us when we foreclose!”

(continued)
 Same example – 125% home equity loan:
 Home currently worth $200,000
 Still owe $150,000 on the mortgage
 Home Equity = $50,000 ($200,000 – $150,000)


125% of $200,000 = $250,000
$250,000 – $150,000 mortgage = $100,000
 If you used over $50,000 of your available credit
– only ½ of your line of credit – you would owe more than the house is worth!
 If you got into financial trouble, you would be tempted to simply walk away from your home
25

 Inexpensive loans
 Parents and family members
 Do Not Even Think About It!
 (Except for down payment on a home – more in chapter 7)
 Loans based on assets, such as a savings acct
 A secured loan should have a lower interest rate than an unsecured loan (all other things equal)
 Medium-priced loans
 Commercial banks and credit unions
 Expensive loans


Retailers such as car or appliance dealers
Credit cards and cash advances
26

27
 Secured Credit – Loans based on assets called “collateral”
 Auto Loans
 Home Loans
 Unsecured Credit
 Credit cards
 Most all other forms of consumer credit

 An excellent way to begin building your credit is to obtain a “secured credit card”


Deposit $500 in a savings account

Receive a credit card with a limit of $500
Use the credit card …
 Remembering to pay off the balance each month!
 Make sure the issuer reports your credit usage!
 After a year or less, you will have built up enough of a credit history to get an
“unsecured credit card”
 You can then close account & get your $500 back
28

 Before you take out a loan, ask yourself...
 Can you afford the loan?
 What do you plan to give up in order to make the payments?

Look closely at your…
 Debt Payments-to-Income Ratio and
 Debt-to-Equity Ratio
29
Or better yet, “Make Love, Not Loans!”

Debt Payments-to-Income Ratio monthly payments * monthly after tax income
Da’ Book sez, “Should be less than 20%.” I think that is obscenely high!
* Not including housing
30

(page 149)
$1,500 Monthly Gross Income
Less:
All Taxes
Social Security / Medicare
Monthly IRA Contribution
Monthly Net Income
Monthly Installment Debt Payments
Squeezya
MonsterCard
Disaster Card
Auto Loan
Total Monthly Debt Payments
Debt Payments-to-Income Ratio ($213 / $1,068)
270
112
50
$1,068
$25
20
15
153
$213
19.94%
31

Debt-to-Equity Ratio total liabilities * net worth
= Should be < 100%
32
Again, this is far too high!
Businesses try to keep it down to between
30% and 50%
*Excluding home value and mortgage

33
Assets (a.k.a. Equity, excluding value of home)
Automobile
Furniture
Computer
Miscellaneous
Total Assets (a.k.a. Equity, excluding home)
Liabilities (a.k.a. Debts, excluding home mortgage)
Auto Loan
MonsterCard
Disaster Card
American Excuse
Total Liabilities (a.k.a. Debts, excluding home)
Debt-to-Equity Ratio ($13,000 / $12,000)
$8,000
1,200
400
2,400
$12,000
$6,500
4,300
1,400
800
$13,000
108.3%

 Before co-signing a loan consider...
 If the person does not pay, you will have to
 Can you afford to pay if the person does not?
 It will affect your credit report as well as theirs
 Request that a copy of overdue payment notices be sent to you
 Surprise – Three out of four co-signers end up paying!
The correct answer, by the way, to the above question is
“No.”
34

 Credit bureaus collect information
 Experian, Trans Union, and Equifax
 888-567-8688 / 888-5OPT-OUT
 “ Get me off your mailing list!”
 Number of mix-ups and errors in credit reports have declined recently but it is still very high
 Bureaus get information from banks, finance and credit card companies, merchants, and others
 Each year, you can get a free credit report from each of the three major credit bureaus
 Use the “Central Source” to get all three at once
 http://www.annualcreditreport.com
 877-FACT-ACT (877-322-8228)
35

36


Your credit score is generated by a company called Fair Isaac Corporation using the data from
Experian, Trans Union, and Equifax
FICO scores range from upper300’s to mid-
800’s
 Generally, anything over 700 is excellent
 Computer will automatically approve you


At around 600, your credit application is supposed to be manually reviewed
 Does not always happen (more later)
Mid500’s or lower, you are considered a high risk

(continued)
 What makes up your FICO score?


Past payment history (35%)
Amounts owed (30%)
 Are you “maxed out?”
 Rule of thumb: Never pass 75% of your credit



 capacity
Length of credit history (15%)
Amount of new credit (10%)
 Can be a “red flag” if you open too many accounts in a short period of time
Types of credit (10%)
No more “Authorized User”
Psst! Do not tell anyone about this info on this slide. It is a secret!
37 http://finance.yahoo.com/banking-budgeting/article/109347/the-fico5-the-componentsthat-make-up-a-fico-credit-score?mod=bb-creditcards

Is your credit report accurate?
 You can get a free copy of your report if you are denied credit
 In addition to the free annual copy of your credit report from each of the three credit bureaus
 Inaccurate information must be corrected within
30 days
 Only authorized persons have access to your report


Ha! Ha! Ha! Ha! Ha! This is a good one!
Anyone can access your credit report!
 Adverse data can be reported for and bankruptcy for ten years seven years
38



Protect yourself by shredding old credit slips, account statements, and credit offers you receive in the mail
 Shredders are cheap; get a decent one
 Spend about $30 to $50
You may not know your identity has been stolen until you receive a bill with charges that are not yours
 Almost 10 million thefts in 2008, $1,200 per victim!
 That is $12 billion
Finding good statistics on identity theft is not easy.
Anyone want to validate my numbers?
39

(continued)
 Take three actions once you know
 Contact the fraud departments of each of the three major credit bureaus
 Contact the creditors for any accounts that have been tampered with or opened illegally
 File a police report
 Identity Theft Resource Center
 http://www.idtheftcenter.org/
40
Why should you bother filing a police report?

(continued)


Sources of identity theft


30% – Security breaches at businesses
30% – Consumer’s lost and stolen wallets,


 checkbooks, etc.
15% – “Friends” and family members
9% – Stolen mail
9% – Attacks and scams targeting home computers
Credit protection businesses
 $10 - $30 per month to protect & insure your identity
 Virtually all of the services can be done by you for free
41

(continued)
 Freezing your credit


Blocks new lines of credit being open
Free in California if you have been already targeted
 Otherwise, $10 per credit bureau (3 x $10 = $30)
 Fraud alerts
 A fraud alert notifies lenders that you have or you
 believe you have been targeted (no charge)
Time limit – 90 days up to 7 years
 Other innovative protection methods
 Counter-intelligence!
 Analyzing transaction data
42
Many companies will do some or all of these services for a fee.

(continued)
 An entire industry is springing up


TrustedID – specializes in credit freezes ($15/mo)
LifeLock – specializes in fraud alerts ($10/mo)




 Now have LifeLock Ultimate! (only $25/mo!)
IdentifySecure –$17.99/month
 Now with Registered Sex Offender Tracker!
IdentitySweep – $14.95/mo
 Now have IdentitySweep 360-Plus! (only $30/mo!)
IdentityForce – $17.95/month
MyPublicInfo – $69.95/year
43
Hmm. Paying for protection. Makes you feel as though you are dealing with organized crime!
http://www.consumerreports.org/cro/2012/02/debunking-the-hype-over-id-theft/index.htm

 Character – Do you pay bills on time?
 Capacity – Can you repay the loan?
 Capital – What are your assets and net worth?
 Collateral – What do you have of value that the lender can take if you do not repay?
 Conditions – What economic conditions could affect your repayment of the loan?
44
Discussion: Who gets credit? Who doesn’t?

 Ask the creditor to clarify the specific reason for denial of credit
 Check your credit report file (It is free, remember?)
 Apply to another creditor with different standards
 Take steps to improve your creditworthiness
 You have the right to provide a 100-word explanation in your file
 For example, you could explain if you were out of work due to an extended illness and were therefore late paying bills for a time
45

(continued)
 The majority of credit applications are now electronically pre-screened
 If your FICO score is below approximately 600, the application is supposed to be reviewed by a human
 In practice, the credit company often simply rejects the application entirely
 Or automatically sends the application to their “subprime” department
 Unfortunately, one account in default can put your score in the low500’s
46
 The moral? Check your credit files before you apply for credit. Get rid of erroneous data.

(continued)
47
 Do Not Fall For…
Anything legitimate that these people can do for you, you can do for yourself for free!
Anything illegitimate they suggest is either illegal or simply will not work
Let’s look at some credit card applications…

Once
Again,
How long can adverse credit data (late payments, charge offs, etc.) be reported on your credit report?
48
A.
3 years
B.
5 years
C.
7 years
D.
10 years
The correct answer is (C).

Once
Again,
How long can a bankruptcy be reported on your credit report?
49
A.
3 years
B.
5 years
C.
7 years
D.
10 years
The correct answer is (D). Now, do not forget these two numbers, 7 & 10.

50
Fair Credit Billing Act
 Notify creditor of error in writing within 60 days
 Send it to the correct address
 They must respond within 30 days
 Credit card company has 90 days to resolve the problem or tell you why they think the bill is correct
 Will not affect your credit rating while in dispute
 You can withhold payment on shoddy goods if you have paid for them with a credit card

51

52

 First try to solve the problem directly with the creditor
 If that does not work, there are more formal complaint procedures
 There are a variety of consumer credit protection laws and federal agencies who administer and assist with complaint procedures
 www.ftc.gov/credit
53

 You know what this one is supposed to do
 “Some of us are more equal than others”
 Don’t Give Up! Never Give Up!
 Someone out there wants to lend to you!
 And after you have established yourself as a good credit risk, the others will come calling…
You can then tell ‘em to “Kiss Off!”
54



Notify creditors if you can not make a payment
Debt collection practices require…
 If a debt collector calls you, within five days they must send you a written notice of amount owed


You can dispute the debt
The debt collector has 30 days to verify the debt
 Send the collector a letter stating that all further contact should be via the U. S. Postal Service
55

56
Collection agencies...
 Can not be abusive or threaten
 Can not call you at work if you say not to
 Can not tell boss and friends
 Can not call you at odd hours
 Must follow set procedures
 The act does not apply to creditors that try and collect the debt themselves

57
 One option for those in credit trouble is to seek help from a non-profit credit counseling service
 National Foundation for Consumer Credit,
 Consumer Credit Counseling Service,
 American Debt Counseling, etc.
 Credit card companies pay for their operation
 Provide education about credit
 Provide help with spending plan
 Provide debt counseling services for those with serious financial problems

 Paying only the minimum balance each month
 Increasing the total balance due each month
 Missing or alternating payments or paying late
 Getting second or third payment notices
 Borrowing money to pay debt payments
 Not knowing how much you owe
 Going over your credit limit on credit cards
 Not talking to your partner about money
 Or talking only to your partner about money
58

 Personal bankruptcy rate is the highest it has ever been
 Bankruptcy was designed as a last resort but has become an “acceptable” tool of credit management
 Many (especially the credit card companies) complained that bankruptcy was being abused
59
“Bankruptcy is a legal proceeding in which you put your money in your pants pocket and give your coat to your creditors” –
Joey Adams

The credit card companies deserve a partial share of the blame for the record number of bankruptcies because they gave too much credit to too many people.
60
A.
Strongly agree
B.
Agree
C.
Disagree
D.
Strongly disagree

 Chapter 13




Plan to pay a portion of your debt
Trustee distributes money to your creditors
Can keep most of your property
Must have a regular income
 Chapter 7
 Submit a petition and pay the fee yourself, or …
 Lawyers charge >$500, including court costs


Can keep some property
Idea is a “fresh start”
 But the person may still wind up being hounded by debt collectors anyway!
61

62
 Provisions of the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act
 Created a “means test” to determine whether you can use
Chapter 7
 “Fresh start”
 Was meant to funnel people into Chapter 13
 “Reorganize”
 Boon for credit card companies
 Who wrote the legislation, by the way?
 Congress or the credit card companies?
 Complements of The K Street Project
(Look it up!)
 Reads “like a credit card industry wish list”
 The backlash resulted in the Credit CARD Act of 2009

63
 Retail store charges
 Bank credit card charges
 Unsecured loans
 Unpaid hospital or physician bills
 Taxes & fines
 Child support & Alimony
 College loans & Co-signer obligations
 Debts arising from illegal activities (ex: DUIs)

 Only if you believe it is okay not to consult a doctor and instead decide to take out your appendix by yourself
64
Find a good lawyer, by the way.

“Uh, Oh!”
On your tenth wedding anniversary, you splurge on a $5,000 second honeymoon, which you charge to your credit card. With an interest rate of 15.9%, how long will it take you to pay back the debt if you make only the 2.2% minimum payment each month?
65
A.
13 years
B.
D.
19 years
C.
28 years
It will be paid off out of your estate when you die
The correct answer is (C).

“Uh, Oh!”
(continued)
And how much of a finance charge will you pay in those 28 years?
66
A.
$2,976
B.
$4,820
C.
$7,129
D.
$15,281
The correct answer is (C).

“Uh, Oh!”
(continued)
Under the new law, the credit card companies now must disclose how long it will take you pay the balance and how much you will actually pay if you only make the minimum payments. The hope is that people who have not taken
BUS-121 will be motivated to pay off their balance quicker. But, of course, all of you already knew this, right?
(Nod your heads, “Yes.”
Thank you very much.)
67

68
$