Unit 4 Credit and Debt
• What is Credit?
• Someone lends you money
• 1. The original amount borrowed is called the
___
• Principal
Common Types of Credit
• 2. Which type of credit has the highest
interest rates?
• Credit Card (Revolving Credit)
• 3. Which type of credit has the lowest interest
rates?
• Student Loan / Mortgage
• 4. Which type of credit has no “term”?
• Credit Card
• 5. Which type of credit has the longest term?
• Mortgage
• 6. Which type of credit usually has a 10 year
term?
• Student
• 7. Which type of credit usually offer tax breaks
for the interest paid?
• Student / Mortgage
Mortgage Details
•
•
•
•
•
Requires a credit check
Requires a down payment
Typically 15 or 30 year term
Interest rates may be fixed or variable (ARM)
Adjustable rate mortgage
The Cost of Using Credit
• 8. If an advertisement states “Buy now and pay
only $19 a month.” – What is the ad NOT telling
you?
• Interest rate, payoff time and payoff amount
• 9. Know the bold terms on p. 44 and 45
• Annual Fee
Credit Limit
Finance Charge
• Origination Fee
Loan Term
• Grace Period
Over limit fee
Late fee
• Universal default
Credit: The Good and the Bad
• 10. Understand the “risks” and “rewards” of
credit
• Risks: Interest, Overspending, Debt (legal
claims against your future income), Identity
Theft
• Rewards: Convenience, Protection,
Emergencies, Build Credit, Quicker
Gratification, Special Offers, Bonuses
• 6 Questions to Ask When You Compare Credit
(know them)
1. What is the interest rate (for purchases)?
2. How long is the loan for?
3. Minimum Monthly Payment?
4. Grace Period ?
5. Extra fees/penalties?
6. Which is best deal for me?
The 4 C’s of Credit
• 11. An asset that lenders can take from you if
you do not repay a loan is ….
• Collateral
• 12. If you put up a house or car as an asset to
guarantee your loan, it is called a ……loan
• Secured
• 13. When assessing your credit worthiness,
lenders want to know if you have ….. . That is,
if you failed to pay the loan, they can sell your
assets.
• Capital
• 14. A pattern of rising income and steady
employment help determine your ____ to
repay your loan.
• Capacity
• 15. A history of paying bills on time helps
demonstrate to lenders that you have good
___ and are worthy of getting a loan
• Character
Keeping Score With Your Credit
• 16. What is a FICO score?
• A number that reflects your credit worthiness
based on the 4 C’s.
• Fair Isaac Corporation 1958
• use predictive analytics to help businesses
automate, improve and connect decisions
across organizational silos and customer
lifecycles.
• *there are several other credit scoring
agencies
• 17. The average consumer has ___ on record
at a credit bureau.
• 13
• 18. Your credit score reflects your …
• Credit worthiness
• 19. Credit scores range from ……..to……..
• 300-850
• 20. Building and maintain a good credit score
is as simple as……
• Discipline
• You have the right to receive one free credit
report per year from each of the three credit
bureaus.
•"The very best rates go to people with scores above 770, but a score of
700 is considered good
• (the average score is 725)
•a score above 700 indicates relatively low credit risk, while scores below
600 indicate relatively high risk... "
•Anything below about 550 is considered awful."
Your Credit Score is made up of….
(Do not need for test)
1. 35% - payment history
2. 30% - “debt to credit limit ratio”:
• Balances on all credit cards and loans ($5000)
Compared to …..
• Available credit limits on all cards ($20000)
• = 25%
• Keep as low as possible
• Good = < 30% ; Very Bad = > 50%
3. 15% - length of credit history
• A simplified look at what Lenders look at….
They will look at a Borrower’s :
Liability
Payment history
Income
4. 10% - # of recently opened accounts and
credit inquiries - when you pay for a
credit score or potential lenders look into
your score
• don’t want too many cards (3-4) ; don’t
want to seek lots of credit in limited time
5. 10% - mix of credit : higher scores if you can
manage 2-3 cards and other loans at same
time
21. Be able to summarize the five ways to hurt
your credit history and score.
•
•
•
•
•
Late payments
Bouncing checks
Too many credit cards/loans
High balances
Changing credit cards frequently
These are not good ways to
manage your credit
Getting Your Piece of the Credit Pie
• 22. As a student, there are 5 ways to begin
building your credit history. Identify them.
• Co-sign on credit card
• Credit card from “your” bank
• Store credit card
• Secured Credit Card (pre-pay) …like debit
• Rent and/or Utility bills in your name
• 23. Your first credit card will most likely have…
• Low limit
10%
Pay
Debt
Know for test “70-20-10 Rule”
20%
Save
Invest
70% Living
Expenses
Pitfalls and Warnings
* = need to know
1. *Making ONLY THE MINIMUM payment raises
the cost of Debt (credit card co’s make most of
their profit off of interest charges)
2. *Too much available credit may look risky to
Previous Balance
1000
other lenders…..why?
Paid the min
- 50
3. *Late Payments =
New Balance ?????
950
But that 950 is charged interest. So…..
Triple Threat
New Balance
960
• Fees
Pay the min
- 48
• Increase interest rates
912
But add interest
= 922
• Lower credit score
So you paid $98 on $1000 balance
Should owe $902 but owe $922
4. 7-10 year history
5. Make a Plan to Pay it Off
• If Multiple Sources of Debt
a. *Pay off smallest balance first = easy to see
progress
b. *Pay off largest interest first = paying less in
the long run
6.
a.
b.
c.
Hounded by Creditors
Negotiate with Creditors
Seek help (credit counseling agencies)
Bankruptcy
Consequences of Failing to Manage Your Credit
a. Bankruptcy
Unable to meet financial obligations
b. Foreclosure
-Inability to make mortgage payments; bank claims
ownership
c. Repossession
-bank sends contractors to take your possessions back
(cars, boats, etc..)
d. Difficulty securing job …why?
-especially in business or finance
e. Hard to obtain future credit
• Red Text = need to know
• PRIME RATE
• Prime Rate as an index or foundation rate for
pricing various short-term loan products.
• When newspapers, academics, investors and
economists refer to the National, Fed, U.S. or
WSJ Prime Rate, it is widely accepted that
they are in fact referring to The United States
Prime Rate as listed in the Eastern print
edition of the Wall Street Journal® (WSJ).
• Traditionally, the WSJ Prime Rate was
determined by polling thirty (30) of America's
largest banks. When twenty-three (23) of
those 30 banks had changed their prime
lending rate, The WSJ would respond by
updating its published Prime Rate.
• Effective December 16, 2008, however, the
WSJ now determines the Prime Rate by
polling the 10 largest banks in the United
States. When at least 7 out of the top 10
banks have changed their Prime, the WSJ will
update its published Prime Rate.
• Providers of consumer and commercial loan
products often use the U.S. Prime Rate as
their base lending rate,
• then add a margin (profit) based primarily on
the amount of risk associated with a loan.
• Moreover, some financial institutions use
Prime as an index for pricing certain timedeposit products like variable-rate Certificates
of Deposit.
• The U.S. Prime Rate is invariably tied to America's
cardinal, benchmark interest rate: the Federal
Funds Target Rate (also known as The Fed Funds
Rate.)
• U.S. Prime Rate = (The Fed Funds Target Rate + 3)
• Now: FFR = (targeted between 0 - .25) + 3 =
• 3.25
• What you pay : 3.25 + (margin or spread for profit)
= …….
• Credit Card ex: 3.25% + 12.74% = 15.99
•
This week Month ago Year ago
• WSJ Prime Rate
3.25\\3.25\\ 3.25
• Federal Discount Rate 0.75\\ 0.75\\ 0.75
• Fed Funds Rate (Current target rate 0-0.25)
0.25\\ 0.25\\ 0.25
• 11th District Cost of Funds 1.452 1.469 1.859
• The prime rate, as reported by the Wall Street
Journal's bank survey, is among the most
widely used benchmark in setting home
equity lines of credit and credit card rates. It is
in turn based on the fed funds rate, which is
set by the Federal Reserve. The COFI (11th
District cost of funds index) is a widely used
benchmark for adjustable-rate mortgages.
• Changes in the fed funds rate and the discount
rate also dictate changes in the Wall Street
Journal Prime Rate, which is of interest to
borrowers.
• The prime rate is the underlying index for
most credit cards, home equity loans and lines
of credit, auto loans, and personal loans.
• Many small business loans are also indexed to
the Prime rate. The 11th District Cost of Funds
is often used as an index for adjustable-rate
mortgages.
• Ratings methodology
• What's included?
• The fed funds rate is the primary tool that the
Federal Open Market Committee uses to
influence interest rates and the economy.
• Changes in the fed funds rate have farreaching effects by influencing the borrowing
cost of banks in the overnight lending market,
and subsequently the returns offered on bank
deposit products such as certificates of
deposit, savings accounts, and money market
accounts.
Sub-Prime
• A type of loan that is offered at a rate above
prime to individuals who do not qualify for prime
rate loans.
• Quite often, subprime borrowers are often
turned away from traditional lenders because
of their low credit ratings or other factors that
suggest that they have a reasonable chance of
defaulting on the debt repayment.
• Good? / Bad?
• Major role in housing collapse
• Is the American Dream (house) your right?
• Is it (should it) be guaranteed?