24
5A Consumer Credit #1 Credit An arrangement to receive cash, goods, or services now and pay for them in the future. Types of credit ???

Chapter 5 first half

Embed Size (px)

DESCRIPTION

Chapter 5 first half

Citation preview

Page 1: Chapter 5 first half

5A Consumer Credit #1

Credit – An arrangement to receive cash, goods, or services now and pay for them in the future.

Types of credit ???

Page 2: Chapter 5 first half

Objective 1Analyze Advantages and

Disadvantages of Using Consumer Credit

• Credit – Based on trust in people’s ability and

willingness to pay bills when due• Consumer Credit

– Use of credit by individuals for personal needs, except a home mortgage

– Dates back to colonial times; exploded after invention of cars (installment loans; traveling)

– A major force in our economy5-2

Page 3: Chapter 5 first half

Uses and Misuses of CreditBefore you use credit for a major purchase, ask:– Do I have the cash for the down payment?

– Do I want to use my savings for this purchase?

– Does the purchase fit my budget?

– Could I use the credit I’ll 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?

5-3

Page 4: Chapter 5 first half

Advantages of Credit• Current use of goods and services

• Permits purchase even when funds are low

• A cushion for financial emergencies

• Advance notice of sales

• Easier to return merchandise

• Convenient when shopping

• Provides a record of expenses5-4

Page 5: Chapter 5 first half

More Advantages of Credit

• One monthly payment

• Safer than carrying cash

• Needed for hotel reservations, car rentals, and shopping online

• Take advantage of “float” time/grace period

• Rebates, airline miles, cash-back rewards, or other “perks”

• Credit indicates financial stability5-5

Page 6: Chapter 5 first half

Disadvantages of Consumer Credit

• Temptation to overspend

• Can create long-term financial problems and slow progress toward financial goals

• Potential loss of merchandisedue to late or non-payment

• Ties up future income

• Credit costs money - more costly than paying with cash

5-6

Page 7: Chapter 5 first half

Objective 2Assess the Types & Sources of

Consumer CreditTwo Basic Types of Consumer Credit

• Closed-End Credit– One-time loans for a specific purpose paid

back in a specified period of time

• Open-End Credit– Use as needed until line of credit max reached

5-7

Examples of each?

Page 8: Chapter 5 first half

Closed-End Credit

• One-time loans for a specific purpose that you pay back in a specified period of time, and in payments of equal amounts

• Mortgage, automobile, and installment loans for furniture, appliances and electronics

• 3 most common types of closed-end credit1. Installment sales credit- loan for high-priced items

2. Installment cash credit- loan of cash for personal use

3.Single-lump credit- loan repaid on a specific day

5-8

Page 9: Chapter 5 first half

Open-End Credit

• Use as needed until line of credit max reached

– Credit cards

– Department store cards

– Home equity loans

• You pay interest and finance charges if you do not pay the bill in full when due

• Revolving Check Credit (Bank Line of Credit)- pre-arranged loan for a specified amount; can be accessed with special checks

5-9

Page 10: Chapter 5 first half

Sources of Consumer CreditLoans

– Borrowing money with an agreement to repay, along with interest, within a certain amount of time (e.g., 3 years)

• Inexpensive loans– Parents or family members

• Medium-priced loans– Commercial banks, savings and loan

associations, and credit unions• Expensive loans

– Finance and check cashing companies – Retailers (e.g., department store credit cards)– Bank credit cards and cash advances

5-10

Page 11: Chapter 5 first half

Sources of Consumer Credit• Home Equity Loans

– Loan based on home equity• Current market value of your home minus the

amount you still owe on the mortgage– Interest is tax-deductible– Should only be used for major purchases

• Credit Cards– Average cardholder has > 9 credit cards– Convenience users vs. borrowers– Finance charge = total amount paid to use

credit5-11

Page 12: Chapter 5 first half

Sources of Consumer Credit• Debit Cards

– Debit cards electronically subtract money from savings or checking accounts

– Most commonly used at ATMs– Widely accepted at stores also

• Stored Value Cards– Gift cards– Prepaid cards

5-12

Page 13: Chapter 5 first half

Sources of Consumer Credit• Smart Cards

– Plastic card equipped with a computer chip that can store 500 times as much data as a normal credit card (e.g., health info)

• Travel and Entertainment (T&E) cards– Not really “credit cards”; balance is due in

full each month– Diners Club; American Express– You don’t pay for goods or services at the

time of purchase 5-13

Page 14: Chapter 5 first half

Objective 3 Determine Whether You Can Afford a Loan and How to Apply for Credit

Before you take out a loan, ask yourself...

Can you meet all your essential expenses and still afford the monthly loan payments?– Add up basic monthly expenses and subtract

from take-home pay; will the difference cover the monthly payment? (NO? Can’t afford it!)

– What do you plan to give up in order to make the payment?

5-14

Page 15: Chapter 5 first half

General Rules of Credit Capacity

*Not including a house payment, which is a long-term liability

Debt Payments-to-Income Ratio

Monthly Debt Payments*

Net Monthly Income

Consumer credit payments should not exceed a maximum of 20% of your net

income.

5-15

Page 16: Chapter 5 first half

General Rules of Credit Capacity

Debt To Equity Ratio

Total Liabilities

Net Worth*= Should be < 1

*Excluding home value

5-16

The lower the ratio, the better; e.g., 0.5 or 0.25

Page 17: Chapter 5 first half

The Five C’s of Credit

• Character - Do you pay bills on time?

• Capacity - Can you repay the loan?

• Capital - What are your assets and net worth?

• Collateral - What assets do you have to secure the loan?

• Conditions- Lenders will review how general economic conditions will affect your ability to repay your loan

5-17

Page 18: Chapter 5 first half

FICO & VantageScore

• FICO Credit Score– 350 to 850– Higher score = less risk– Available from http://www.myfico.com for a

fee; can sometimes get for free from lenders• VantageScore

– New scoring technique– Developed collaboratively by 3 credit agencies– Range = 501 to 990

5-18

Page 19: Chapter 5 first half

Credit Scoring Factors

• Bill payment history, weighted to emphasize past 12 months (35%)

• Proportion of outstanding debt to available credit limits (30%)

• Length of credit history (15%)

• Number of recent credit inquiries (10%)

• Mix of types of credit used (10%)

Page 20: Chapter 5 first half

Factors of CreditworthinessECOA (Equal Credit Opportunity Act)

– Gives all applicants the same rights. – Credit providers may not discriminate based on:

• Age• Social Security or public assistance• Housing loans (redlining)

– If you are denied credit, you have the right to know the reasons • You can request a copy of your credit report

within 60 days if you are denied credit based on what is in your files

5-20

Page 21: Chapter 5 first half

Your Credit Report• Credit Reports

– Record of your complete credit history• Credit Bureaus

– Agencies that collect information on how promptly people and businesses pay their bills

– Experian, Trans Union and Equifax are the 3 major credit bureaus

– Credit Bureaus obtain information from banks, finance companies stores, credit card companies and other lenders

5-21

Page 22: Chapter 5 first half

Four Main Parts to a Credit Report

• Identifying Information: name, SS Number, current/previous addresses, birthdate, employer

• Public Record Information from Local Courthouse: liens, foreclosures, bankruptcy

• Other Credit History Information: list of loans and credit cards, timeliness of payments, defaults and negative information (7 years)

• Inquiries: Usually 2 years; self-initiated and promotional (for marketing purposes)

Page 23: Chapter 5 first half

Your Credit Report

• Who can obtain a credit report?

– Only authorized persons have access to your report for approved legitimate business purposes

– Examples???

• Time Limits on Unfavorable Data

– Adverse data can be reported for 7 years

– Bankruptcy can be reported for 10 years

5-23

Page 24: Chapter 5 first half

Wrap Up

• Concept Check 5-1- Reasons to Borrow and Advantages/Disadvantages

• Concept Check 5-2- Definition of Terms; Difference Between Credit and Debit Cards

• Concept Check 5-3- Definition of Terms