5A Consumer Credit #1

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

Types of credit ???

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

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 expenses5-3

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 stability5-4

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

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Credit Card Debt- A Student’s Story

Video link: https://www.youtube.com/watch?v=7U6pmkTC8i0

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

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Examples of each?

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

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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?

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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.

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General Rules of Credit Capacity

Debt To Equity Ratio

Total Liabilities

Net Worth*= Should be < 1

*Excluding home value

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

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

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FICO & VantageScore

• FICO Credit Score– 300 to 850 range– Higher score = less risk– Available from http://www.myfico.com for a fee;

can sometimes get for free from lenders• VantageScore

– Another scoring technique– Developed collaboratively by 3 credit agencies– https://your.vantagescore.com/score-influences

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FICO Credit Scoring Factors

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

• Amounts owed (30%)

• Length of credit history (15%)

• Number of recent credit inquiries (10%)

• Mix of types of credit used (10%)

• Uses a rating scale for risk of default; like a GPA for credit

• The higher the number, the better (lower interest loans)

• Can often get free via creditors (e.g., via online account)

Lower Score = Higher Interest Rates

Resource: www.myfico.com/myfico/creditcentral/loanrates.aspx 15

The Credit Score Quiz

http://www.creditscorequiz.org/16

By Consumer Federation of America

Credit Score VideoVideo link: https://www.youtube.com/watch?v=Hf4BgvN5f_E

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

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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)

Sample Credit Report

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Identifying Information

Credit History

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Recent Inquiries

Accounts in Collection

Public Records

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

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Wise Credit Management Quiz

http://njaes.rutgers.edu/money/wise-credit/

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Activity: Calculator Clues

• Free Credit Score Estimator Calculator (MyFICO): https://www.myfico.com/ficocreditscoreestimator/estimator.aspx

• Estimate Your Credit Score (CalcXML): http://www.calcxml.com/calculators/credit-score-calculator

• FICO Score Estimator (WhatsMyScore.org): https://whatsmyscore.org/estimator/

• Credit Score Estimator Calculator (Privacy Matters): http://www.privacymatters.com/personal-finance-calculators/credit-score-estimator.aspx