Chapter 6

Chapter 6

Building andMaintaining Good Credit

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Learning Objectives

1. Explain reasons for and against using credit.2. Establish your own debt limit.3. Achieve a good credit reputation.4. Describe common sources of consumer credit.5. Identify signs of over-indebtedness and

describe options available for debt relief.


Reasons For andAgainst Using Credit

• Credit is any arrangement in which goods, services or money is received in exchange for a promise to repay at a later date.

• Good uses of credit include emergencies, reservations, convenience, owning expensive items sooner, earning a college education, etc.


Reasons For andAgainst Using Credit

• The downside of credit:– Use of credit reduces financial flexibility– It is tempting to overspend– It can be difficult to get out of debt– Interest is costly

• Interest, Finance Charge, Annual Percentage Rate (or APR)


Debt Payments-to-Disposable Income

• Maximum 14% limit of monthly debt payment as percent of disposable income • A Monthly payment (mortgage not included) of 15% to 18% as percent of disposable income is precariously over-indebted and should NOT aquire more debt.


Setting Debt Limits• Ratio of debt-to-equity method uses your

Debt-to-Equity Ratio: Ratio of your consumer debt to your assets.– Equity: Amount by which the value of a person’s

assets exceeds debts.– Example: Assume a household has $9,120

monetary assets, $20,500 tangible assets and $167,000 investment assets for total assets of $196,620. If total household debt is $9,365, the equity is $187,255 ($196,620 - $9,365) and the debt-to-equity ratio is 5% ($9,365/$187,255)

– A ratio of 33% or higher is excessive.



Managing Student Loan Debt• When possible, choose grants, scholarships first• Choose the most advantageous repayment

pattern allowed.• Pay electronically.• Make your repayments on time, every time.• Consolidate your student loans.• If necessary, sign up for the Federal

government’s income-based repayment plan.• Go to http://studentaid.edu.gov/ and select

“Repay Your Loans” then “Repayment Plans”

http://studentaid.edu.gov/


Credit Approval Process1. You apply for credit.

• Credit Application – ability to pay debt• Credit History – record of credit usage

2. The lender conducts a credit investigation.• Credit Rating – evaluation of credit worthy• Credit Report – Info about payment history• Credit Bureau – Firm that collects history• Credit Scoring (or Risk Scoring) System –

rates credit worthiness & likelihood of repayment


Credit Approval Process

3. The lender decides whether to accept the application.• Credit Agreement – loan on credit card• Promissory Note• Tiered Pricing - Interest rate charged based upon level of risk


Making Sense of YourFICO Credit Scores

• Percent indicates weight of characteristic used when determining credit score


Your Credit Reputation• Building credit history: Ways to establish Credit:

– Establish both a checking account and a savings account.

– Have your telephone and other utilities billed in your name.

– Request, acquire, and use an oil-company credit card.

– Apply for a bank credit card.– Ask a bank for a small short-term cash loan.– Pay off student loans.


Your Credit Reputation

• Managing your credit bureau file for free• Fair Credit Reporting Act (FCRA) – Requires

that credit reports contain accurate, relevant, and recent information and access is restricted for approved purposes.


Sources of Consumer Loans• Depository institutions such as commercial banks, mutual savings

banks, savings banks and credit unions loan money to their banking customers. – Wells Fargo, First National Bank, Centris Federal, etc.

• Sales finance companies loan money to buy consumer products. GMAC Financial Services, Ford Motor Credit

• Consumer finance companies make small cash loans. CitiFinancial, Beneficial Finance Corp, HSBC, Household Finance, etc.

• Stockbrokers loan money to their clients. Charles Schwab, Fidelity Investments, A.G. Edwards, etc.

• Insurance companies loan money to their policyholders. Allstate, State Farm, Farmers Insurance


What it Costs to Borrow Money

• Above payment schedule based upon $1,000 Loan over two and five year periods


10 Signs of Overindebtedness

• Exceeding debt limits and credit limits• Not knowing how much you owe• Running out of money• Paying only the minimum amount due• Requesting new credit cards and increases

in credit limits• Paying late or skipping credit payments• Using debt-consolidation loans• Taking add-on loans• Experiencing garnishment• Experiencing repossession or foreclosure


Debt Collection• Federal law regulates debt collection practices.• Federal Fair Debt Collection Practices Act

(FDCPA) – Prohibits third-party debt collection agencies from

using abusive, deceptive and unfair practices to collect past due debts.

• Debt collection agencies– Specialize in making collections that could not be

obtained by the original lender for a fee. – Prohibited from calling at unusual hours, numerous

calls, false claims, contacting employer and abusive tactics


Steps to Take toGet Out from Under Excessive Debt

• Determine your account balances and the payments required.

• Focus your budget on debt reduction.• Contact your creditors.• Do not take on new credit.• Refinance.• Find good help.


Bankruptcy

• Bankruptcy is a last resort.• Discharged debts• Chapter 13 of the Bankruptcy Act:

Wage earner or regular income plan – Reorganization plan to repay debts in 3-5 years– Stay – prevents creditors from recovering claims

temporarily before court proceedings• Chapter 7 of the Bankruptcy Act:

Straight bankruptcy – liquidation (sale) of assets to repay creditors and remains on record for 10 years– May result in future problems when credit requested for home or

car purchase


The Top 3 Financial Challenges in Building and Maintaining Good Credit

People experience difficulty in building and maintaining good credit when they do the following:

1. Make late payments on credit cards.2. Pay more than 14 percent of disposable

income toward nonmortgage debt payments.3. Fail to regularly check the accuracy of credit

bureau files.


Good Money Habits in Buildingand Maintaining Good Credit

• Protect your credit reputation just as you would guard your personal reputation.

• Calculate your own debt limits before taking on any credit.

• Obtain copies of your credit bureau reports regularly, and challenge all errors or omissions on them.

• Never cosign a loan for anyone, including relatives.

• Always repay your debts in a timely manner.


Questions ?

Documents

Chapter 6