Chapter 6Chapter 6

Introduction toIntroduction to

Consumer CreditConsumer Credit

What is Credit?What is Credit?

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

• Consumer credit refers to the use of credit for personal needs (except a home mortgage) by individuals and families, in contrast to credit used for business purposes

Questions to Consider Before Questions to Consider Before Making a Major PurchaseMaking a Major Purchase

• Do I have the cash I need 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 need for this purchase in some

better way?• Could I postpone the purchase?• What are the opportunity costs of postponing the

purchase?• What are the dollar costs and the psychological costs

of using credit?

Advantages of CreditAdvantages of Credit• You enjoy goods and services now• Advance notice of sales and the right to

order by phone or to buy on approval• Easier to return merchandise• Shopping convenience• Efficiency of payment (one bill)• Safety• No finance charge if bill is paid in full• Bonuses

Disadvantages of CreditDisadvantages of Credit

• Temptation to overspend

• Can create serious long-term financial problems

• Can damage family relationships

• Ties up future income

• Costs money

Types of CreditTypes of Credit

• Closed-end– A one-time loan that you will pay back over a

specified period of time with equal payments

• Open-end– A company gives you a certain limit on the

amount of money you can borrow

Protecting Against FraudProtecting Against Fraud• Sign your new cards as soon as they arrive.• Treat your cards like money. Store them in a secure

place.• Shred anything with your account number before

throwing it away.• Don’t give your card number over the phone or online

unless you initiate the call.• Don’t write your card number on a postcard or the

outside of an envelope.• Remember to get your card and receipt after a

transaction, and double-check to be sure it’s yours.• If your billing statement is incorrect or your credit cards

are lost or stolen, notify your card issuers immediately.• If you don’t receive your billing statement, notify the

company immediately.

Protecting Online PurchasesProtecting Online Purchases• Use a secure browser• Keep records of your online transactions• Review your monthly bank and credit card

statements• Read the policies of web sites you visit• Keep your personal information private• Give payment information only to businesses

you know and trust• Never give your password to anyone online• Do not download files sent to you by strangers

or click on hyperlinks from people you don’t know

Open-End CreditOpen-End Credit

• Credit cards

• Travel and entertainment cards

• Home equity loans

Can You Afford a Loan?Can You Afford a Loan?

• Debt Payments-to-Income Ratio– Experts suggest you should spend no more

than 20% of your net income on debt payments but 15% is better.

• Debt-to-Equity Ratio– Divide your total liabilities by your net worth.

If it is about 1, you have reached the upper limit of debt obligations.

Credit BureausCredit Bureaus

• Experian

• TransUnion

• Equifax

• Check your credit report annually—it is free!

• Reported for seven years (ten years if you have declared bankruptcy)

Five C’s of CreditFive C’s of Credit• Character—will you repay the loan?• Capacity—can you repay the loan?• Capital—what are your assets and net

worth?• Collateral—what if you don’t repay the

loan?• Conditions—what are the general

economic conditions that could affect your ability to repay the loan?

Credit ScoreCredit Score

• FICO is a number generally between 350 and 850 that rates how risky a borrower is

• VantageScore (new) features a common score range of 501-990 and is the same for all three major credit bureaus

Dealing with a Stolen IdentityDealing with a Stolen Identity

• 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 fraudulently

• File a police report

Consumer Credit Protection Consumer Credit Protection LawsLaws

• Truth in Lending and Consumer Leasing Acts-creditors must disclose credit information

• Equal Credit Opportunity Act (ECOA)-prohibits discrimination

• Fair Credit Billing Act-creditors must correct billing errors

• Fair Credit Reporting Act-credit bureaus and creditors must correct errors in your credit file

• Consumer Credit Report Reform Act-places the burden of proof for accurate credit information on the credit bureau rather than on you