Unit 4 Good Debt… Bad Debt…

Using Credit Wisely

What do we know about credit???

What is credit?

How does a credit card work?

Who has a credit card?

What can

happen if you

make a

payment late or

go over your

credit limit?

What is a credit limit?

What is a credit

score?

When can you apply for a credit card?

Credit –

• Buy now… Pay later!

What’s the catch???

amount of money loaned to you with the expectation that it will be paid back later

Interest• Amount you pay to use someone else’s money• Buy now, then pay for it over a period of time

with interest– Higher interest rate = Higher total amount – When you use credit to buy something you end up

paying more

Interest can sneak up on you…

• If you pay your full balance off every month there will be no interest added

• If you just make the minimum payment every month…

– Takes longer to pay off balance– You will end up paying a lot more money – Example: Interest

Why people use credit?• To buy something you couldn’t afford if you had

to pay for it all at onceExamples: - car

- college tuition- vacation

• Convenience- They have the money but don’t want to carry cash

• Shopping online

• Immediate Satisfaction– Regardless if they can afford it or not

Not a smart way to use

credit!!!

Common Types of Credit

1. Credit Card

2. Installment Loan

3. Student Loan

4. Mortgage

1. Credit Card

Institution: - banks, credit unions, stores, and gas stations

Features: - Some can be used just about anywhere, others only at a

specific place- No payoff deadline- Monthly minimum payments may vary… based on the

balance - Usually have highest interest rate out of these 4 types

of credit

Examples:

2. Installment Loan

Institution: - banks, credit unions, auto dealers, and other financial institutions

Features: - Used for large purchases

*cars and appliances- Loan term can vary from a few months to many years- Monthly payments usually set for life of loan - Usually lower interest rates than credit cards

3. Student Loan

Institution: - banks, credit unions, and the federal government

Features: - Used for college tuition and other expenses - Some loans let you wait to make payments until after

graduation- Loan term usually up to 10 years- Monthly payment amounts are usually set annually - Usually lower interest rate than installment loans

*May provide an income tax break on the interest paid

• The truth about student loans

Student Loan Activity in Moodle!!!

4.Mortgage

Institution: - banks and credit unions

Features: - Used specifically for a loan to purchase a home- Usually repaid over 15-30 years- Monthly payments may be set for the life of the loan - Usually lower interest rate than installment loans

*May provide an income tax break on the interest paid

Cost of Using Credit

Using credit comes with a price…

• Biggest part of the price is the interest rate

Advertisers: “Buy it now for only $19 a month!”

• Doesn’t tell you what you really are paying?!?!

Read the fine print of credit card or loan application!

Annual Percentage Rate-APR

• The cost of the loan per year as a percentage of the amount borrowed

• Best credit feature to compare

• Law requires exact same APR calculations

• Beware of “teaser rates”

REVIEW!

What is a Mortgage? Installment loan?

What is the biggest part of the cost of using credit?

What is the best credit feature to compare?

What other factors should you look at when choosing to use credit?

Other factors connected to cost of using credit…

What you need to look for… • Annual fee • Credit limit• Finance charge• Origination fee• Loan term• Grace period

Annual Fee

• Yearly charge you pay to use credit

• Usually charged by credit card companies

Credit Limit

• Maximum amount of credit a lender will give to customer

• $500• $1,000• $10,000• $25,000

• Can increase over time

Finance Charge

• Actual dollar cost of using credit

• Extra price you pay for the privilege of borrowing money

Origination Fee

• Charge for setting up a loan

• Usually associated with home loans

Loan Term

• Length of time you have to pay off loan

• Applied to installment, student, and mortgage loans

• Longer loan term = Lower monthly payment

• Cost increases because of interest

Grace Period

• Length of time before interest kicks in

• If you pay off your balance each month, you will not pay any interest

• Look for credit card with a grace period of 25 days or more

Everyone Makes Mistakes…

• Payment after due date• Spend more than credit limit

What are the consequences????

Consequences • Over-The-Limit Fee– Spending more than your credit limit

• Late Fee – Making payment after the due date – Know how much late fee is and when it will be

charged

May NOT be the only penalty for a late payment!

• Universal Default Clause – Hike up your interest rate for one late payment

– Even if it’s to a different creditor – Could be for a very low and minor payment

REVIEW• What is a grace period?

• What type of loan usually has a origination fee?

• What is the Universal Default Clause?

Credit: The Good and Bad

• Before you decide whether credit is the best choice for you

• Extremely important to know all the rewards and risks

Benefits1. Convenience2. Protection 3. Emergencies4. Opportunity to Build Credit5. Quicker Gratification6. Special Offers 7. Bonuses

Convenience

• Safer than carrying around large amounts of cash

• Easier for travel expenses

• Used to buy items on internet

ProtectionCredit Card:• Easier to get a refund

• Some cards offer buyer protection

– Type of insurance for:• Damaged items• Mistaken charges on

account

Emergencies

• Always have a way to pay for sudden expenses

• Examples:– Car breaks down – Injuries

Opportunity to Build Credit

• Best way to build credit history

• Must be responsible with credit card

• Makes it easier to get more credit in the future

Quicker Gratification

• Allows you to buy expensive items– Car– House

*Only way some people can afford these items

Special Offers• Decrease short-term

costs of credit cards

• Examples: – Reduced interest rate– No payments until next

year

*Be careful when these deals expire!!!

BONUSES• Offer bonus points:– Frequent-flyer miles

– Cash rebates for every dollar you spend

*These perks may come with higher interest rates

Rewards

Potential Risks1. Interest

2. Overspending

3. Debt

4. Identity Theft

INTEREST

• Amount you pay for using credit

• Makes item more expensive

OVERSPENDING• Use credit to live

beyond their means

• Buying items they can’t afford

• Time goes on, amount grows, harder to pay off balance

DEBT• Entire amount of money

you owe to your lenders

• Lenders have legal claims against your future income

• Too much debt… can destroy financial plan and future

Identity Theft • Personal info is used

without your permission

• Frauds/Crimes

• Be careful giving out information

Moodle Activity

• Identity Theft

• Answer questions in the discussion topic in Moodle!

Review…

• 4 potential risk we looked at

• What is overspending

• Identity theft

Are you worthy????

When you apply for a credit card or a loan you will usually need:

– Social security number– Driver’s license number– Date of birth– Address and phone number – Name of employer– Monthly income– Other debts– Monthly rent or mortgage

What Lenders Look For…

• Once you apply, lender decides if your creditworthy

• They decide if and how much to lend you

• What all lenders look for is referred to as

THE 4 C’s

THE 4 C’s OF CREDIT

1. Collateral

2. Capital

3. Capacity

4. Character

1. Collateral• An asset of value lenders can take from you if

you don’t repay the loan

• Typically for home mortgage or car loan

• “Secured Loan”

Borrows money for house…

Loans money for house.

= Collateral

2. Capital• Personal items of value

• Can be taken away and sold to repay loan

Examples:

House Investments

3. Capacity• Lender’s main concern is whether you are able

to repay a loan• Key factors:– Income – Employment history

*Rising income and steady employment gives lenders confidence

*Lots of debt, lenders will question your ability to make payments

4. Character • Are you trustworthy?!?!

• Measure this by looking at your credit record

• History of paying bills on time shows you are responsible!

Review…• What do you usually need to apply for a loan

or credit card?

• What are the 4 C’s of Credit?

• What are the two key factors of capacity that lenders look at?

Applying for a Loan

Exercise 4E: Apply for a Loan

Page 48

Credit Report

• Record of your personal financial transactions– “Credit History”

• Tells lenders…• Any credit you have• Loan amounts you received• Credit card balances• Paid bills on time?

• Your credit report card for the past 7 to 10 years

Credit Score

• Number that reflects your creditworthiness based on 4 C’s

• Score changes over time

• FICO Scores

FICO• Public company that provides data and

decision making services including Credit Scoring

• Helps financial companies make decisions

• One of the most popular scoring systems– 90% of the larger banks use FICO– Scores: 300 – 850

Review…

• What does FICO stand for?

• What are some things on a application for a loan?

• What is a good credit score?

• How far back does your credit score go?

FREE Credit Reports

• Free Credit Report Commercials

• NOT free!

• Website to get a credit report that truly is free!

• The Real Free Credit Report Website

3 Reporting Agencies

1. Equifax

2. Experian

3. TransUnion

Building Good Credit History

Takes discipline…• Always pay bills on time– Best way to show creditors you are responsible with

your money

• Make regular deposits into savings account– Lenders like to see a consistent savings pattern

• Be choosy about credit cards and loans–Only ones you really need and keep them for a long

time

• Better to have low credit card balance and pay it off rather than no balance

Hurting Credit History and Score

• Making late payments

• Writing checks when you don’t have enough money to cover

• A lot of credit cards and loans

• High balances on credit cards and loans

• Changing credit cards frequently

Monitoring Your Credit Report

• Law requires credit bureaus to provide information that is:

– Correct– Complete – Confidential

• You have the right to see everything• Very important to regularly review your credit

report» Look for any errors or fraudulent charges » Entitled for free credit report once a year» NO EXCUSES!

Wrong Credit ReportIf you find any mistakes or inaccurate

information on your report…1. Don’t Panic! 2. Contact credit reporting agency3. Ask representative to investigate

By Law: • Agency must investigate the questionable item• Correct or delete anything that is wrong

Other Options…If that doesn’t work…

» Attach a short statement to your report » Describe the situation » Facts that support your claim

• Credit bureaus must delete unfavorable information after 7 years

• Must remove any bankruptcy after 10 years

Will not be on your report permanently!

How You Can Get Credit• Tough to get credit while your in school• Some options you may take:–Ask parent or trusted adult to co-sign

» Equally responsible for the debt» Legally and financially

–Ask the place where you have a checking or savings account

» Already have a track record»May be more likely to get approved

–Apply for a store credit card»Easier than the major credit cards

–Apply for a “secured credit card”»Deposit money into account»Make charges against that amount

–Renting a place with friends… get one utility bill in your name

»Pay bill on time

70-20-10 Rule A great way to keep up with your debt!How it is broken down:• Spend 70% of income on living

expenses- Rent, food, gasoline

• Save or invest 20% of your income

- Financial goals- Emergency expenses•Spend 10% on debt payments

- Credit cards- Car loans- Students loans

Review…

• What should 70% of your income be used for in the 70-20-10 Rule?

• 20% of your income?

• 10% of your income?

• What are some ways you can try to get credit when you are a student?

The Dangers of Debt

• Debt can take a toll on youDangers:- Harder to achieve financial

goals - Stress about your bills can

affect your health - Not having money for

medical expenses- Can affect relationships

negatively - People try to hide financial

problems

Reducing Amount of Debt

• Stop using the plastic • Live entirely on cash • Make commitment to pay your debt• Find out how bad it is and how much you

really owe• Come up with a repayment plan • Stick with plan!

Strategies toStop Using Credit

Bankruptcy

• Last resort when someone gets too far in debt

Bankruptcy- legal process to get out of debt when you can’t make payments

2 Types: -Chapter 7-Chapter 13

2 Types of Bankruptcy • Chapter 7– Allows you to erase most of your debt– Must undergo financial counselingTo apply:– Must be unemployed– Very low income

• Chapter 13– Allows you to repay your debts over a period of

time– Usually no more than 5 years– Court oversees repayment plan

Bankruptcy Facts…

• NOT all debts will be erased • Common types that are not erased

» Student loans» Child support» Alimony» Fines for crimes

• Now much harder to declare for Chapter 7 • Very serious action• Can stay on credit record up to 10 years

• Makes it much harder and more expensive to buy a house or get a credit card

• Very costly to everyone » Lenders raise rates to make up their loss

Why people file…• Result of irresponsible borrowing • “Clean Slate” for people who had an

unavoidable and unexpected event take place

» Chance to rebuild life

• Bankruptcy

Law and Order of Debt

• Lenders may take legal action against you • Lenders must respect the rights you have• Must be told specific reason if you get turned

down for loan or credit card

• LAWS:

- Truth in Lending Act- Fair Debt Collection Practices Act

Truth in Lending ActLenders must:

• Tell you true interest rate and total finance charge before you sign credit application

• Be truthful

• Not mislead you with advertisements

Fair Debt Collection Practices Act

• Protects you from the harassment of creditors• Debt collector is NOT allowed to:

• Use abusive language• Call at unreasonable hours /excessive number• Threaten to notify employer or friends• Try to collect more than you owe• Send you misleading letters

*Can sue if collectors act in this way

REVIEW!!!!!

• Test questions…–4 Multiple Choice–4 Fill in the Blank–2 Short Answer/Essay

REVIEW GAME!• JEOPARDY

• https://jeopardylabs.com/play/unit-4898