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
5-12
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
5-13
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
5-22
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