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2 What is Credit? Credit is the ability to borrow money with a promise of future payment.

3 Why borrow? Goals - car, appliances, furniture, etc Home Education Health

4 Plan your Borrowing When to borrow Is it important that I buy the goods or services now? Do I have to borrow to buy? Can I afford to make the payments? Will I be able to buy other products/services that I want if I borrow to buy this product?

5 Plan your Borrowing How much to borrow First rule of borrowing is go buy responsibly. 20/10 rule of thumb Total debt other than house loan should not exceed 20% Total payments excluding mortgage payments should not exceed 10% of monthly income.

6 How much can you afford? Using the rule Never borrow more than 20% of your yearly net income If you earn \$400 a month after taxes, then your net yearly income is: 12 x \$400 = \$4,800 Calculate 20% of your annual net income to find your safe debt load \$4,800 x 20% = \$960 You should never have more than \$960 of debt outstanding

7 How much can you afford? Using the rule Never allow payments to exceed 10% of your monthly net income If you earn \$400 a month after taxes Calculate 10% of your monthly net income to find your safe payment load \$400 x 10% = \$40 You should never owe more than \$40 of month in payments

8 How much can they safely carry? Most people can afford a certain amount of credit and stay within a safe budget. This amount is called a safe debt load. The following exercises will give you practice determining safe debt loads based on various incomes and fixed expenses.

9 How much can they safely carry? David has a monthly net income of \$1,360. His fixed monthly expenses consist of a rent payment of \$450. He is paying off a student loan of \$116 per month. David would like buy a new television set using a credit card. What is the largest monthly payment David can afford for the television set so that his credit card payments and student loan keep him within a safe debt load of 10%?

10 How much can they safely carry? David can afford \$20 a month. \$1,360 x 10% = \$136 (his monthly debt load) \$136 - \$116 = \$20 (debt load existing debt)

11 How much can they safely carry? Marsha and Michael have a combined monthly net income of \$3,500. Their fixed monthly expenses consist of %675 for rent. They also have an outstanding student load balance of \$6,000 and a balance of \$1,000 for the stereo they bought last month. How much more debt can they take on and still be within a safe debt load?

12 How much can they safely carry? Marsha and Michael can afford \$1,400 \$3,500 x 12 = \$42,000 \$42,000 x 20% = \$8,400 \$8,400 - \$6,000 - \$1,000 = \$1,400

13 Advantages of Credit Advantages Able to buy needed items now Don t have to carry cash Creates a record of purchases More convenient than writing checks Consolidates bills into one payment

14 Disadvantages of Credit Disadvantages Interest (higher cost of items) May require additional fees Financial difficulties may arise if one loses track of how much has been spent each month Increased impulse buying may occur

15 Your Creditworthiness Credit worthiness Measure of your reliability to repay a loan Creditworthiness determined by three C s Character Capacity Capital

16 The Three C s Character will you repay the debt? From your credit history, does it look like you possess the honesty and reliability to pay credit debts? Have you used credit before? Do you pay your bills on time? Can you provide character references? How long have you lived at your present address? How long have you been at your present job?

17 The Three C s Capacity can you repay the debt? Have you been working regularly in an occupation that is likely to provide enough income to support your credit use? Do you have a steady job? What is your salary? How many other loan payments do you have? What are your current living expenses? What are your current debts? How many dependents do you have?

18 The Three C s Capital what if you don t repay the debt? Do you have any valuable assets such as real estate, savings, or investments that could be used to repay credit debts if income is unavailable? What property do you own that can secure the loan? Do you have a savings account? Do you have investments to use as collateral?

19 Loan Application Insert sample loan application from page 337 in textbook Economic Education for Consumers

20 Two Basic Forms of Consumer Borrowing 1. LOANS Get borrowed amount all at once, then need to make payments to lenders with interest 2. CREDIT CARD ACCOUNTS Purchase amount added to your account, then must pay at least required minimum each month

21 It COSTS to Use Credit 1. Interest - Future repayment usually includes interest. 2. Opportunity cost - what you could be spending if you weren t repaying a loan plus interest!

22 It COSTS to Use Credit Cards Interest Opportunity cost Annual fees Grace period Credit limit Penalities Minimum payments

23 Types of Consumer Borrowing Secured loan is backed by collateral (something of value) Unsecured loan is not backed by any collateral

24 Types of Credit Single-payment credit Paid in a single payment Interest is not usually charged Examples: phone bills, utilities and medical bills Installment credit Paid in 2 or more regularly scheduled payments of a set amount Interest is included Examples: appliances, cars and etc Revolving credit Credit limit Regular scheduled minimum payments Continued use like a credit card

25 Sources of Loans Banks Finance companies Life insurance companies Credit card cash advances Pawnbrokers Rent-to-Own

26 Say What? For example: You want to use credit to buy an outfit for \$100. \$100 X.15 interest = \$15 \$100 + \$15 = \$115 Therefore, you are really giving up \$115 worth of future spending for the ability to spend \$100 now. The opportunity cost of of using credit to buy this outfit is whatever you would have bought for \$115 one year later.

27 APR When you borrow money, you eventually have to pay the lender something if you carry a balance. That something is APR. Annual Percentage Rate

28 More about APR Ted owes \$720 on his credit card, which has an interest rate of 18% per year. What is Ted s monthly interest rate? Take yearly interest rate and divide by 12 (for 12 months)..18 / 12 =.015 (1.5% per month)

29 More about APR Now, Ted decides to pay his minimum payment of \$20 on his \$720 balance. How much of his payment will be interest? Take amount owed and multiply it by monthly interest rate. \$720 *.015 = \$10.80 (\$10.80 of his \$20 payment is going toward interest)

30 More about APR Now, how much will this \$20 payment reduce Ted s debt? Take the minimum payment and subtract the monthly interest total. \$20 - \$10.80 = \$9.20 (Ted s debt of \$720 is only reduced by \$9.20)

31 How long before Ted pays his debt? At this rate, it will take Ted over 5 years to pay off the original debt of \$720! Always pay more than the minimum balance, or try to pay off your balance each month to avoid paying more than you need to.

32 Your Responsibilities Borrow only what you can repay Read and understand the credit contract Pay debts promptly Notify creditor if you cannot meet payments Report lost or stolen credit cards promptly Never give your card number over the phone unless you initiated the call or are certain of the caller s identity Keep accurate records Pay more than the minimum

33 Your Rights Truth in Lending Act (1968) Ensures consumers are fully informed about cost and conditions of borrowing including finance charges and APR. Fair Credit Reporting Act (1971) Protects the privacy and accuracy of information in a credit check

34 Your Rights Fair Credit Billing Act (1974) Sets up a procedure for the quick correction of mistakes that appear on credit card accounts Equal Credit Opportunity Act (1975/1977) Prohibits discrimination in giving credit on the basis of sex, race, color, religion, national origin, marital status, age, or receipt of public assistance

35 Your Rights Fair Debt Collections Practices Act (1977) Prevents abuse by professional debt collectors, and applies to anyone employed to collect debts owed to others; does not apply to banks or other businesses collecting their own accounts Consumer Credit Reporting Reform Act (1996) Makes it easier for consumers to correct mistakes in their credit reports.

36 Rights Another one President Bush Signs the Fair and Accurate Credit Transactions Act of 2003 Improving the quality of credit information, and protecting consumers against identity theft Gives every consumer the right to their credit report free of charge every year Helping prevent identity theft before it occurs by requiring merchants to leave all but the last five digits of a credit card number off store receipts

37 Fair and Accurate Credit Transactions Act of 2003 Creating a national system of fraud detection to make identity thieves more likely to be caught. Previously, victims would have to make phone calls to all of their credit card companies and three major credit rating agencies to alert them to the crime. Now consumers will only need to make one call to receive advice, set off a nationwide fraud alert, and protect their credit standing.

38 Current Credit Card Legislation of 2009 Contains relief from penalty fees and certain interest rate spikes (highlights below) Restricts raising interest rates on previous purchases (yes-retroactively raising rates) Loosens how late payments are determined Credit card gift cards are valid for at least 5 years Students under 21 need parent s permission Consumer can chose if they want to go over the credit limit and incur a fee

39 Building a Credit History Establish a steady work record Pay all bills promptly Open a checking account and don t bounce checks Open a savings account and make regular deposits Apply for a local store credit card and make regular monthly payments or pay off Apply for a small loan using your savings account as collateral

40 Read before you sign Some things to watch out for Acceleration clause Balloon payment Early payoff penalty

41 Consumer Identity Fraud Criminals need your social security number, driver license or credit card number to open charge accounts in your name. Protect yourself by guarding your personal documents. Identity theft can ruin your credit until it is resolved.

42 Help for Credit Problems Debt consolidation loan combines smaller loans together typically at a lower interest rate and under one payment. Credit Counseling Services are available to assist consumers in creating a budget and paying off their bills. Bankruptcy is a last resort when a consumer s debt is so out of control that they will not be able to repay their debts.

43 A Credit Report

44 Manner of payment codes

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