Credit Management. Unit CHAPTERS. 16 Credit in America. 17 Credit Records and Laws. 18 Responsibilities and Costs of Credit. 19 Problems with Credit

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1 Uit 4 Credit Maagemet CHAPTERS 16 Credit i America 17 Credit Records ad Laws 18 Resposibilities ad Costs of Credit 19 Problems with Credit CASE: Suze Orma PROJECT: Maagig Credit ad Debt 354 Copyright 2010 Cegage Learig, Ic. All Rights Reserved. May ot be copied, scaed, or duplicated, i whole or i part.

2 Baaa Stock/Jupiter Images Uit 4 begis with a geeral itroductio to what credit is ad why it is importat to you as a cosumer i the America ecoomy. Credit has may advatages for those who use it wisely, but it ca also be a trap. I Chapter 17, you will lear about credit bureaus, ratigs, ad reports, ad your rights ad resposibilities as a credit user. You will also discover the may credit laws that have bee eacted to protect cosumers. I Chapter 18, you will study the resposibilities associated with cosumer credit alog with the high costs of credit. You will also explore ways to miimize those costs ad maage credit wisely. Fially, i Chapter 19, you will lear about credit problems ad ways to avoid them, both whe gettig started ad as a fial resort. 355 Copyright 2010 Cegage Learig, Ic. All Rights Reserved. May ot be copied, scaed, or duplicated, i whole or i part.

3 Chapter 16 Credit i America 16.1 Credit: What ad Why 16.2 Types ad Sources of Credit Cosider THIS It was two days before the sprig festival, ad Jasmie still had t purchased the supplies she eeded i order to make her costume. She had bee savig her moey for four moths ad was still $50 short of her goal. I ll just have to borrow the rest, she told her frieds. Otherwise, I wo t be able to get the costume completed ad that meas I ll have let dow the team. I really wated to pay cash ad ot go ito debt, but i this case, it ca t be helped. Credit is serious because it s moey I ll have to pay back i the future. I probably should have used credit a little sooer. Now I ll have to work all ight i order to get this costume completed. I leared a importat lesso. There s a time ad a place for usig credit. 356 Uit 4 Credit Maagemet

4 16.1 Credit: What ad Why GOALS Discuss the history of credit ad the role of credit today. Explai the advatages ad disadvatages of usig credit. TERMS credit, p. 357 debtor, p. 358 creditor, p. 358 capital, p. 358 collateral, p. 359 fiace charge, p. 359 lie of credit, p. 359 deferred billig, p. 360 THE NEED FOR CREDIT Whe you borrow moey or use a charge accout to pay for purchases, you are takig advatage of the most commoly used method of purchase i the Uited States: credit. Over 80 percet of all U.S. purchases are made with credit rather tha cash. Credit is the use of someoe else s moey, borrowed ow with the agreemet to pay it back later. The eed for credit arose i the Uited States whe the coutry grew from a barterig ad tradig society to a currecy exchage ecoomy. Durig the 1800s, the Idustrial Revolutio started a ew ecoomy. Items were maufactured i mass for sale to others. People o loger produced everythig exclusively for their ow use. With their earigs, they were able to buy the thigs they previously had to make for themselves. Soo the eed developed for sources of credit to help families meet their fiacial eeds. Cosumer credit had begu. EARLY FORMS OF CREDIT Oe of the earliest forms of credit was the accout at the geeral store. Wage earers or farmers would pick up supplies ad put the amout due o accout. Whe the borrowers received a paycheck or sold a harvested crop, they would pay their accout i full, ad the chargig process would begi agai. The store rarely charged iterest. Credit was a coveiece that storeowers provided for customers they kew well ad trusted. The customers paid off their accouts as soo as they could. As the use of credit expaded, idividual purchasig power also icreased. Because credit icreased people s ability to buy more goods ad services, the America ecoomy grew at a healthy pace. People bought luxuries as well as ecessities with the help of credit, ad the average America s stadard of livig rose. Both busiesses ad cosumers beefited from credit. Betwee 1920 ad 1990, buyig o credit became the America way of life. No loger was credit saved for emergecies. May differet forms of credit developed to meet chagig cosumer eeds ad wats. I the 1990s, record umbers of people declared bakruptcy. Overuse of credit cards was oe of the mai reasos. With the ecoomic prosperity of the decade, Chapter 16 Credit i America 357

5 people were optimistic ad willig to sped their icome well ito the future. But this overspedig brought eormous credit debt. CREDIT TODAY Credit today is a way of life. Merchats ecourage cosumers to use credit to buy all kids of goods ad services. Baks, stores, ad credit card compaies offer credit i the form of cards, loas, ad lies of credit. Both short-term ad log-term fiacig is available. Some trasactios are difficult to make without a credit card, such as reservig a hotel room, retig a car, or makig a olie purchase. It s o loger How How did the use of credit get started i this coutry? ca I get credit? but How ca I wisely maage credit? Millios of Americas are overexteded with credit. They have adopted a lifestyle that is depedet o the use of credit to make eds meet. The average America has more tha $5,000 i credit card debt. Some people are livig beyod their meas ad are abusig credit. They are barely able to make the miimum paymet o outstadig debt ad resort to tactics such as usig oe credit card to pay aother credit card. This techique of robbig Peter to pay Paul results i ever-icreasig credit card debt. May people have o savigs, o emergecy fud, ad o way to support themselves if they should lose their job or experiece a fiacial dowtur. These people ofte tur to credit. For them, credit becomes a burde, a eemy, ad somethig to avoid. 358 Uit 4 Credit Maagemet THE USE OF CREDIT A debtor is a perso who borrows moey from others. This moey, called debt, must be repaid. A creditor is a perso or busiess that loas moey to others. Creditors charge moey for this service i the form of iterest ad fees. A debtor must be qualified to receive credit. Qualifyig for Credit Digital Visio/Getty Images To qualify for credit, you must have the ability to repay the loa. Qualificatios are based o three thigs: icome, fiacial positio, ad collateral. Icome You eed to have a job ad ear a icome i order to make loa paymets. Icome ca also come from other sources, such as iterest, divideds, alimoy, royalties, ad so o. Icome represets cash iflow. Whe your earigs exceed your expeses, you have the capacity to take o debt. Fiacial Positio Your fiacial positio is based o capital. Capital is the value of property you possess (such as bak accouts, ivestmets, real estate, ad other assets) after deductig your debts. Havig capital tells the creditor that you have accumulated assets, which idicates resposibility. Your debt represets cash outflow ad will be compared to your cash iflow (icome).

6 Collateral To borrow large amouts of moey, creditors ofte wat more tha just your promise to repay; they wat collateral. Collateral is property pledged to assure repaymet of a loa. If you do ot make your loa paymets, the creditor ca seize the pledged property. For example, whe you buy a car o credit, the car serves as collateral. If you do ot repay the loa, the car ca be repossessed. The ledig istitutio ca take possessio of the car ad sell it to repay the loa. Makig Paymets Oce you have completed a credit purchase, you owe moey to the creditor. The pricipal (amout borrowed) plus iterest for the time you have the loa is called the balace due. You geerally will make mothly paymets util you repay the balace due i full. The paymets iclude both pricipal ad iterest, ad with each paymet, the amout you owe is reduced. The fiace charge is the total dollar amout of all iterest ad fees you pay for the use of credit. It is the price you pay for the privilege of usig someoe else s moey to buy goods ad services ow. Credit card or store accout statemets usually specify a miimum paymet. This is the least amout you may pay that moth uder your credit agreemet, though you may pay more to further reduce your debt. All credit paymets are due by a specific due date. Typically, you will be give 10 to 25 days from the date you receive a bill i which to pay. If you do ot pay withi the time allowed, you are likely to be charged a late fee, which is added to the balace due. I additio, your iterest rate may go up as a result of late paymets. For particularly expesive purchases, you may have to sig a loa agreemet. You agree to make regular paymets for a set period of time. At the ed of that time, you will have repaid the etire debt. This is a type of secured loa, because the goods you purchased with the loa serve as collateral for the moey loaed. ADVANTAGES AND DISADVANTAGES OF CREDIT Some people use credit extesively while others pay cash as much as possible. May people get ito trouble each year by ot usig credit carefully. Credit ca have several advatages, but you must ot lose sight of its disadvatages. ADVANTAGES OF CREDIT Used correctly, credit ca greatly expad your purchasig power ad raise your stadard of livig. For example, credit allows you to purchase expesive items ow that you do ot curretly have eough cash to buy, ad the pay for them over time. As a result, you ca ejoy items like furiture ad a car earlier i your life. Makig your paymets o time helps you establish a good credit record that will help you get loas i the future. Credit ca also provide emergecy fuds. A sudde eed for cash ca be solved by a lie of credit, which is a preestablished amout that ca be borrowed o demad with o collateral. To establish a lie of credit, you fill out the applicatio with a leder. Leders examie your icome ad fiacial positio ad approve a amout that they believe you ca repay. With a lie of credit, moey is always available should you eed it. Chapter 16 Credit i America 359

7 *Gajeder* D:/Temp_Dailyproductio/Rya_120640/z_productio/z_3B2_3D_files/rya_ _ch16.3d, 19/12/08/15:17:38, 15:17, page: 360 GLOBAL View Traditioally, cosumers i Thailad preferred to use cash whe purchasig goods ad services. This coservative attitude toward cashless trasactios hidered cosumer credit expasio. As of 2002, it was estimated that oly 10 percet of the Thai populatio had a credit card. Major card issuers the bega aggressive marketig campaigs ad promotioal offers to etice ew customers. With extesive icetives for cosumers ad a low miimum icome threshold for credit card eligibility, may card issuers witessed cosiderable growth i their customer umbers. Today may cosumers i Thailad rely o credit. THINK CRITICALLY What cosumer beefits as well as problems might result from the boom i credit card use i Thailad? How ca cosumers avoid the disadvatages of credit as it grows i popularity? 360 Uit 4 Credit Maagemet Credit is coveiet. Credit customers ofte get better service. If there is a problem with a purchase, cardholders ca withhold paymet util it is resolved. Regular charge customers of a departmet store, for example, receive advace otices of sales ad special offers ot available to the geeral public, such as deferred billig. Deferred billig is a service available to charge customers whereby purchases are ot billed to the customer util much later tha the stadard billig time. For example, merchadise purchased i October might ot be billed util Jauary, with o paymet due util February. Cosumers also have more leverage whe usig credit rather tha cash or other methods of purchase. With credit, the moey remais to be paid, givig the cosumer more power i the evet of a dispute. With a debit card, check, or cash, moey has already bee paid for the purchase, which may make it more difficult to settle a dispute ad get a refud. Fially, carryig a credit card is safer tha carryig large sums of cash. DISADVANTAGES OF CREDIT Use of credit also has disadvatages. For istace, credit purchases may cost more tha cash purchases. Merchats must pay fees, which are usually a percetage of credit card sales, to credit card compaies, ad they ofte pass this cost o to customers i the form of higher prices. I additio, a item purchased o credit ad paid for over time costs more because of the fiace charges. A fiace charge of 18 percet a year is 1½ percet a moth. O a $1,000 balace, the fiace charge would be $15 a moth. The larger your balace ad the loger you take to pay it off, the greater the fiace charges. Whe you use credit, you tie up future icome. You have committed to makig paymets. Durig that time, those fuds are ot available to you for buyig other products you may eed. This situatio ca put a strai o your budget. Buyig o credit ca lead to overspedig. Because o cash leaves your bak accout, you may ot realize how much moey you are really spedig. You ca get ito trouble with credit if you buy more tha you ca pay back comfortably. At the ed of the moth, whe the bills come i, you may be surprised at how much you have really spet. Usig credit too much ca result i debts so high that you ca ever pay them off, ad it may eve lead to bakruptcy.

8 Plaig a Career i... Loa Processig Nearly 90 percet of all loa processors work i baks, savigs baks, credit uios, ad other fiacial istitutios. For most people, takig out a loa is the oly way they ca pay for a house, a car, or a college educatio. Busiesses also deped o credit to start their compaies, buy ivetory, ad expad. Loa processors guide their cliets through the process of applyig, qualifyig, ad executig loa documets. This process ivolves gettig credit reports ad verifyig other iformatio, such as employmet history, capital, ad collateral. Loa officers must also be sure that loa applicats are able to meet the requiremets of the uderwriter the compay that provides the loa fudig. Loa processors ofte specialize i cosumer, commercial, or mortgage loas. They ear commissios based o the loas that are closed (completed). Employmet Outlook l A average rate of employmet growth is expected. Job Titles l l l l Loa cosultat Loa processor Loa collectio officer Mortgage loa specialist Needed Skills l A bachelor s degree i fiace, ecoomics, or a related field is desirable. l l Traiig ad licesig requiremets vary by state. Good commuicatio skills ad high motivatio are eeded. What's it like to work i... Loa Processig Blake works as a cosumer ledig specialist for a credit uio. He helps customers obtai loas for cars, boats, ad major appliaces. Blake works with customers to help them obtai the fiacig optio that best meets their eeds. Each day, Blake keeps up with the latest fiacial market ews. He kows whe iterest rates are risig or fallig. He kows the best rates he ca offer his customers ad what it takes to qualify for them. Whe customers ask for his assistace, he must be able to give them good estimates of what a loa will cost them ad how log it will take to process ad close o the loa. Blake s office is comfortable ad complete with all he eeds to facilitate the loa process, icludig a high-speed Iteret coectio. What About You? Would you like workig with people of various backgrouds to help them obtai fiacig so that they ca meet their goals? Do you like advisig people to esure they make kowledgeable decisios? Is a career as a loa processor right for you? Chapter 16 Credit i America 361

9 16.1 Assessmet KEY TERMS REVIEW Match the terms with the defiitios. 1. Property pledged to assure repaymet of a loa 2. A service whereby purchases are ot billed to the customer util much later 3. A perso who borrows moey 4. The value of property you possess 5. The total dollar amout of iterest ad fees you pay for the use of credit 6. A perso or busiess that loas moey to others a. capital b. collateral c. credit d. creditor e. debtor f. deferred billig g. fiace charge h. lie of credit 7. The use of someoe else s moey, borrowed ow with the agreemet to pay it back later 8. A preestablished amout that ca be borrowed o demad with o collateral CHECK YOUR UNDERSTANDING 9. Compare the use of credit today to its use i this coutry s early years. 10. Why is it importat to make credit card paymets o or before the due date? 362 Uit 4 Credit Maagemet APPLY YOUR KNOWLEDGE 11. Credit ca be very beeficial or it ca lead to fiacial rui. Discuss the advatages of credit i terms of purchasig power. Discuss how credit ca become a trap ad lead to overspedig ad other problems. THINK CRITICALLY 12. Idividuals ad families must make choices regardig credit how much credit, whe is it appropriate, ad so o. How does your family make use of credit? Do you see credit use i your family as a good or bad thig? Explai your aswer. 13. I the early part of our atio s history, we had o credit. People used cois or paper moey to make purchases. Today, we are movig toward a paperless ad cashless society. Would it be possible to live without ever usig cois, paper moey, or eve checks? Explai how people might live o credit aloe.

10 16.2 Types ad Sources of Credit GOALS List ad describe the types of credit available to cosumers. Describe ad compare sources of credit. TERMS ope-ed credit, p. 363 aual percetage rate (APR), p. 364 grace period, p. 364 closed-ed credit, p. 365 service credit, p. 366 fiace compay, p. 367 loa sharks, p. 368 usury law, p. 368 pawbroker (or pawshop), p. 368 TYPES OF CREDIT You will likely use several forms of credit throughout your life. Differet types of credit are desiged to meet differet cosumer eeds. OPEN-END CREDIT Credit card accouts are a ope-ed form of credit. Ope-ed credit is where a borrower ca use credit up to a stated limit. As paymets are made, the limit allows for more use of credit. The borrower usually has a choice of repayig the etire balace withi 10 to 25 days or repayig it over time while makig at least miimum paymets. Ope-ed credit ca be used agai ad agai, as log as the balace owed does ot exceed the credit limit. Charge Cards I a charge card agreemet, a cosumer promises to pay the full balace owed each moth. Travel ad etertaimet cards, such as America Express ad Dier s Club, are examples of charge cards. O all charges, the balace must be paid i full whe the bill is received. A 25-day billig period is commo. These cards are widely accepted atiowide ad overseas, usually have high or o credit limits, ad provide istat purchasig power. Baaa Stock/Jupiter Images Why would ayoe wat to use a charge card if the balace has to be paid i full whe billed? Chapter 16 Credit i America 363

11 Charge cards ofte iclude rewards or rebates based o purchases. These rewards ca be a percetage of dollar purchases or gift items of value. You beefit i two ways you do ot icur iterest charges, ad you receive a payback (such as a reward or rebate) based o card usage. Revolvig Accouts With a revolvig accout, the cosumer has the optio each moth of payig i full or makig paymets at least as high as the stated miimum. The miimum paymet is based o the amout of balace due. Most all-purpose credit cards, such as Visa, MasterCard, ad Discover, as well as store accouts, are revolvig credit agreemets. Retail store cards, such as departmet store ad gasolie compay cards, are also based o revolvig credit. May of these credit cards also offer rewards or rebate programs. Figure 16.1 shows a credit card statemet for a revolvig credit accout. Credit Card Agreemets Credit card compaies keep a record of trasactios made o your accout ad sed you a bill at the ed of each billig period. If you pay off the total each moth, you probably ca avoid a fiace charge. But remember a credit card is a form of borrowig ad usually ivolves iterest ad other charges. Before selectig a credit card, be sure to compare the followig terms that will affect the overall cost of the credit you will be usig. Aual Percetage Rate. The aual percetage rate (APR) is the cost of credit expressed as a yearly percetage. The Truth-i-Ledig law requires leders to iclude all loa costs i the APR. The APR must be disclosed to you whe you ope the accout ad must be oted o each mothly bill you receive. Usually the APR is a variable rate, ad it ca be very high o credit cards. Grace Period. The grace period is a timeframe withi which you may pay your curret balace i full ad icur o iterest charges. The grace period may be from 10 to 25 days, ad to qualify, you must have had o balace carried forward from the previous period. If there is o grace period specified, the card issuer will impose a iterest charge from the date you use your credit card. Aual Fees. May credit card issuers charge a aual fee. The fee ca rage from $15 to $35 or more, ad you must pay it whether or ot you use the card. Trasactio Fees. If you use a credit card check, pay by phoe, or request a balace trasfer, you may be charged a trasactio fee. These fees may ru from 3 to 10 percet of the trasactio amout. Pealty Fees. If you go over your credit limit or make your paymet late, you are likely to be charged a flat pealty fee, such as $30 to $50. Method of Calculatig the Fiace Charge. If you pay for purchases over time, it is importat to kow how the card issuer will calculate your fiace charge. The method used ca make a differece, sometimes a big differece, i how much fiace charge you will pay. Examples of these methods will be show i Chapter Uit 4 Credit Maagemet

12 FIGURE 16.1 Credit Card Statemet Accout Number Paymet Due Date New Balace Miimum Paymet Due /24/-- $ $20.00 Idicate Amout Paid 70 ADDRESS CHANGE ADDRESS CITY/STATE/ZIP ELIZABETH SANCHEZ 3410 MAIN STREET VANCOUVER WA (AREA CODE) PHONE Please retur this portio with your paymet. Detach here Accout Number To avoid additioal FINANCE CHARGES beig applied to your curret purchases o ext moth s statemet, pay the ew balace o this statemet i full by the due date. Page 1 of 1 Date Store Referece Descriptio Charges Paymets Or Credits 3/28 4/07 4/12 4/ SPECIAL CARE TREATMENT COSMETICS COSMETICS CLEANSERS, TONERS, MOISTURIZERS PAYMENT-THANK YOU FINANCE CHARGE ANNIVERSARY TO DATE PURCHASES $1, ANNIVERSARY TO DATE DIVIDEND $5.96 YOU WILL EARN A 1% DIVIDEND ON MCADAMS PURCHASES MADE PRIOR TO YOUR NEXT BILLING. DIVIDEND WILL BE CREDITED ON YOUR JUNE 19-- STATEMENT. Previous Balace New Charges Paymets Or Credits Average Daily Balace (For Fiace Charge Oly) FINANCE CHARGE (50 Miimum) Late Paymet Fee = New Balace Billig Date Paymet This Moth Due Date 04/24/-- 05/24/-- PERIODIC RATE 1.50 ANNUAL PERCENTAGE RATE Credit Lie 2,000 Amout Past Due Miimum Paymet Due Paymets or credits received after paymet due date will appear o ext moth s statemet. For customer service iquiries, please call AMOUNTS DUE HEREUNDER MAY BE ASSIGNED. NOTICE: SEE REVERSE SIDE FOR IMPORTANT INFORMATION. CLOSED-END CREDIT To pay for very expesive items, such as cars, furiture, or major appliaces, cosumers ofte use closed-ed credit. Closed-ed credit is a loa for a specific amout that must be repaid i full, icludig all fiace charges, by a stated due date. Ofte called istallmet credit, closed-ed agreemets do ot allow cotiuous borrowig or varyig paymet amouts. The borrower takes out a closed-ed loa for a particular amout ad the repays it with fixed paymets, or istallmets, that iclude pricipal ad iterest. The cotract for closed-ed credit tells, amog other thigs, the amout loaed, the total fiace charge, ad the amout of each paymet. Sometimes Chapter 16 Credit i America 365

13 a dow paymet is required. The product purchased with the loa becomes collateral to assure repaymet. SERVICE CREDIT Almost everyoe uses some type of service credit. Service credit ivolves providig a service for which you will pay later. Your telephoe ad utility services are provided for a moth i advace; the you are billed. May busiesses icludig doctors, lawyers, hospitals, dry cleaers, ad repair shops exted service credit. Terms are set by idividual busiesses. Some of these creditors do ot impose fiace charges o upaid accout balaces, but they do expect regular paymets to be made util the bill is paid i full. Others, such as utility ad telephoe compaies, expect paymet i full by a specified due date. However, they usually offer a budget pla as well, which allows you to average bills to get lower mothly paymets. SOURCES OF CREDIT The extesio of credit is a service to cosumers. It is ot free cosumers must pay for it, the same as they would pay for ay other purchased service. As with other thigs you buy, it pays to shop aroud to get the best deal. RETAIL STORES Retail stores sell goods directly to cosumers. Examples iclude departmet stores, discout stores, ad specialty stores. May retail stores offer their ow credit cards. These cards are accepted oly at the issuig store. Store credit customers ofte receive discouts, advace otice of sales, ad other privileges ot offered to cash customers or to customers usig bak credit cards. Most retail stores also accept credit cards issued by major credit card compaies. Acceptig credit cards helps retail stores attract customers, because people like to shop where they ca buy o credit. CREDIT CARD COMPANIES You may receive credit offers directly from credit card issuers, such as Visa, MasterCard, America Express, ad Discover. These all-purpose cards are geerally accepted atiowide ad eve iteratioally. You ca also get a allpurpose credit card through your fiacial istitutio or other orgaizatios. Affiity cards are credit cards sposored by professioal orgaizatios, college alumi associatios, ad some members of the travel idustry. Although these cards may show the ame of the orgaizatio, they are actually issued ad serviced by a credit card compay. The affiity card issuer usually doates a portio of the fees ad/or a percetage of the purchases made with the card to the sposorig orgaizatio. With a all-purpose credit card, you have a automatic lie of credit up to the limit of the card. Some cards eve allow you to take a cash advace, which is moey borrowed agaist your lie of credit. You ca access this moey at a teller machie, at a customer service desk i your bak, or by writig a access check agaist the credit card accout. Access checks, which are supplied by the 366 Uit 4 Credit Maagemet

14 credit card compay, look just like regular checks ad are treated by the credit card compay as a purchase. You must pay back the cash advace i the same way that you pay for credit card purchases. There is ofte a trasactio fee for this service i additio to iterest charges, which may or may ot be the same rate as purchases made with the card. Some compaies (like America Express) offer both charge cards, where the balace must be paid i full each moth, ad credit cards, where you are required to pay oly a portio ofthebalaceeachmoth.it s importatto read the terms carefully, so you are sure which type of accout you are gettig. BANKS AND CREDIT UNIONS I additio to offerig credit cards, commercial baks ad credit uios make closed-ed loas to idividuals ad compaies. They loa moey to cosumers for specific purchases, such as a home, car, or vacatio. Iterest o closed-ed loas teds to be lower tha o credit cards, usually because there is collateral used as security o the loas. Credit uios make loas to their members oly. Iterest rates are sometimes lower tha those charged by baks because credit uios are oprofit ad are orgaized for the beefit of members. Credit uios may be more willig to make loas because the members who are borrowig also have a stake i the success of the credit uio. FINANCE COMPANIES A fiace compay is a orgaizatio that makes high-risk cosumer loas. I may cases, people who are tured dow by baks ad credit uios ca get loas at fiace compaies. These high-risk loas are usually accompaied by high iterest rates. Fiace compaies are secod oly to baks i the volume of credit exteded. There are two types of fiace compaies: Cosumer fiace compaies Sales fiace compaies A cosumer fiace compay makes most of its loas to cosumers who are buyig durable goods. Durable goods are items expected to last several years, Photodisc/GettyImages What types of credit do baks ad credit uios offer? Chapter 16 Credit i America 367

15 such as automobiles, appliaces, ad electroics. Well-kow cosumer fiace compaies iclude HSBC. A sales fiace compay makes loas to cosumers through authorized represetatives, such as car dealerships. For example, GMAC Fiacial Services fiaces Geeral Motors automobile dealers ad their customers. Both types of fiace compaies borrow moey from baks ad led it to cosumers at higher rates. Fiace compaies take more risks tha baks. Therefore, they must be more careful to protect their loas. If you do ot make your paymets whe due, you ca expect a call from someoe at the fiace compay who will ask for a explaatio. The compay will stay i costat cotact with you util you make your paymets as agreed. You ca expect phoe calls, letters, ad eve persoal visits if you deviate eve slightly from the agreed-upo paymet schedule. High iterest rates are aother form of protectio for fiace compaies. The high icome from iterest makes up for the percetage of loas that become ucollectible. The growth of fiace compaies is partially the result of efforts to elimiate loa sharks, which are ulicesed leders who charge illegally high iterest rates. Nevertheless, it is difficult to elimiate such practices, which take advatage of the poorest members of society those who ca least afford to pay. A usury law is a state law that sets a maximum iterest rate that may be charged for cosumer loas. I states where usury laws exist, fiace compaies charge the maximum rate allowed. Where o usury laws exist, fiace compaies charge as much as the customer is willig to pay. Whe a emergecy or other extreme eed arises, cosumers feel forced to pay these higher rates to get the moey they eed. What do pawbrokers usually accept as collateral? Why? Digital Visio/Getty Images PAWNBROKERS A pawbroker (or pawshop) is a legal busiess that makes high-iterest loas based o the value of persoal possessios pledged as collateral. Possessios that are readily salable (such as gus, cameras, jewelry, radios, TVs, ad collector s cois) are usually acceptable collateral. The customer brigs i a item of value to be appraised. The pawbroker the makes a loa for cosiderably less tha the appraised value of the item. Some pawshops give oly 10 to 25 percet of the value of the article. Most give o more tha 50 or 60 percet. For example, if you have a rig appraised at $500, you could probably borrow betwee $50 ad $300 with the rig as collateral. You would tur the rig over to the pawbroker ad receive a receipt ad 368 Uit 4 Credit Maagemet

16 a certai legth of time from two weeks to six moths to redeem the rig by payig back the loa plus iterest. If you do ot pay back the loa ad claim the rig, the pawbroker will sell it i the pawshop ad keep the proceeds. Property acquired by a pawbroker is cosidered collateral for the loa because it is somethig of value that may be sold if you fail to pay off the loa. PRIVATE LENDERS Oe of the most commo sources of cash loas is the private leder. Private leders might iclude parets, other relatives, frieds, ad so o. Private leders may or may ot charge iterest or require collateral. Those who loa moey to frieds ad relatives should take special steps to be sure their iterests are protected. For example, rather tha loaig cash to someoe based o oral promises, they should get the agreemet i writig with a formally siged ote or other documet that will serve as evidece of the debt. OTHER SOURCES OF CREDIT Other sources of credit iclude the followig: Life isurace policies Borrowig agaist a deposit Borrowig agaist a asset Life isurace policies that build cash value ca be used to borrow moey. The loa does ot have to be repaid, but iterest will be charged. The loa amout will reduce the value of the policy. You will lear more about life isurace policies i Chapter 27. If you have a certificate of deposit (CD) or retiremet accout with a fiacial istitutio, you might be able to borrow moey agaist it. A loa agaist this type of accout usually has a good iterest rate because of the collateral providig safety. I additio, borrowig a amout agaist such a deposit allows you to avoid the pealties for early withdrawal. However, you should cosider the drawbacks to this type of loa. If you do ot repay the loa, the bak or other leder ca collect the accout balace. Also, you are slowig dow the growth of your savigs pla by withdrawig moey from it. Thus, this type of loa should be cosidered a last resort. You may also borrow agaist a asset, such as your car. If you ow a vehicle free ad clear (o loa agaist it), you ca take the title to your credit uio or bak ad ask for a loa. They will use the car title as collateral for the loa. Usually the car must be fairly ew five years old or less for this type of loa. A payday loa is a small, short-term loa that is iteded to cover a borrower s expeses util his or her ext payday. Typical loas are betwee $100 ad $500 ad are due i two weeks, with iterest rates of up to 400% APR. O a two-week loa, fees average $15 for each $100 let. I 2008, the state of Ohio passed a law to more closely regulate payday ledig. Access www. cegage.com/school/pfiace/mypf ad click o the lik for Chapter 16. Read the article ad the aswer the followig questios: What did the Ohio law do? Why did the Ohio legislators thik the law was eeded? What does the payday ledig idustry say i respose? What is your opiio about the Ohio law? Chapter 16 Credit i America 369

17 ISSUES IN YOUR WORLD CREDIT CARD TRAPS Credit offers may soud good, but you must read the fie prit carefully. There are may traps to avoid. What may appear to be a great deal ca be a very expesive lesso that hurts your credit ratig. Watch for the followig sigs that the credit offer is ot as good as it souds: Low Itroductory Rate. Iterest rate offers may be as low as 0 percet for six moths. The fie prit may tell you that if you are late by eve oe day i makig a paymet, the rate will rise to 25 to 30 percet or more! This itroductory rate may be subject to chage without otice. Fixed Percetage Rate. The offer may say the iterest rate is fixed, which should mea that it will ot go up. But the fie prit may tell you that the fixed rate is subject to chage without otice ad that it ca be adjusted (raised) at the optio of the creditor. Closed Accout Rate. You may see fie prit that says closed accout rate. This is the rate you will be assessed if you close your accout. These rates are ofte very high 25 to 30 percet or more! This tactic is used by credit card issuers to keep you from closig your accout whe they raise your iterest rate. Without this clause, cosumers could reject a chage i terms regardig iterest rates, close the accout, ad cotiue makig paymets based o the origial agreemet util the balace is paid off. But if the agreemet specifies a closed accout rate, you wo t be able to lock i the lower rate you had previously agreed to pay. Late Fees. Most credit card issuers charge late fees if you do ot pay your accout withi the time specified. Ofte this timeframe is oly 10 to 25 days. These late fees are bad eough, but you may also discover that if your accout is late, the issuer will also raise your iterest rate. O credit reports, your late paymet(s) ca make you appear to be a high risk, so other creditors may also raise your iterest rates. Over-the-Limit Fees. Card issuers will charge you a fee for exceedig your credit limit. This fee is added to your balace, ad it will take eve more moey to pay the accout dow (remember, iterest charges are icreasig your balace daily). Fie prit may tell you that if you go over the limit, your iterest rate will icrease. Trasactio Fees. Some credit card compaies allow you to trasfer balaces from other credit cards. They may also provide you with access checks where you ca borrow moey without preapproval. There may be very high trasactio fees for these types of borrowig, such as 3 to 10 percet of the trasactio amout, i additio to flat fees, such as $30. To avoid beig take advatage of, read the credit offers carefully ad compare them to offers by kow leders, such as your credit uio or bak. Ask questios ad be sure you uderstad the terms ad coditios. THINK CRITICALLY 1. Look for a credit card offer i your mail. The read the fie prit. Make a list of all the potetial traps you fid. 2. Discuss credit offers with parets ad other adults ad ask about their experiece with credit offers. Write a paragraph about what you lear. 370 Uit 4 Credit Maagemet

18 16.2 Assessmet KEY TERMS REVIEW Match the terms with the defiitios. Some terms may ot be used. 1. The providig of a service for which you will pay later 2. A timeframe withi which you may pay your balace i full ad icur o iterest charges 3. A legal busiess that makes highiterest loas based o the value of persoal possessios pledged as collateral 4. State law that sets a maximum iterest rate that may be charged for cosumer loas 5. A orgaizatio that makes high-risk cosumer loas 6. The cost of credit expressed as a yearly percetage a. aual percetage rate (APR) b. closed-ed credit c. fiace compay d. grace period e. loa sharks f. ope-ed credit g. pawbroker h. service credit i. usury law CHECK YOUR UNDERSTANDING 7. What is a revolvig credit agreemet? 8. Why might it be better to get a bak loa rather tha a loa from a fiace compay? APPLY YOUR KNOWLEDGE 9. How is ope-ed credit differet from closed-ed credit? What are the advatages ad disadvatages of each? Which of these is most likely to have a lower aual percetage rate? Why? THINK CRITICALLY 10. Do you thik it is ufair that some cosumers get free credit by takig advatage of the grace period o credit cards?give reasos for your aswer. 11. Oe major advatage of credit is that it helps cosumers deal with emergecies. How does this advatage have special meaig where service credit is cocered? 12. If you were goig ito busiess for yourself, you would have to decide whether or ot to accept credit cards from customers. Explai the poits i favor of both positios. Chapter 16 Credit i America 371

19 16 Chapter Assessmet SUMMARY Credit bega as the Uited States grew from a barterig society to a currecy exchage ecoomy with mass-maufactured products available to cosumers. Today, credit has become a way of life. The perso who borrows moey is called the debtor; the perso or busiess that loas moey is called the creditor. To qualify for credit, your ability to repay will be assessed based o your icome, fiacial positio, ad collateral. For the privilege of usig credit, you will pay a fiace charge, which icludes iterest ad fees. A lie of credit ca be preestablished to provide for emergecy fuds. Advatages of credit are the ability to buy ow ad pay later, a source of emergecy fuds, deferred billig, ad the safety of ot havig to carry a lot of cash. Disadvatages of credit are higher product prices, fiace charges, decreased ability to sped i the future, ad the tedecy to oversped. Ope-ed credit allows you to borrow agai ad agai, up to a set limit. The aual percetage rate is the cost of credit expressed as a yearly percetage. With a grace period, you ca avoid iterest charges so log as you pay your balace i full every moth by the due date. Closed-ed credit is a oe-time loa for a specific amout that must be repaid i full by a specified due date. Leders geerally require paymet i mothly istallmets. May service providers, such as your utility compay, provide service credit, allowig you to pay for services a moth or more after their use. Sources of credit iclude retail stores, credit card compaies, baks, credit uios, fiace compaies, pawbrokers, private leders, ad life isurace policies. Loa sharks are ulicesed leders who charge illegally high rates ad prey o people who ca least afford to pay. Usury laws i some states protect cosumers from ufairly high iterest rates. 372 Uit 4 Credit Maagemet

20 APPLY WHAT YOU KNOW 1. Give a example of a situatio i which you would use collateral whe makig a purchase o credit. What would be the advatage to usig collateral with a closed-ed loa over makig the purchase with your credit card? 2. Compaies ad orgaizatios that offer credit cards compete for your credit card busiess by offerig low itroductory rates. Search the Iteret for offers of a special deal. What is the low itroductory rate? Read the fie prit. What will the rate be after the itroductory period? At the regular rate, how much fiace charge would you have to pay o a $1,000 balace each moth? How does this compare to the itroductory rate? 3. How are cosumer fiace compaies differet from sales fiace compaies? Why do fiace compaies charge high iterest rates? 4. Why might credit uios offer lower iterest rates o loas tha do commercial baks or credit card compaies? 5. Does your state have a usury law? You ca fid out by cosultig your state s web site, a curret almaac, or other library resources. Idetify the maximum fiace rate that your state allows. The idetify the maximum rates allowed by eighborig states. 6. What is the purpose of a pawshop? What kid of merchadise ca you fid at a pawshop? MAKE ACADEMIC CONNECTIONS 7. Commuicatio Write a oe-page paper about credit the good ad the bad of how it has affected you, what it meas to your family, ad what it meas to retailers ad other busiesses. Explai i a eutral toe how credit is both positive ad egative for the ecoomy as a whole. 8. Research/History Do library ad/or Iteret research about the Idustrial Revolutio i this coutry ad how it chaged the lives of Americas. How did people adapt? Specifically, explai how people chaged their buyig ad spedig habits. 9. Ecoomics Whe citizes i a ecoomy save moey, their deposits provide moey that ca be loaed to others. This icreases the supply of moey ad lowers its cost to borrowers. Research the ecoomic cocepts of average propesity to save (APS) ad margial propesity to save (MPS). Explai what these cocepts are, how they are computed, ad why they are importat to the ecoomy as a whole. 10. Iteratioal Studies Choose aother atio i the world ad research the use of credit i that coutry. Compare it to the Uited States. How differet is the stadard of livig ejoyed by its citizes? Prepare a oe-page report of your fidigs. Chapter 16 Credit i America 373

21 SOLVE PROBLEMS AND EXPLORE ISSUES 11. Suppose that your elderly eighbors have ever used credit. Whe they were youg, their families lost their life savigs durig bad ecoomic times. As a result, they do t have much trust i fiacial istitutios ad prefer to use oly cash. What types of problems ca result from ot usig credit? What would be your advice to them, kowig that they have a good icome ad have o eed to buy o credit? 12. Iterview three or four adults about credit. Ask them the followig questios: (a) How do you feel about the use of credit? (b) Do you thik iterest rates charged o credit cards ad accouts are reasoable? (c) Do you prefer to make purchases usig credit or cash? Why? Prepare a short report from what you lear. 13. Fid three credit card offers. You ca fid them i juk mail, s (spam), bill eclosures, advertisemets, credit card web sites, ad eve kiosks foud i shoppig areas. Aalyze ad compare the provisios of the offers, such as the itroductory rates, regular rates (variable or fixed), grace periods, aual fees, ad so o. Prepare a report of your fidigs. 14. Do you feel that the advatages of usig credit outweigh the disadvatages? How would you advise a youg perso just startig out about credit? Write a paper givig reasos for your opiios. 15. A fried of yours wishes to buy a ew car but has oly eough moey to make a dow paymet. She asks your advice about where she ca fiace the balace of her loa for $10,000. What will you tell her? Explai. 16. Your cousi Tyler eeds $100 immediately. He has a portable stereo worth at least $800 ad wats to take it to a pawbroker. Explai to him how much he might be able to borrow agaist the stereo ad what ca happe whe usig pawbroker credit. EXTEND YOUR LEARNING 17. Ethics The wide use of credit ca lead to abuses. Some people take out more credit tha they ca repay. The they refuse to pay back what they have borrowed. Whe merchats get stuck with upaid balaces, they pass alog that cost to other customers i the form of higher prices. Thus we all pay for people who overuse credit. Is it ethical for people to overexted their credit, kowig or suspectig that they will ot be able to repay it? What ca we all do to keep the cost of products ad services at reasoable levels? For related activities ad liks, go to Uit 4 Credit Maagemet

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