Module 4: Credit Cards and Credit Scores

Transcription

1 Module 4: Credit Cards and Credit Scores Remember that credit is money. Benjamin Franklin

2 What Is Credit? Borrowed money: It s not yours to keep! Definition: Money loaned to an individual or a group with the intention of receiving future re-payment of principal (the amount loaned) and interest. 2

3 Two Common Types of Credit Installment Credit (FIXED) Typically for large purchases, such as car or computer Revolving Credit (VARIABLE) Mostly used in the form of credit cards *Often times fixed loans will have a lower interest rate because an asset (i.e. house of car) is offered as collateral 3

4 Responsible Borrowing Habits Homeownership College Tuition Jewelry Vacations Good uses of credit: Student loans Mortgage and associated tax credits Credit card rewards Basic transportation (a cheap reliable car to get you to your workplace) Bad uses of credit: Using a credit card to pay for expenses that you don t have cash for, like: Vacations Jewelry Huge TV An expensive car that you can t otherwise afford 4

5 Using a Credit Card Don t spend more than you can pay off each month! Banks make money from people who spend more than they can pay by charging them fees. Credit card fees are extremely high compared to other forms of credit: Typical mortgage rate: 3.6% APR 1 Typical student loan rate: 6.8% APR 2 Typical credit card rate: 16.8% APR 3 1 HSH.com: Current mortgage rate for 30-year $200,000 loan as of December 16, Fixed Stafford Loan rate: Finaid.com 3 Indexcreditcards.com: Average consumer credit card rate, overall market as of December 15,

6 Sample Credit Card Statement See PDF for full statement: 6

7 Evaluating Credit Card Offers Compare the three credit cards listed below and choose the one with the best options for your situation. Be prepared to explain your choice. Bank of America Cash Rewards Chase Freedom American Express Gold Card 7

8 Evaluating Credit Card Offers Compare the three credit cards in this scenario and choose the one with the best options for your situation. Be prepared to explain your choice. Card Type Annual Fee APR Cash Back Other Rewards Bank of America Cash Rewards $ % 1% on all purchases, 2% on groceries, 3% on gas Discount programs Chase Freedom $ % 1% on all purchases, 5% on rotating categories Discount programs 10% cash back on Chase shopping program American Express Gold $125 Can t carry a balance None Discounts on hotels Gift card rewards 8

9 How Compound Interest Can Work Against You Remember we learned the advantages of compound interest when you invest your money in a savings account. Let s decide we are purchasing a $1,000 3D-flat screen TV, but we can only pay the minimum $20 payment each month. Our interest rate is 20% APR. Month Beginning Balance Interest Accrued (Beginning Balance x APR/12) Monthly Payment Ending Balance (Beginning Balance + Interest Accrued Monthly Payment) 1 $1,000 $ ($20.00) $ $

10 How Compound Interest Can Work Against You Remember we learned the advantages of compound interest when you invest your money in a savings account. Fill in the spreadsheet for a credit card using a 20% APR, compounded monthly, and $20 minimum payment. How long does it take to pay off $1,000? 9 years Month Beginning Balance Interest Accrued (Beginning Balance x APR/12) Monthly Payment Ending Balance (Beginning Balance + Interest Accrued Monthly Payment) 1 $1,000 $ ($20.00) $ $ $ ($20.00) $ $ $ ($20.00) $ $ $ ($20.00) $ $ $ ($20.00) $ $ $ ($20.00) $ How much interest have you paid over just 6 months? $99.15 What would happen if the interest accrued was greater than the monthly payment? 10

11 Benefits and Risks of Using Credit Cards Benefits Risks Develop responsible money spending habits (i.e. the ability to estimate how your spending corresponds to your monthly payments). Earn rewards! Let your credit card company pay you by taking advantage of rewards. Temptation to spend beyond your means and accumulate debt. Lose your ability to make good use of credit: Unpaid debt can lead to bankruptcy and becomes part of your credit history for 7 to 10 years. Overspending will lead to higher interest payments. You ll lose even more money on interest expenses. 11

12 Ratings Systems What are some common rating systems? U.S. News College Rankings BCS Rankings (college football) Movie ratings: G through R Consumer reports ratings (cars, appliances, etc.) Why do we use ratings systems? Quickly process a lot of information See comparisons Standardize review procedures In the case of credit, your credit score shows how RESPONSIBLE you are with your money. 12

13 Makeup of the FICO Score Fair Isaac is the company that invented credit scoring. The FICO score is still the most commonly used. Factors that determine risk: FICO Score ü ü ü ü ü ü ü Your bill-paying history The number & types of accounts you have Ratio of debt to available credit (smaller is better) Do you pay your bills by the due date? Collection actions Outstanding debt The age of your accounts 13

14 What Does Your Score Mean? Credit Score What it Means Excellent Score. A lender is likely to offer you their best interest rate Good. You should have no trouble getting a loan at a good interest rate Average. You may have trouble getting a loan at a good interest rate Below Average. You may qualify for a loan but not at good interest rates Poor Score. You probably will not qualify for a loan, and if you do your interest rate will be extremely high FUHGEDDABOUTIT! 14

15 How to Prevent Identity Theft Protect your Social Security Number and bank accounts; NEVER give that information over the phone! Check your credit report. The three reporting agencies that collect information and create credit reports are: Equifax, Experian, and Trans Union Checking your credit report Use annualcreditreport.gov; NOT freecreditreport.com CreditKarma.com is also a free site to gauge creditworthiness What if there is an error on your credit report? Call or write a letter immediately! There are consumer protection laws to keep in mind: visit for information if you are a victim of identity theft. 15

16 The Importance of Having a Good Credit Score What does it mean to have Good Credit? Good Credit means you have a proven history of repaying your debts. This means you pay your cell phone bill on time, pay your credit card bill on time, etc. Why is it important to have good credit? Don t get denied for a loan for mortgage or tuition. Obtain loans at lower interest rates in the future. How do I get good credit? Pay your bills on time and in full (including medical bills). If you don t have an established history of using credit, consider wisely using a credit card to build credit history. BUT, do not take out too much credit at once. Open a bank account. NEVER miss a debt payment! 16

17 Co-signers Credit card availability is limited for those under the age of 21 if you don t have a part-time job or savings, so a co-signer may be required. A co-signer is a person that pledges to meet the obligations of your debt in case you fail to pay your credit card bill. Co-signers must have a high enough credit score (a relative with a poor credit history may not be able to co-sign a credit card for you). If you don t pay your credit card, your co-signer will be responsible for all payments due, including interest and late fees. Beware of co-signing for ANYONE! Their irresponsibility can become your credit problem! 17

18 Client 1 I am 18 years old and just started college. A small group of my friends want to bust out for spring break and take a oneweek vacation in Florida. I am planning to charge the $1,500 cost of the trip on my credit card because I haven t saved up enough money from my part-time job and I probably won t be able earn that much in a long time. My parents or friends won t lend me the money either. I plan to pay the cost off incrementally over time. What are the advantages of putting the vacation on a credit card? What are the disadvantages of using a credit card to pay for the vacation? Do you recommend that this client charge the trip on their credit card? 18

19 Client 2 I am 22 years old. I am just about to complete a two-year dental hygienist program. My workplace is 20 miles from my apartment and is not on a city bus route. My car has 225,000 miles on it, and I ve been spending a lot of money on repairs lately. I have saved up $2,000 for a down payment on a slightly used car, but I will need to borrow several thousand more to buy a small and dependable used car. What are the advantages of getting an auto loan? What are the disadvantages of getting an auto loan? Do you recommend that this client apply for the loan? 19

20 Talk About It! Ask your parents, family members/relatives and older friends: When did they first start using a credit card? Do they pay the minimum payment or pay the full balance every month? If they know their credit score, do they know what the number means and how it affects their credit health? 20

21 The End