CHAPTER 4

Going Into Debt

Debt = Principal + Interest

Credit Receiving money

either directly or indirectly to buy goods and services TODAY with the promise to PAY BACK LATER

Principal: amount originally borrowedInterest: amount to be paid for using someone else’s money

Americans and Credit

CREDIT REALITY

EVERYTIME you use credit, you are going into DEBT (this includes

taking out a loan)

Definition

CONSUMER DURABLESRepay this type of loan

over a period of time in equal installments (payments).

Examples: mortgage or car loan

Length of loan determines the amount of the payment & interest Longer time period = higher

interest, lower payment

Manufactured items people use for a long time before replacing them

Commonly purchased with installment loans

Installment Loans

MORTGAGEInstallment debt owed

on real estate property (houses, buildings, land)

WHY USE CREDIT???

1. Immediate need (gratification)

2. Spread payments over “life” of the item

BUYING ON CREDIT- ASK YOURSELF THIS:

1. Do I really need this item?2. Can I wait for this item?3. If I pay cash, what am I giving up? (opportunity

cost)4. Will the satisfaction I get from an item be

greater than the interest I have to pay?5. Have I done comparison shopping?

% rates Loan rates Prices

6. Can I afford to borrow or use credit now?7. Will I be over my limit?

HOME MORTGAGE

1. Use the real estate flyers to select three properties of varying prices.

2. Calculate the total interest (I=principal x interest x years) & total payout (total interest + principal) for the following conditions on EACH property.

Example: I = 100,000 x .0375 x 15Example: TP = 56,250 + 100,000

30 year, 5.25% 20 year, 4.25% 15 year, 3.75%

3. Calculate the MONTHLY payment for each loan set. (monthly payment = total payout / total months of loan)Example: MP=156,250/180

4. Using the “Buying on Credit” analysis, which property would you purchase at which term rate and WHY?

Mortgage

15 year(180)

20 year(240)

30 year(360)

1. Price

$100,000

I: $56,250TP: $156,250

Monthly Pmt.$868

I:TP:

Monthly Pmt.

________

I:TP:

Monthly Pmt.

________

2. Price

_____

I:TP:

Monthly Pmt.

________

I:TP:

Monthly Pmt.

________

I:TP:

Monthly Pmt.

________

3. Price

_____

I:TP:

Monthly Pmt.

________

I:TP:

Monthly Pmt.

________

I:TP:

Monthly Pmt.

________

Match institutions to the main functions:

A. Commercial BankB. Charge AccountsC. Consumer Finance

CompaniesD. Savings BanksE. Credit UnionsF. Savings & Loans

(S&L)

accept deposits, loan $, transfer funds from one bank, individual, or business to anothermortgage loans (single and multifamily), commercial mortgage, auto loans, accepts depositssavings accts., home loans, checking accts. at lower interest rates, “small savers”owned & operated by its members, provide checking & savings accts. at higher interest, loans at lower interesttakes over installment debts & adds a collection fee, higher interest fees, loan to “high risk”allows customer to buy goods or services from a particular company & pay them later

Types of Financial Institutions

Match institutions to the main functions:

A. Commercial BankB. Charge AccountsC. Consumer Finance

CompaniesD. Savings BanksE. Credit UnionsF. Savings & Loans

(S&L)

accept deposits, loan $, transfer funds from one bank, individual, or business to anothermortgage loans (single and multifamily), commercial mortgage, auto loans, accepts depositssavings accts., home loans, checking accts. at lower interest rates, “small savers”owned & operated by its members, provide checking & savings accts. at higher interest, loans at lower interesttakes over installment debts & adds a collection fee, higher interest fees, loan to “high risk”allows customer to buy goods or services from a particular company & pay them later

Types of Financial Institutions

A

F

D

E

C

B

REGULAR CHARGE ACCT.

“30 day charge” with a credit limit

Credit limit: max amount of goods or services a person or business can buy on the promise to pay in the future (usually $500-$1000)

Process: bill sent at end of 30 days; 0% interest charged if paid in full before interest is charged at the end of the month (billing cycle)

CHARGE ACCOUNTS

Revolving Charge Account

Allows you to make additional purchases from the same store even if previous month’s bill is not paid in full

Terms: usually must pay 1/5th of balance interest; has a credit limit

No “common lender” symbol in corner

Credit Card

Like a charge card only can be used at many random stores, resturants, businesses, etc.

Terms: Varying credit limits Higher interest rates (10%-30%

range based on credit score) Special rates to reliable

customers

COMMONLY HAVE THESE LOGOS

Debit Card

“Check Card” – works like a check from your checking or savings account at a banking institution

Transfers funds electronicallyOnly funds IN your account are

accessible for use through the card

Can be used for ATM withdrawal of cash

No interest charge, but fees!!! Rules are decided at each bank.

Finance Charges and Percentage Rates

Finance Charge Cost of credit expressed in $ and includes interest

costs plus other charges connected to credit (annual membership fee)

Computing finance charge (4 ways): Previous balance Average daily balance Adjusted balance Past due balance

Creditors must inform you which method is being used.

Annual Percentage Rate (APR) Cost of credit expressed as a yearly percentage

See Page 93

How do I apply for credit?

1. Know who is watching: Credit Bureau

A private business hired to do a credit check.

Credit Check An investigation to reveal

current income, debts, detailsof personal life, repaymenthistory

Completed prior to MOST financial transactions or even prior to obtaining employment

CAPACITY TO PAY

CHARACTER

Related to income & debt

Spotty employment = questionable record

Factor in current amount of debt

If debt is high, reluctant to loan

Reputation of being trustworthy & reliable

Educational background

Trouble with law or criminal background = reluctant to loan

3 Credit Check Factors

COLLATERAL

Capital (personal wealth)

Past ability to save & accumulate

Personal ability to pay (able to sell items of value)

Credit Rating

Information is supplied by the credit bureau which determines rating or risk – good, average, or poor.

This determines if a creditor will lend money to you and at what price = “CREDITWORTHINESS”

Factors to “poor” credit rating: not paying

bills on time, inconsistent employment, debt delinquency, criminal record, high

debt/low income

SECURED LOANS UNSECURED LOANS

A loan that is backed up with collateral

Signed legal agreement

Example:Auto loan / title of car or repossession

When a loan is granted without collateral

Based on reputation alone

Co-signer – person who signs the loan contract along with borrower & promises to repay the loan if the borrower does not

TYPES OF LOANS

Responsibility as a Borrower

Paying on time! Past due notices –

received if you are late in paying

Collection agency – extensive late payment leads to “aggressive” collection

Late or non-payment = increase in cost for ALL customers

Keeping records!! Track credit purchases

and KNOW what you have borrowed!

Notify immediately if credit cards or ID are lost or stolen

Thieves are not all as obviousas him!

Government Regulation on Credit

Usury Law Law restricting the

amount of interest charged for credit

Recently changed to help consumers

Higher rates can be charged on loans of higher risk

Personal Bankruptcy The inability to pay debts

based on the income received or the condition in which debtors give up most of what they own for distribution to creditors

Should be a last resort Stays on credit history

for 10 years Offers a fresh start but is

difficult to get future credit!