Credit Management

Chapter 16 - Credit in America

Chapter 17 - Credit Records & Laws

Chapter 18 - Responsibilities and

Costs of Credit

Chapter 19 - Problems with Credit

Credit in America

• The History of Credit– Early Years

• Accounts at the general store• Banks were reluctant to loan, charged high interest

– The 1900s• Began to understand advantages of credit• Laws enacted to protect consumers

– Today• Easier to use

Vocabulary of Credit• Debtor - person who borrows money• Creditor - person/company who loans money• Capital - property you possess that is worth

more than your debts• Collateral - property pledged to assure

repayment of a loan• Finance change - the interest you pay for the

use of credit (handling charge, service charge, carrying charge)

More Vocabulary• Minimum payment - least amount you can pay

that month• Due date - date payment is due• Late fee - amount charged if payment is not

made on time• Installment agreement - contract you sign for

an expensive purchase wherein you agree to make regular payments for a period of time

• Secured loan - loan that uses the goods being purchased as collateral

Advantages of Credit• If used correctly, credit can:

1. Expand your purchasing power

2. Raise your standard of living

3. Purchase expensive items earlier than if you had to pay cash

4. Can provide emergency funds

5. Convenient

6. Provides proof of purchase

Disadvantages of Credit

1. Credit purchases may cost more than cash purchases.

2. You tie up future income.

3. Can lead to overspending.

Video

• http://www.pbs.org/wgbh/pages/frontline/shows/credit/view/

Kinds of Credit• Open-Ended Credit

– An agreement to lend the borrower an amount up to a stated limit and to allow borrowing up to that limit again whenever the balance falls below it

• Closed End Credit– A loan for a specific amount that must be repaid in

full by a stated due date

• Service Credit– An agreement to have a service performed and

pay for it later

Open-Ended Credit

• Open 30-day accounts– A credit agreement that must be paid in full

every 30 days.

• Revolving Credit Accounts– A credit agreement that allows you the

option of paying a minimum amount each month (credit cards)

Shopping for a Credit Card• Need to consider and compare:

1. Annual percentage rate (APR)

2. Free Period - (grace period) allows you to avoid finance charges if balance paid in full by certain date

3. Annual Fees

4. Transaction Fees and Late Fees

5. Method of Calculating the Finance Charge

Closed-End Credit• Does not allow for continuous borrowing• Set payments (installments)• Sometimes called an installment loan• Must include: amount loaned, total

finance charge, amount of each payment

• Usually requires a down payment• Items bought serve as collateral

Service Credit

• An agreement to have a service performed now and paid for later

• Almost everyone uses some form of service credit

• Examples: phone, utilities, doctors, etc.

• Most do not charge a finance charge

Sources of Credit• Retail Stores• Banks and Credit Unions• Finance Companies• Pawnbrokers• Private Lenders• Other sources

– Life insurance policies– Certificates of deposit

Establishing Good Credit• Credit Records

– Credit History is the complete record of your borrowing and repayment performance

• Credit File– On file with a credit bureau (a company that

gathers, stores, and sells credit information to business subscribers)

– Three major U.S. Credit Bureaus - Experian, Equifax, and Trans Union

Credit Report

• A written statement of a consumer’s credit history

• You can request a copy of your credit report at any time– Normally there is a small fee ($5 - $15)– If you are denied credit, you can get a

FREE credit report if you ask within 30 days of being denied credit

Credit Report Information

• Any public information becomes a part of your credit report– Bankruptcy, marriage, divorce, paying

property taxes, job promotions, lawsuits, etc.

• Subscribers pay a monthly fee to the credit bureaus and provide the information to the bureau

Creditworthiness• Are you a good risk for credit?• Creditors will look at five basic

qualifications:

1. Character

2. Capacity

3. Capital

4. Conditions

5. Collateral

Character• A responsible attitude toward living up

to agreements.• Will you repay the debt?• Credit history will show if you pay your

bills on time which shows good character.

• Creditors also look for stability. How often do you move or change jobs?

Capacity

• The financial ability to repay a loan with present income.

• Can you repay the debt?

• Creditors will want to know if you have the financial resources to add another bill to your monthly expenses.

Capital

• The property that you possess that is worth more than your debts.

• Is the creditor fully protected if you fail to repay?

• If the credit is unsecured, do you have enough to cover the debt?

Conditions• The state of the economy can affect

your ability to repay.• What general economic conditions can

affect your repayment of debt?• Will look at your job stability - do you

work in an industry that is struggling? -do you live in an area that is struggling?

Collateral

• Property pledged to assure repayment of a loan.

• Similar to capital

• What assets back up your promise to pay?

Questions a Creditor May Legally Ask

• Personal Information (Name, age, number of dependents, phone #)

• Employment Information (place and length of employment, history)

• Obligations (alimony, child support, outstanding debts and accounts)

• Residence (own or rent, immigration status, how long there, history)

Getting Started

• Establish a Savings Account

• Open a Checking Account– Shows that you can handle money

• Open a Store Credit Account

• Get a Small Loan

• Apply for a Credit Card

Assignment

• Chapter 17 worksheets are due on Wednesday at the BEGINNING of class

• Have them complete BEFORE you come to class

• YES THEY WILL BE GRADED!!!

Credit Ratings• A measure of creditworthiness• Excellent (A rating): pay bills before due

date, well established, has not missed any payments, paid more than the minimum

• Good (B rating): pay bills on due date or within grace period, does not miss payments

• Fair credit rating: usually pays within grace period but may be late occasionally

• Poor credit rating: payments not regular, may miss a payment, frequently reminded to make a payment

What’s in aCredit Report?

• Summary of Information

• Public Record Information

• Credit Information

• Account Detail

• Requests for Credit History

• Personal Information

Fair Credit Reporting ActIf you are denied credit:• You have the right to know what is in your

credit file and who has seen your file• Can see your file at no charge if requested

within 30 days of denial• A small fee will be charged any other time• You have the right to have inaccurate

information investigated and removed; or write a statement re: the information giving your side of the story

Fair Credit Billing Act• Creditors must resolve billing errors within a

specified period of time• You have to notify the creditor of the error -

must be in writing and mailed within 60 days after you receive the statement

• Creditor must acknowledge your complaint within 30 days and correct (or show why you owe) error within 90 days

Equal Credit Opportunity Act• Designed to prevent discrimination in

judgment of creditworthiness• Credit may not be denied:

– solely because your are a woman, single, married divorced, separated, or widowed

– Because of religion, nationality, race, color, or age.– Because you receive public assistance,

unemployment, social security, or retirement benefits

• Credit applications can be oral or written (creditors are prohibited from asking certain questions)

• Creditor may not discourage you from applying for credit for any reason prohibited by the act

• A denial must be sent to you in writing and a specific reason must be listed

• New accounts must list both spouses as responsible for payments

Fair Debt Collection Practices Act

• Designed to eliminate abusive collection practices by debt collectors

• Cannot use threats, obscenities, and false or misleading statements

• Restricts time and frequency of contacts

• Must verify accuracy of bills and allow the consumer the opportunity to clarify

Using Credit Responsibly

• Responsibilities of Consumer Credit– To Yourself– To Creditors– Creditors’ Responsibility to You

Responsibilities to Yourself

• Use credit wisely

• Don’t live beyond your means

• Check out the businesses where you make credit purchases

• Comparison shop

• Have the right attitude about using credit

Responsibilities to Creditors

• Limit your spending to amounts you can repay according to contract terms

• Read and understand all terms of the agreement

• Contact the creditor immediately if you find an error

• If you can’t make a payment, contact the creditor

Creditors’ Responsibilities to Yourself

• Assist consumers in making wise decisions• Inform customers about all rules and

regulations, and fees• Cooperate with established credit reporting

agencies• Establish and carry out sound lending and

credit policies• Establish and maintain fair and reasonable

methods of contacting customers

Protecting Yourself from Credit Card Fraud

• Costs businesses and consumers millions of dollars a year

• Most common type of fraud is illegal use or a lost or stolen credit card– Card holder’s liability is limited to $50– Businesses may lose money

Safeguard Your Cards

More Safeguarding• Tear up any carbons or extra copies

• Do not lend your card to anyone

• Destroy expired cards

• Don’t give credit card information by phone to people or business you don’t know

• Keep your receipts and verify with your statement

Protect Your Cards Online

• Deal only with companies you know and trust

• Look for the secure site symbol

• All legitimate online merchants should clearly state their privacy policy

Avoiding Unnecessary Credit Costs

• Accept only the amount of credit that you need. • Do not increase credit spending when your

income increases.• Keep the number of credit cards to a minimum.• Pay cash for purchases under $25.• Understand the cost of credit.• Shop for loans.• Use credit to beat inflation.• Time your credit card purchases carefully.• Take full advantage of rebate programs.

Factors Affecting Credit Costs

• Method used to compute finance charges.• Source of credit• Total amount financed• Length of time you are making payments• Ability to repay debt• Type of credit selected• Collateral or security offered• Interest rates• Economic Conditions• The business’s costs of providing credit

Computing Costs of Credit• Simple Interest Formula

– I = P x R x T

• Annual Percentage Rate Formula– (2 x n x f)/P(N+1)

• Credit Card Billings– Adjusted Balance Method– Previous Balance Method– Average Daily Balance Method

Solving Credit Problems

• Major disadvantage to credit is it can lead to overspending

• Usually does not happen suddenly– Years of poor planning– Impulse buying– Careless budgeting

The 20/10 Rule

• Credit counselors suggest 20/10 Rule

• Total borrowing should not exceed 20% of your yearly take-home pay

• Don’t take on monthly payment that total more than 10% of your monthly take home pay

• Does not apply to mortgages

Credit Counseling

• Private or government-sponsored services

• Fees usually based on ability to pay

• Help set up budgets and show you best way to use your income

• Cannot get loans from them

Debt Adjustment

• For people who need stricter discipline that advice from a counselor

• Charge fees and require contracts

• They take over – Contact creditors to work out payment plan– Control your accounts and pay your bills

Credit Repair• Need to repair your credit rating

• Obtain copies of your credit reports– Challenge any incorrect information

• Take steps to assure the information reported about you is correct– Clear up debts responsibly– Make payment arrangements– Request that corrected information be

supplied to credit bureaus

Legal Recourse

• When debtors are in severe debt trouble and cannot meet their bills, final most serious step is bankruptcy– Legal process that relives debtors of the

responsibility of paying their debts or protects them while they try to repay

• Bankruptcy is a second chance but carries serious consequences

Purpose of Bankruptcy Laws

• Two goals of bankruptcy law:

1.Protect debtors by giving them a fresh start

2.Give fair treatment to creditors competing for debtors’ assets

• Original federal Bankruptcy Act was 1898

• Bankruptcy Reform Act of 1994 tightened rules for bankruptcy

Types of Bankruptcy• Voluntary and Involuntary

• Voluntary– Most common kind– Occurs when you file a petition with a federal court

asking to be declared bankrupt

• Involuntary– Occurs when creditors file a petition with the court,

asking the court to declare you bankrupt– Does not occur often because creditors prefer to

be repaid in full

Voluntary Bankruptcy:How it Works

• Court notifies newspapers and creditors

• Creditors may file claims

• Court collects your assets & sells your property as needed

• If assets do not cover all liabilities, each creditor is given a proportional share

• Remainder of debt is discharged– Some debts cannot be discharged: taxes, child

support, and alimony

• Once declared bankrupt, cannot file again for six years

Types of Bankruptcy• Liquidation or Reorganization• Chapter 11

– Reorganization for businesses that allows them to continue operating under supervision

• Chapter 7– Commonly called straight bankruptcy– Wipes out most debt for giving up most assets– See next slide for exempted items

• Chapter 13– Reorganization form for individuals that allows them

to pay off their debts over three to five years

Federally Exempted Items(as of January 1, 2001)

1. $15,000 equity in a home or burial plot ($30,000 on joint bankruptcy)

2. $2,400 interest in a motor vehicle

3. Items worth up to $400 for a single item for household goods and furnishings, appliances, clothing, and personal items, for a total of not more than $8,000

4. $1,000 in jewelry

5. $1,500 in tools, books, and other items used in a trade or business

6. Other property worth up to $800, plus up to $7,500 of the unused part of the $15,000 exemption for equity in a home or burial plot

More About Bankruptcy

• If considering bankruptcy, seek legal advice– Legal fees range from $150 to $1,500– Can help you protect some of your assets

• Creditors may ask debtor to repay debt even after bankruptcy has discharge them (reaffirmation)

Reaffirmation

• May wish to reaffirm a loan that someone co-signed for you

• May choose to reaffirm rather than allow the collateral to be repossessed

• Requires a court hearing and debtors have 30 days to change their minds

• Creditors may NOT harass debtors

Major Causes of Bankruptcy

• Business Failure– As a sole proprietor, your personal assets

can be taken for your business

• Emotional Spending

• Failure to Budget and Plan– Bankruptcy is not limited to poor people

• Catastrophic Injury or Illness

Advantages of Bankruptcy1. Debts are erased.

– Offers a fresh start.

2. Exempted assets are retained.– Able to retain certain assets to help start over.

3. Certain incomes are unaffected.– Bankruptcy does not affect: social security, veterans’

benefits, unemployment compensation, alimony, child support, disability payments, and payments from pensions.

4. The cost is small.– Fees small compared to amount of financial relief

provided.

Disadvantages of Bankruptcy

1. Credit is damaged.– Judgment cannot be wiped off your record for 10 years.

2. Property is lost.– Property you get to keep is limited to the exemptions.

3. Some obligations remain.– Not ALL debt is erased.

4. Some debts can be reaffirmed.

5. Co-signers must pay.– If you do not reaffirm a debt that has a co-signer, they will

be forced to pay the debt off.