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Ch. 6 & 7 (6-4 Using Credit Wisely (6-4 a Shopping for the best deal…

- - - - Annual fees
      - Rate of interest charged on account balance
      - Length of the grace period
      - Method of calculating balances
  - - - If you have a lot of unused credit capacity, it may be harder to get a loan because of lender concerns that you could become overextended. Also, your FICO score will be reduced because of the amount of potential credit represented by the cards.
        
        SO DON'T KEEP MORE THAN TWO
      - Should you decide to start using a new card (because their offer was just too good to pass up), then get rid of one of your old cards—physically cut up the old card and inform the issuer in writing that you’re canceling your account.
  - - - Never, ever, give your account number to people or organizations who call you, no matter how legitimate it sounds.
      - If you initiated the call, it’s okay to give your account number over the phone when ordering or purchasing something from a major catalog house, airline, hotel, and so on.
      - Use the same precautions when purchasing something over the Internet with your credit card—don’t do it unless you’re dealing with a major retailer who uses state-of-the-art protection against fraud and thievery.
      - When paying for something by check, don’t put your Social Security or credit card account number on the check, and don’t let the store clerk do it.
      - Don’t put your phone number or address (and certainly not your Social Security number) on credit/charge slips, even if the merchant asks for it—they’re not entitled to it.
      - When using your card to make a purchase, always keep your eye on it. If the clerk wants to make another imprint, ask for the first one and tear it up on the spot.
      - Always draw a line on the credit slip through any blank spaces above the total.
      - Destroy all old credit slips; and when you receive your monthly statement, be sure to go over it promptly to make sure there are no errors. If you find a mistake, call or send a letter immediately, detailing the error.
      - If you lose a credit card or it’s stolen, report it to the card issuer immediately—the most you’re ever liable for with a lost or stolen card is $50 (per card), but if you report the loss before the card can be used, you won’t be liable for any unauthorized charges.
      - Destroy old cards or those you no longer use.
  - - - a form of legal recourse open to insolvent debtors, who may petition a court for protection from creditors and arrange for the orderly liquidation and distribution of their assets
      - Usually middle class folks with little or no education
    - - Wage Earner Plan
        
        an arrangement for scheduled debt repayment over future years that is an alternative to straight bankruptcy; used when a person has a steady source of income and there is a reasonable chance of repayment within three to five years
      - Straight Bankruptcy
        
        a legal proceeding that results in “wiping the slate clean and starting anew”; most of a debtor’s obligations are eliminated in an attempt to put the debtor’s financial affairs in order
        
        allowed under Chapter 7 of the bankruptcy code
        
        About 70 percent of those filing personal bankruptcy choose this route.
        
        However, straight bankruptcy does not eliminate all the debtor’s obligations, nor does the debtor necessarily lose all of his or her assets
        
        The debtor also may retain the equity in a home, a car, and some other personal assets
- - - - To avoid paying cash or large purchases immediately (large outlays)
      - To meet a financial emergency
      - For convenience
      - For investment purposes
    - - Overuse
    - - First Steps
        
        Open one or two charge accounts and use them once in a while
        
        Get a small loan, put it in a certificate of deposit or money market account, and pay it back
      - Build a Strong Credit History
      - Evaluating Creditworthiness
        
        Capacity
        
        Collateral
        
        Capital
        
        Character
        
        Condition
      - How Much Credit Can You Handle?
        
        Make sure the monthly repayment burden doesn't exceed 20% of your take-home pay
        
        Borrow what you can pay back
        
        Keep debt service ratio to 10%-15%
        
        Total monthly consumer credit payments/monthly take-home pay
  - - - Credit extended ahead of time
        
        Credit limit + required payments according to set terms
    - - Bank credit cards
        
        Open credit account ex.
      - Line of Credit
        
        Max credit a customer is allowed to have outstanding at any point in time
      - Cash Advance
        
        A loan obtained by a bank credit card holder at any participating bank or financial institution
        
        Seems like a cash loan, so like getting money out of an ATM but the credit card version
      - Interest Charges
      - Other Fees
        
        Base Rate
        
        Grace Period
    - - Reward Cards
        
        Frequent flyer program
        
        Free miles for each dollar charged on a credit card
        
        Free tickets, first-class upgrades, and other travel-related benefits
        
        Automobile rebate programs
        
        Annual rebates of up to 5 percent that can be used, up to specified limits, for new car purchases, leases, or auto maintenance programs
        
        Other merchandise rebates
        
        Norwegian Cruise Line, NASCAR, Starbucks, and Marriott Hotels
        
        Worth a damn?
        
        Generally work best for those who can use the rebates, charge a lot, and don’t carry high monthly balances.
        
        Depends on usage patterns and annual cost of the card before and after rebate
        
        Most incentive cards carry higher interest rates than regular bank cards do.
      - Affinity Cards (Cards with a Cause)
        
        Issued in conjunction with some charitable, political, or other nonprofit organization
        
        Annual fees more expensive than a regular card since the company is making a profit with it
      - Secured Credit Card
        
        Secured
        
        a type of credit card that’s secured with some form of collateral, such as a bank CD (usually $500 at 12-18 months)
        
        Collateral
        
        the amount of credit is determined by the amount of liquid collateral you’re able to put up
        
        Meant to help those with bad credit get back on track
        
        Issued as Visa or Mastercard
        
        Annual fees and finance charges are equal to, or greater than, those of regular credit cards
      - Student Credit Card
        
        Has promotional programs that are meant to appeal to college students
        
        Like free music, movie tickets, and the like
        
        Other than these things they aren't very special
        
        Just requires enrollment into a 2 or 4 year university
        
        And a source of income that can be a part time or full time job or, it's implied, money from family
        
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    - - A type of credit card issued by retailers that allows customers to charge goods and services up to a preestablished amount
        
        Retailers like them because it builds customer loyalty, customers like it because it's convenient
        
        Holder is expected to pay for purchases in full upon receipt of the monthly bill
        
        Interest typically fixed at 1.5 percent to 1.85 percent monthly, or about 18 percent to 22 percent per year
        
        Considerably more than what most bank cards charge
    - - A card used to make transactions for cash rather than credit; replaces the need for cash or checks by initiating charges straight against the checking account
        
        Cons
        
        Some debit card issuers charge a transaction fee or a flat annual fee
        
        Some merchants may even charge you for using your debit card
        
        Pros
        
        You avoid the potential credit problems
        
        You avoid potentially high charges of a credit card
        
        Rewards: Some gas stations give discounts for cash purchases and consider a debit card to be as good as cash.
      - Debit v Credit: When stolen
        
        Debit
        
        Instead, your liability resulting from a lost or stolen debit card is typically limited to $50 up to a maximum of $500, “depending on the circumstances of the loss.”
        
        By the time you find a fraudulent charge on your debit card, your money—not the bank’s money—is already gone, and it’s up to you to get it back, not the bank.
        
        Can take months to get the money back
        
        Credit
        
        When a credit card is lost or stolen, federal banking laws ensure that the cardholder is not liable for any fraudulent charges if the loss or theft is reported before that card is used.
        
        If reported after the card is used, the cardholder’s maximum liability is $50.
        
        Ways to be safe
        
        Be careful using outdoor ATMs
        
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        Protect your PIN at gas stations
        
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        Know that the internet is a dangerous place to use a debit card
        
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        Some restaurants keep debit info on file
        
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        If you find a fraudulent charge on your credit card bill, you can just decline or dispute the charge
        
        Can take days to get the money (or credit rather I guess) back
    - - Offered by banks, brokerage houses, and other financial institutions
        
        They’re accessed by writing checks on regular checking accounts or specially designated credit line accounts
        
        They are a form of open account credit and often represent a far better deal than credit cards
        
        Not only because they offer more credit but also because they can be a lot less expensive. And there may even be a tax advantage to using one of these other kinds of credit.
      - Three types
        
        Overdraft Protection
        
        a line of credit linked to a checking account that allows a depositor to overdraw the account up to a specified amount
        
        Usually $500-$1000, but can be up to $10,000
        
        The consumer taps this line of credit by simply writing a check, and if that particular check happens to overdraw the account, the overdraft protection line will automatically advance funds in an amount necessary to put the account back in the black.
        
        In some cases, overdraft protection is provided by linking the bank’s credit card to your checking account (treated as a cash advance from your credit card)
        
        Unsecured Personal Loans
        
        A line of credit made available to an individual on an as-needed basis
        
        In essence, it’s a way of borrowing money from a bank, S&L, credit union, savings bank, or brokerage firm any time you wish but without going through all the hassle of setting up a new loan.
        
        Usually set up for minimums of $2,000 to $5,000 and often amount to $25,000 or more. As with an overdraft protection line, once an advance is made, repayment is set up on a monthly installment basis. Depending on the amount outstanding, repayment is normally structured over a period of two to five years.
        
        Home Equity Credit Lines
        
        A line of credit issued against the existing equity in a home
        
        the difference between the home's fair market value and the outstanding balance of all liens on the property
        
        Under the new law, interest charges on home equity loans up to $100,000 can only be fully deducted if you itemize deductions
        
        and the home equity loan proceeds are used to buy or improve your first or second home.
        
        You may only deduct interest on your total debt on mortgage and home equity up to $750,000 under the new law.
        
        Among the cheapest forms of consumer credit. For example, while the average rate on credit cards in the spring of 2018 was almost 17 percent, the average rate on home equity credit lines was about 5.7 percent.
        
        Usually repayment periods of 10-15 years
  - - - The Credit Application
        
        The type of information requested in a typical credit card application covers little more than personal/ family matters, housing, employment and income, and existing charge accounts.
        
        Checks creditworthiness: character and capacity
      - The Credit Investigation
        
        an investigation that involves contacting credit references or corresponding with a credit bureau to verify information on a credit application
        
        How much money you make
        
        How much debt you have and how you handle it
        
        How stable you are economically (age, employment history, rent/own home
      - The Credit Bureau
        
        an organization that collects and sells credit information about individual borrowers
        
        covers things like Social Security number, age, number of dependents, employment record and salary data, public records of bankruptcies, and the names of those who recently requested copies of your file
    - - Credit scoring
        
        a method of evaluating an applicant’s creditworthiness by assigning values to such factors as income, existing debts, and credit references
      - An overall credit score is developed for you by assigning values to such factors as your annual income, whether you rent or own your home, number and types of credit cards you hold, level of your existing debts, whether you have savings accounts, and general credit references.
        
        Fifteen or 20 different factors or characteristics may be considered, and each characteristic receives a score based on some predetermined standard.
      - FICO scores
        
        Fair Isaac uses only credit information in its calculations. There’s nothing in them about your age, marital status, salary, occupation, employment history, or where you live.
        
        payment history (35 percent), amounts owed (30 percent), length of credit history (15 percent), new credit (10 percent), and mix of credit types used (10 percent).
    - - APR annual percentage rate
        
        the actual or true rate of interest paid over the life of a loan; includes all fees and costs
      - ADB average daily balance (method)
        
        a method of computing finance charges by applying interest charges to the average daily balance of the account over the billing period
        
        ADB INCLUDING new purchases
        
        For each day in the billing cycle, take the outstanding balance, including new purchases, and subtract payments and credits; then divide by the number of days in the billing cycle.
        
        ADB EXCLUDING new purchases
        
        Same as the first method but exclude new purchases
    - - The Statement
        
        showing billing cycle and payment due dates, interest rate, minimum payment, and all account activity during the current period
        
        Retail charge cards have similar monthly statements, but without a section for cash advances
        
        The statement summarizes your account activity
        
        the previous balance (the amount of credit outstanding at the beginning of the month—not to be confused with past-due, or late, payments
        
        new charges made (four, in this case) during the past month
        
        any finance charges (interest) on the unpaid balance
        
        the preceding period’s payment
        
        any other credits (such as those for returns)
        
        and the new balance (previous balance plus new purchases and finance charges, less any payments and credits)
      - Payment
        
        Credit card users can avoid future finance charges by paying the total new balance shown on their statement each month
- - - - 7-4b Finance Charges, Monthly Payments, and the APR
        
        Add on method
        
        a method of calculating interest by computing finance charges on the original loan balance and then adding the interest to that balance
        
        generally rank as one of the most costly forms of consumer credit, with APRs that are often well above the rates charged even on many credit cards.
        
        With add-on interest, the finance charges are calculated using the original balance of the loan. This amount (the total finance charges) is then added on to the original loan balance to determine the total amount to be repaid
        
        Prepayment penalty
        
        Rule of 78s (or sum of the digits method)
        
        a method of calculating interest that has extra-heavy interest charges in the early months of the loan
        
        what is wrong is that the Rule of 78s front-loads an inordinate amount of interest charges to the early months of the loan, thereby producing a much higher principal balance than you’d normally expect.
        
        (Remember: The more of the loan payment that goes to interest, the less that goes to principal)`
      - 7-4a A Real Consumer Credit Workhorse
        
        In addition, installment loans can be set up with maturities as short as six months or as long as 7 to 10 years or even 15 years.
        
        These so-called home equity loans are similar to the home equity credit lines discussed in Chapter 6, except they involve a set amount of money loaned over a set period of time (often as long as 15 years) rather than a revolving credit line from which you can borrow, repay, and reborrow.
      - differ from single-payment loans in that they require the borrower to repay the debt in a series of installment payments (usually monthly) over the life of the loan
    - - 7-3b Finance Charges and the Annual Percentage Rate
        
        loan disclosure statement
        
        a document, which lenders are required to supply borrowers, that states both the dollar amount of finance charges and the APR applicable to a loan
        
        Although disclosures like this one allow you to compare the various borrowing alternatives, you still need to understand the methods used to compute finance charges because similar loans with the same stated interest rates may have different finance charges and APRs.
        
        Two such methods:
        
        simple interest method
        
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        discount method
        
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      - 7-3a Important Loan Features
        
        is repaid in full with a single payment on a given due date
        
        payment usually consists of principal and all interest charges. Sometimes, however, interim interest payments must be made (e.g., every quarter), in which case the payment at maturity is made up of principal plus any unpaid interest.
        
        can be secured or unsecured and can be taken out for just about any purpose
        
        gives a lender information about the purpose of the loan as well as the applicant’s financial condition
        
        Three important things to consider
        
        Loan Collateral
        
        lenders prefer items they feel are readily marketable at a price that’s high enough to cover the principal portion of the loan—for example, an automobile, jewelry, or stocks and bonds.
        
        In most cases, lenders don’t take physical possession of the collateral but instead file a lien, which is a legal claim that permits them to liquidate the collateral to satisfy the loan if the borrower defaults.
        
        If the borrowers maintain possession or title to movable property—such as cars, TVs, and jewelry—then the instrument that gives lenders title to the property in event of default is called a chattel mortgage.
        
        If lenders hold title to the collateral—or take possession of it, as is often the case with stocks and bonds—then the agreement giving them the right to sell these items in case of default is a collateral note.
        
        Loan Maturity
        
        the maturity (or term) on a single-payment loan is usually one year or less; it very rarely extends to two years or longer. When you request a single-payment loan, be sure that the term is long enough to allow you to obtain the funds for repaying the loans but not any longer than necessary
        
        Loan Repayment
        
        However, commercial banks and other single-payment lenders may not accept early repayments or, if they do, may charge a prepayment penalty on them. This penalty normally amounts to a set percentage of the interest that would have been paid over the remaining life of the loan.
        
        Many credit unions actually permit early repayment of these loans with reduced finance charges.
        
        Loan rollover
        
        the process of paying off a loan by taking out another loan
        
        However, you can expect the interest rate on a rollover loan to go up a bit; that’s the price you pay for falling short on the first loan.
    - - 7-2b Keeping Track of Your Consumer Debt
        
        If 20 percent or more of your take-home pay is going to monthly credit payments, then you’re relying too heavily on credit; if your debt safety ratio works out to 10 percent or less, you’re in a strong credit position.
        
        Every 3-4 months or annually, list all outstanding consumer debts except home mortgage
      - 7-2a Shopping for Loans
        
        Finance Charges
        
        Loan Maturity
        
        Total Cost of the Transaction
        
        Collateral
        
        Other Cost Considerations
        
        Can you choose a payment date that will be compatible with your spending patterns?
        
        Can you obtain the loan promptly and conveniently?
        
        What are the charges for late payments, and are they reasonable?
        
        Will you receive a refund on credit charges if you prepay your loan, or are there prepayment penalties?
        
        if it’s not too inconvenient, using collateral often makes sense because it may result in lower finance charges—perhaps half a percentage point or so.
    - - 7-1c Where Can You Get Consumer Loans
      - 7-1b Different Types of Loans
        
        Types Explained
        
        Auto loans.
        
        Account for about 30 percent of all consumer credit outstanding.
        
        Generally have maturities ranging from 36 to 60 months.
        
        Loans for other durable goods.
        
        Furniture, home appliances, TVs, home computers, recreational vehicles, and even small airplanes and mobile homes.
        
        Secured and generally require some down payment.
        
        Maturities vary with the type of asset purchased: 9- to 12-month loans for less costly items, such as TVs and computers, versus a 10- to 15-year loan for (say) a mobile home.
        
        Education loans
        
        Personal loans
        
        Typically used for nondurable expenditures, such as an expensive European vacation, or to cover temporary cash shortfalls.
        
        Many personal loans are unsecured
        
        Consolidation loans.
        
        Used to straighten out an unhealthy credit situation
        
        By borrowing money from one source to pay off other forms of credit, borrowers can replace, say, five or six monthly payments that total $400 with one payment amounting to $250.
        
        Usually expensive
        
        Single-Payment or Installment Loans
        
        Single-Payment
        
        a loan made for a specified period, at the end of which payment is due in full
        
        Interim financing
        
        the use of a single-payment loan to finance a purchase or pay bills in situations where the funds to be used for repayment are known to be forthcoming in the near future
        
        Installment
        
        a loan that is repaid in a series of fixed, scheduled payments rather than a lump sum
        
        with each installment made up partly of principal and partly of interest. For example, out of a $75 monthly payment, $50 might be credited to principal and the balance to interest
        
        The repayment period can run from six months to six years or more.
        
        Student Loans
        
        William D. Ford Federal Direct Loan Program (Direct)
        
        Two types
        
        In the subsidized loan program, the U.S. Department of Education pays interest while the student is in school and also during certain grace and deferment periods.
        
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        In the unsubsidized program, the borrower is responsible for all interest, whether in or out of school. Direct loans carry low, government-subsidized interest rates.
        
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        Federal Perkins loans
        
        Parent Loans for Undergraduate Students (PLUS)
        
        Under this program, parents can take out loans to meet or supplement the costs of their children’s college education, up to the full cost of attendance.
        
        Unlike the others, interest does begin accruing before you get out of school (interest included either way)
        
        Usually require monthly (principal and interest) payments over a period of 5 to 10 years.
        
        If you have several student loans outstanding, you can consolidate the loans at a single, blended rate and extend the repayment period to as long as 20 years. You also can ask for either:
        
        (1) an extended repayment for a longer term of up to 30 years;
        
        (2) a graduated repayment schedule, which will give you low payments in the early years and then higher payments later on; or
        
        (3) an income-contingent repayment plan, with payments that fluctuate annually according to your income and debt levels.
        
        Private vs public loans
        
        public lenders are often more flexible than private lenders in providing financial relief when borrowers are under pressure. For example, federal programs provide public service loan forgiveness, income-based repayment, and loan repayment assistance programs.
      - 7-1a Using Consumer Loans
        
        Single Payment
        
        CONSUMER loans, different from open forms of credit
        
        loans made for specific purposes using formally negotiated contracts that specify the borrowing terms and repayment schedule
        
        Another difference is that an open line of credit can be used again and again, but consumer loans are one-shot transactions made for specific purposes
        
        Because there’s no revolving credit with a consumer loan, no more credit is available (from that particular loan) once it’s paid off.
        
        no credit cards or checks are issued with this form of credit.
        
        whereas open account credit is used chiefly to make repeated purchases of relatively low-cost goods and services, consumer loans are used mainly to borrow money to pay for big-ticket items.
        
        Installment Loans
      - 7-1 c Where to Get Loans
        
        Consumer Finance Companies
        
        a firm that makes secured and unsecured personal loans to qualified individuals; also called a small loan company
        
        Credit Unions
        
        Savings and Loan Associations
        
        While they aren’t major players in the consumer loan field, S&Ls can make loans on such consumer durables as automobiles, televisions, refrigerators, and other appliances.
        
        They can also make certain types of home improvement and mobile-home loans as well as some personal and educational loans. Rates of interest on consumer loans at S&Ls are fairly close to the rates charged by commercial banks.
        
        Only the members can obtain installment loans and other types of credit from these institutions, but credit unions can offer membership to just about anyone they want, not merely to certain groups of people.
        
        Because they are nonprofit organizations with minimal operating costs, credit unions charge relatively low rates on their loans. They make either unsecured or secured loans, depending on the size and type of loan requested.
        
        Sales Finance Companies
        
        a firm that purchases notes drawn up by sellers of certain types of merchandise, typically big-ticket items
        
        The cost is often higher than the rates charged by banks and S&Ls, particularly when you let the dealer do all the work in arranging the financing (dealers normally get a cut of the finance income, so it’s obviously in their best interest to secure as high a rate as possible).
        
        Captive sales finance companies
        
        a sales finance company that is owned by a manufacturer of big-ticket merchandise GMAC is a captive finance company
        
        Life Insurance Companies
        
        cash value
        
        an accumulation of savings in a life insurance policy that can be used as a source of loan collateral
        
        Commercial Bank
        
        Typically charge lower rates than most other lenders, largely because they take only the best credit risks and are able to obtain relatively inexpensive funds from their depositors