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Chapter 4: Introduction to Consumer Credit - Coggle Diagram
Chapter 4: Introduction to Consumer Credit
Types of Credit
Closed-End Credit
loans made only once, which the borrower repays in equal installments over a set period of time
Installment cash credit
= direct loan of money for personal purposes (i.e. home improvements)
Single lump-sum credit
= loan that must be repaid in total on a specified day (30-90 days)
Examples
: mortgage loans, automobile loans, installment loans
Open-End Credit
Line of credit
= the dollar amount which may or may not be borrowed made available by the lender
Interest
= a periodic charge for the use of credit
Revolving check credit
= prearrange loan from a bank for a specified amount, A.K.A. bank line of credit
Examples:
cards issued by departments stores, bank cards, travel and entertainment cards and overdraft protection
Credit Cards
about half of all credit card users are convenience users and pay balances in full each month
others are borrowers, carrying a balance over and paying finance charges
cash advances accrue interest from the moment you accept the cash in addition to the transaction fee
Co-branding - linking a credit card with a business trade name offering points or rebates on product and services
Smart cards and Debit Cards
Smart Cards
have embedded computer chip
combine credit cards, driver's license, healthcare ID with your medical history and insurance information, etc
Debit Cards
bank cards, ATM cards, cash cards, and check cards
electronically subtracts from your account the moment you make a purchase (no delay in payment)
Stored-Value (or Gift) Cards
prepaid cards
resemble debit cards and use magnetic stripe technology to store and track funds
used in lieu of paper gift certificates
used for business purposes (payroll, travel expenses, government benefit payments)
retailer bankruptcy can make cards worthless
Travel and Entertainment Cards
not considered as credit cards
monthly balance is due in full
Diners Club or Carte Blanche cards
Annual fee allows you to replace lost passports, buy airline tickets, find doctors, and access airport lounges around the world
Smartphones and Home Equity Loans
Smartphones
most smartphones are able to make purchases, called mobile commerce
Home Equity Loans
Based on the difference between current market value of your home and the amount owed on the mortgage
Borrow up to 85% of the appraised value of the home less amount still owed
Interest on loan is tax deductible
It is set up like a
revolving line of credit
Debit/Credit Card Fraud
Protecting yourself against debit/credit card fraud
sign new cards as soon as they arrive
treat cards like money and keep them in a secure place
shred anything with your account number on it
don't give your card number over the phone or online unless you initiate the call and don't write it on postcards
get card and receipt after every transaction and check for billing statement errors
notify the card issuer if you don't get your billing statement or if your card is lost or stolen
Protecting your credit card information on the internet
use a secure browser
keep records of online transactions
review monthly bank and credit card statements
read policies of the website you visit
keep personal information private
never give your password to anyone online
give payment information only to businesses you know and trust
don't download files sent to you by strangers or click on hyperlinks from people you don't know
LO4: Consumer Credit Counseling Services
What the Consumer Credit Counseling Service (CCCS) Does?
Aids families by helping set up realistic budget and plan for expenditures
Provides education about credit buying and budgeting
Can administer a debt repayment plan
Alternative Counseling Services
Nonprofit counseling services are available from universities, credit unions, military bases, and housing authorities.
Check with banks or consumer protection offices for reputable, low-cost financial counseling.
LO1: What is Consumer Credit?
Credit
arrangement to receive cash, goods, or services now and pay for them in the future
Consumer Credit
use of credit for personal needs (except a home mortgage) by individuals and families
The Importance of Consumer Credit in Our Economy
Advancement of automobiles in early 1900s, installment credit was introduced
Economist recognize consumer credit is a major force in the American economy
Generation X views credit like a lifeline
Advantages of Credit
Immediate access to goods and services
Permits purchase even when funds are low
A cushion for financial emergencies
Advance notice of sales
Easier to return merchandise
Convenient when shopping
Safer than cash
Indicates financial stability
Disadvantages of Credit
Temptation to overspend
Failure to repay loan may result in loss of income, valuable property, and your good reputation
It does not increase total purchasing power
Credit costs money
LO3: Measuring Your Credit Capacity
Debt Payments-to-Income Ratio
Dividing monthly debt payments by net monthly income
Don't include house payment in your monthly payment debt payment total
Should not exceed 20% of your net (after-tax) income.
Debt-To-Equity Ratio
Divide your total liabilities by your net worth.
Don't include the value of your home and the amount of its mortgage in total net worth.
Cosigning Loan
The creditor will give you a notice that tells you:
being asked to guarantee the debt, so consider if you can afford it if the borrower defaults.
If the borrow does not pay, you may have to pay up to the full amount and also any late or collection fees.
If a payment is missed, the creditor can collect the debt from you without first trying to get it from the borrower.
If You Do Consign
Be sure you can afford to pay the loan. If not, your credit rating could be damaged.
Consider that the liability for this debt may prevent you from getting other credit that you want.
If your pledge property, could lose it if the loan goes into default.
Check your state's law to learn about consigner's rights.
Request that a copy of overdue-payment notices.
Building and Maintaining Your Credit Rating
A good credit rating is an asset that should be nurtured and protected.
Limit your borrowing to capacity to repay.
Live up to the terms of contracts.
Check to see what is in your credit report.
Most creditors rely on credit reports.
CREDIT BUREAUS
Consumer Reporting Agencies (CRAs) collect information about consumers.
Experian, TransUnion and Equifax
Consumer Financial Protection Bureau gets about 36,000 complaints each year about credit bureaus.
WHO PROVIDES DATA TO CREDIT BUREAUS?
They get information from banks, court records, finance companies, merchants, credit card companies and other creditors.
Fair Credit Reporting Act.
This act regulates the use of the credit reports.
Requires the deletion of obsolete information.
Gives consumers the right to have erroneous data corrected.
Only authorized persons have access to your report.
Adverse data can be reported for 7 years.
Time Limits on Adverse Data
Maybe reported for 10 years if bankruptcy has been declared.
Unpaid tax liens can be reported for 15 years.
Incorrect Information in Your Credit File
Mistakes may occur even though credit bureaus are required to follow reasonable procedures.
When notified, a bureau must investigate the proposed inaccurate data.
The reporting agency must remove the item unless the creditor verifies the information is accurate if you contest an item on your credit report.
What are the Legal Remedies?
Any consumer reporting agency or used of reported information that fails to comply with provisions of the Fair CRA may be sued by the affected consumer.
If found guilty, the consumer may be awarded actual damagers, court costs, attorney fees and punitive damages.
Action must be brought within two years of occurrence or discovery
The Cost of Credit
The Cost of Credit
The Truth in Lending Law mandates APR and finance charge disclosure by creditors.
Finance Charge covers all credit costs, like interest, fees, insurance premiums, and appraisal fees.
Annual Percentage Rate (APR)
the percentage cost of credit on a yearly basis
your key to comparing costs, regardless of the amount of credit or how much time you have to repay for it
APR is the true rate of interest to compare rates with other sources of credit
the law doesn't set interest rates or other credit charges, but it does require disclosure so that you can compare costs
Tackling the Trade-Offs
Term vs Interest Cost
longer loans with smaller monthly payments results in more total interest
A comparison
choice of loan depends on what you need
lowest-cost loan Vs lower monthly payment
longer loans may have higher total costs
size of downpayment makes a difference
Lender Risk Vs Interest Rate
minimize borrowing costs by accepting these conditions
variable interest rate - based on fluctuating rates
secured loan - pledge property or assets as collateral
up-front cash - making a large downpayment
a shorter term - shorter period of time = smaller chance something will prevent repayment
Calculating the Cost of Credit
Simple interest
Interest computed on principal only and without compounding
The dollar cost of borrowing
Interest = Principal × Rate of interest × Time
(I = P × r × T)
Simple interest on the declining balance.
Used when more than one payment is made on a simple interest loan.
Interest is paid only on the amount of original principal not yet repaid.
The more frequent your payments, the lower the interest you will pay
Add-On Interest
Interest is calculated on the full amount of the original principal.
Then this interest amount is immediately added to the original principal.
Then the total (interest plus principal) is divided by the number of payments to be made to arrive at the payment amount.
When more than one payment is made, this method results in an effective rate of interest higher than stated rate of interest.
Cost of Open-End Credit
Average daily balance method
The fairest method of computing finance charges.
Creditors calculate your monthly interest by averaging your daily balances and multiplying it by the monthly interest rate.
New purchases during the billing period may be included or excluded from the average daily balance calculation.
Two-cycle Average Daily Balance Method
May include or exclude new purchases.
Method of computing finance charges that uses the average daily balance for two consecutive billing cycles
The Credit CARD Act of 2009 bans this method
Cost of Credit, Inflation, and Taxes
Cost of credit & expected inflation
Borrowers and Lenders are concerned about dollars, then about goods and services those dollars can buy (purchasing power)
Inflation erodes the purchasing power of money.
Each percentage point increase in inflation means a decrease of approximately 1% in the quantity of goods and services you can purchase with a dollar.
Cost of credit & Tax Consideration
Interest paid on consumer credit is not tax deductible.
LO5: Avoiding and Correcting Credit Mistakes
Identity Crisis
What to do if your identity is stolen:
Contact the fraud department of each of three major credit bureaus.
Contact the creditors for any accounts that have been tampered with or opened fraudulently.
File a police report and keep a copy in case your creditors need proof of the crime.
Tear or shred personal information before placing in trash.
cancel checks and ATM card if compromised.
Contact the Privacy Rights Clearinghouse or call 619-298-3396
Social Security Administration may issue you a new Social Security number.
File a complaint with Federal Trade Commission at 1-877-FTC-HELP
Defective Goods or Services
You may withhold payment on any damaged or shoddy goods or poor services if you have paid for them with a credit card.
Need to have made a sincere attempt to resolve the problem with the merchant.
Your Credit during the Dispute
Creditor may noy threaten your credit rating while you are resolving a billing dispute.
Once written, a creditor is prohibited from giving out information that would damage your credit reputation.
Until your complaint has been answered, the creditor may not take any action to collect the disputed amount.
-After explaining, creditor may report you as delinquent on the dispute amount and take action.
In case of Billing Error
Call your creditor. If dispute exists, notify creditor of error in writing withing 60 days.
Include your explanation of the error and your account number to the billing inquiries address.
Must respond within 30 days
Credit card company has two billing periods but no longer than 90 days to correct your account.
Your credit rating is not affected while item is disputes.
FAIR CREDIT BILLING ACT.
Passed in 1975
Sets procedures for promptly correcting billing mistakes, refusing to make credit card or revolving credit payments.
LO6: Complaining about Consumer Credit
Credit Card Accountability, Responsibility and Disclosure Act of 2009.
Consumer Credit Consumer Reporting Reform Act.
Fair Credit Reporting Act.
Fair Credit Billing Act.
Equal Credit Opportunity Act.
-Truth in Lending and Consumer Leasing Acts.
Protection Under Consumer Credit Laws
There are a variety of major federal consumer credit laws.
If that does not work, there more formal complaint procedures.
If you have a complaint about credit, first try to solve the problem directly with the creditor.
Complaining about Consumer Credit
Sources of Consumer Credit
Analyze the major sources of consumer credit
Inexpensive loans
Parents or family members.
Borrowing on financial assets
Stafford Loans
Medium-priced loans
Commercial banks, savings and loan associations, and credit unions.
Expensive loans
Finance companies
Retailers
Check cashers
Bank credit cards
Tax refund loans
Declaring Personal Bankruptcy
Assess the choices in declaring personal bankruptcy
BANKRUPTCY
A legal process in which some or all of the assets of a debtor are distributed among the creditors because the debtor is unable to pay his or her debts.
Declaring bankruptcy is a last resort because it severely damages your credit rating.
Bankruptcy Abuse Prevention and Consumer Protection Act of 2005
Executive Office for U.S. Trustees develops a financial management training curriculum to educate individual debtors on how to better manage their finances.
Debtors complete an approved instructional course in personal financial management.
Clerk of each bankruptcy district maintains a list of credit counseling agencies and instructional courses on personal financial management.
Should A Lawyer Represent You In A Bankruptcy Case?
You have the right to file your own bankruptcy case and to represent yourself at all court hearings.
You must complete and file with a bankruptcy court several detailed forms concerning property, debts, and financial condition.
May find it easier to complete forms with assistance from experienced counsel.
Managing Your Debts
Develop a plan to manage your debts.
Notify creditors if you can’t make a payment and try to work out a modified payment plan.
If automobiles are repossessed, you will owe difference between selling price and unpaid debt in addition to legal, towing, and storage charges.
Debt Collection Practices
Fair Debt Collection Practices Act.
Regulates debt collection agencies.
If a debt collector calls you, within five days must send you a written notice of amount owed, the creditor’s name, and your right to dispute the debt.
You can dispute the debt or pay it.
If you dispute debt, you may request verification of the debt within 30 days; if not sent, you can insist that communication about the debt cease.
If verification sent, you may pay the debt or give notice that you will not pay.
Warning Signs of Debt Problems
Emotional problems such as the need for instant gratification.
The use of money to punish or get even.
The expectation of instant comfort among young couples who overuse the installment plan.
Keeping up with the Joneses.
Overindulgence of children.
Misunderstanding or lack of communication among family members.
Amount of finance charges makes it difficult to repay.
Danger Signals of Potential Debt Problems
Paying only the minimum balance each month.
Increasing the total balance due each month.
Missing or alternating payments or paying late.
Intentionally using overdraft protection or taking frequent cash advances.
Using savings to pay routine bills such as food.
Receiving second or third payment notices.
Not talking to your partner about money or talking only about money.
Depending on overtime to meet routine expenses.
Using up your savings.
Borrowing money to pay old debts.
Not knowing how much you owe.
Going over your credit limit on credit cards.
Having little or no savings for the unexpected.
Being denied credit due to a credit report.
Getting a credit card revoked by the issuer.
Putting off medical or dental visits because you can’t afford them now.
The Serious Consequences of Debt
Robbing Peter to pay Paul can affect family health.
May result in loss of job due to garnishments.
May result in neglecting the educational needs of children.
May result in heavy drinking.
May result in neglect of children.
May result in marital difficulties.
May result in drug abuse.
May result in bankruptcy.
Describe the information creditors look for when you apply for credit
Credit rights of women are protected under the E C O A.
how to improve your credit score
Get copies of your credit report — review for accuracy.
Pay your bills on time.
Lower balances
Use credit wisely to improve score over time.
Beware of credit-repair scams.
What if Your Application is Denied?
Ask questions.
E C O A gives you the right to know the specific reasons for denial.
If the denial is based on a credit report, you are entitled to know the specific information in the credit report that led to it.
You may ask the bureau to investigate any inaccurate or incomplete information and correct its records.
After you receive this information from the creditor, you should contact the local credit bureau to find out what information it reported.
Sample Credit Application Questions
7 more items...
Amount of loan requested.
Proposed use of the loan.
Your name and birth date.
Social Security and driver’s license numbers.
Present and previous street addresses.
Present and previous employers and their addresses.
Present salary.
Number and ages of dependents.
Other income and sources of other income.
F I C O and Vantagescore
Between 300 and 850.
Higher the score, less risky you are.
Ignores negative credit history if affected by natural disasters.
Model allows predictive score for those with short credit histories.
Does not count debt collections that have been paid off.
VantageScore was launched in 2006.
Age, Public Assistance, and Housing Loans
Age.
ECOA states creditor can only ask about age to verify old enough to sign a binding contract (18 or 21 years old).
Public Assistance.
You may not be denied credit because you receive Social Security or public assistance.
Housing Loans.
E C O A covers your application for mortgage or a home improvement loan
WHAT CREDITORS LOOK FOR: 5 Cs.
Conditions — What economic conditions could affect your ability to repay the loan?
Collateral — What property do you have to pledge that the lender can repossess if you default on the loan?
Capital — What are your assets and net worth?
Capacity — Can you repay the loan?
Character — Do you pay bills on time?