Goodheart-Willcox Co., Inc.

9
Credit
Goodheart-Willcox Co., Inc.

Chapter Objectives
Explain the advantages and disadvantages of
using credit.
Identify the different types of consumer
credit.
Describe how to establish a sound credit
rating.
Define the key terms in credit contracts and
agreements.

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continued

Chapter Objectives
Compare credit terms and charges.
Outline the steps involved in managing
credit.
Identify steps to take in resolving credit
problems.
Summarize the laws that govern the use of
credit.

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Understanding Consumer
Credit
Credit plays an important role in the
economy
Provides extra buying power that
supports mass production and
distribution
Helps make more goods and services
available to consumers at lower prices

Goodheart-Willcox Co., Inc.

continued

Understanding Consumer
Credit
Credit is a medium of exchange
It is an agreement between two parties
Creditor supplies money, goods, or services
to the borrower
Borrower agrees to make future payment
by a particular date or according to an
agreed-upon schedule

Goodheart-Willcox Co., Inc.

continued

Understanding Consumer
Credit
There is a risk that the borrower cannot
repay what is owed
Creditors minimize risk by
having borrowers sign a contract
taking a borrower who defaults to court
and even taking back property

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Reasons to Use Credit

Gives you the
opportunity to
buy costly items
that you may not
be able to buy
with cash

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continued

Reasons to Use Credit

You can use goods and services as you
pay for them
Credit can be used as a source of cash
for emergencies and unexpected
expenses
You can take advantage of sale prices
when you dont have cash

Goodheart-Willcox Co., Inc.

continued

Reasons to Use Credit

Convenience
eliminates the need to carry a lot of cash
provides a purchase record
simplifies shopping by phone, mail, and
Internet

You can make purchases that are part of

a long-range financial plan: education,
furniture, vacation
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Drawbacks of Credit Use

Using credit reduces future income
Expenseusing credit costs money
(finance charges)
Temptationusing credit makes it easy
to spend money you dont have
Risk of serious consequencesfinancial
problems arise when debts arent paid
on time and in full
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Cost of Credit
Using credit is more costly than
paying with cash

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continued

Cost of Credit
Borrowers must pay principal plus
finance charges
Finance charges reimburse creditors for
the costs of making credit available
taking the risk that borrowers may default

Goodheart-Willcox Co., Inc.

continued

Cost of Credit
Creditors

may borrow money to make credit

available; when they borrow, they must
also pay interest
lose the chance to invest money
incur costs for opening and servicing credit
accounts
absorb losses of unpaid accounts and cost
of collecting overdue debts

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Finance Charges
Are the dollar amounts paid for credit
Consist of two parts: interest and fees
Are expressed as percentages

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In Your Opinion
Have you ever lent
money to a friend?
Based on your
experience, do you
think creditors
deserve to be paid
a finance charge?

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Annual Percentage Rate (APR)

The higher the APR, the more you pay
Example: Interest for a $500 loan repaid
in 12 monthly payments would cost
$50.08 at 18%
$58.72 at 21%
$67.36 at 24%

Goodheart-Willcox Co., Inc.

Amount of Credit Used

The more credit you use, the more you
pay
Example: Interest on a loan repaid in 12
monthly payments at an APR of 18%
would cost
$50.08 for a $500 loan
$110.01 for a $1,000 loan
$220.02 for a $2,000 loan
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Length of Repayment Period

The longer you take to repay what you
borrowed, the more you pay
Example: Interest on a $500 loan at 1.5%
per month (18% APR) would cost
$50.08 if repaid in 12 monthly payments
$99.44 if repaid in 24 monthly payments
$150.88 if repaid in 36 monthly payments

Goodheart-Willcox Co., Inc.

Types of Credit
Closed-end credit
must be repaid by
a certain date
Open-end credit
allows the
borrower to use
money for an
indefinite period
Goodheart-Willcox Co., Inc.

Closed-End Credit
Most are installment loans that let you
borrow a given amount of money and
repay it with interest in regular
installments
Examples: student loans, car loans,
most home loans

Goodheart-Willcox Co., Inc.

continued

Closed-End Credit
A secured loan requires collateral
finance charges may be lower because
creditor can take property if loan is not
repaid
An unsecured loanfinance charges are
usually higher because no collateral;
borrower must have strong credit rating
or a cosigner
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Open-End Credit
Borrower can continue to use credit if
he or she makes scheduled payments,
pays finance charges, and stays within
borrowing limit
Regular charge accounts
Revolving credit accounts

Offered by retailers, merchants, banks,

credit agencies
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continued

Open-End Credit
You must make at
least the
minimum
payment each
month
Total amount you
may owe at any
one time is
limited
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Establishing Credit

Start with a job

Open a savings account
Open a checking account
Apply for a credit card at a local
department store or gas company

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Your Credit Rating

Determines whether you can get credit
and what you will pay for it
Is measured by the three Cscharacter,
capacity, and capital
A creditworthy applicant is judged to
have the assets, income, and tendency
to repay debt

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The Credit Report

Three major national agencies sell credit
reports to creditors
Each agency collects information about
financial and credit transactions
The information on these reports often
differs
Carefully review your credit reports
and report errors to agencies
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continued

The Credit Report

The report lists
every credit account
ever opened
outstanding balances
negative data, such
as late payments,
unpaid debts,
bankruptcy

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Credit Scores
A credit score is a numerical measure of a
loan applicants creditworthiness
The higher the score, the greater a
persons creditworthiness
The lower the score,
the more trouble you will have getting credit
the more expensive credit will be

Goodheart-Willcox Co., Inc.

continued

Credit Scores
Credit score factors:
Bill paying
Debt-to-credit-limit-ratio
Credit history length
Recent credit application
Different types of credit

You may have more than one credit

score generated by different agencies
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Getting a Credit Card

Common types of
credit cards include
general-purpose
company or retail
store
travel and
entertainment

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Shopping for a Credit Card

Understand possible fees, penalties, and
consequences of failing to carry out the
terms of the agreement
Be wary of acceleration clauses, balloon
payments, and add-on clauses

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The Contract
Read the
contract
(application)
thoroughly
before
signing it

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Disclosures
Annual percentage rates:
What is the APR?
How long will a lower introductory rate
last? What is the regular rate?
Can the rate be raised for any reason?
Is the rate fixed or variable?

Goodheart-Willcox Co., Inc.

continued

Disclosures
What is the grace period?
What method is used to calculate the
interest rate?
Is there an annual fee? If so, how much?
What are fees for
late payments
exceeding credit limit
cash advances
balance transfers

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Subprime Credit Cards

Easier to get; offered to those with poor
credit histories
Often carry high interest rates, large
annual fees, and other charges
Low credit limits
Often a bad deal for consumers

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Managing Your Credit

Know your
financial
personality.
What are your
money attitudes
and habits?

Goodheart-Willcox Co., Inc.

continued

Managing Your Credit

Keep track of spending
Create a budget
Dont use more credit than you can pay off
each month
Save your receipts and keep a log of credit
charges

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Remember Alternatives to Using

Credit
Not to buy
Pay with savings
Postpone buying now and buy later
with cash

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Check Monthly Statements

Check statements
against your own
record of charges,
payments, and
credits

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Check Your Credit Report

Regularly
Find and correct
errors
immediately
Make sure no one
has applied for
credit in your
name

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Report Lost or Stolen Cards

Keep a list of your credit cardsissuers,
account numbers, issuer phone numbers
Report lost or stolen cards right away
If your card is lost or stolen, you are
responsible for
$50 per card that is charged by others
no charges made by others if you notify the
issuer before the card is used
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Handling Credit Problems

Poor credit use consequences:
Inability to get loans and credit cards
Paying higher interest rates for credit
Having fewer housing choices
Having fewer job prospects because many
employers check credit reports
Paying higher insurance premiums

Goodheart-Willcox Co., Inc.

continued

Handling Credit Problems

Blemishes on credit reports:
Accurate negative information, such as
missed or late payments, may remain on
your report for seven years
Bankruptcies may remain on your report
for 10 years

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continued

In Your Opinion
Would you cosign a loan for your best
friend or a family member if doing so
would endanger your credit rating?

Goodheart-Willcox Co., Inc.

Handling Credit Problems

Actions taken to recover debts:
Collection agencies are hired to get
payment
Repossession of property, including
foreclosure
Liens against property
Wage garnishment

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Bankruptcy
Desperate debtors last resortfile for
personal bankruptcy
Court excuses debtor from repaying some
or all debt
Debtor gives up certain assets and
possessions

Two typesChapter 7 and Chapter 13

Consequences of bankruptcy are severe
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The Easy-Access Credit Trap

Easy-access credit includes
payday loans
pawnshops
rent-to-own
title loans

A loan shark is someone who uses

predatory lending tactics and easyaccess credit
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Inform Creditors
They may change payment dates and
amounts if you have trouble paying bills

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Get Credit Counseling

Use reputable nonprofit credit
counseling services
Avoid credit counseling firms that
charge high fees
demand that the debtor pay them rather
than their creditors

Goodheart-Willcox Co., Inc.

Consumer Credit Legislation

Truth in Lending Law requires creditors
to tell consumers what credit will cost
Equal Credit Opportunity Act prohibits
creditors from discriminating against
consumers
Fair Credit Reporting Act requires
accuracy and privacy of credit report
information
Goodheart-Willcox Co., Inc.

continued

Consumer Credit Legislation

Fair Credit Billing Act protects
consumers from unfair billing practices
Electronic Funds Transfer Act protects
consumers in EFT transactions
Fair Debt Collection Practices Act
protects consumers against unfair
methods of collecting debts

Goodheart-Willcox Co., Inc.

continued

Consumer Credit Legislation

Preservation of Consumers Claims and
Defenses Ruling protects debtors who
have a legitimate dispute with a seller
Bankruptcy Abuse Prevention and
Consumer Protection Act
was meant to increase fairness of the
bankruptcy system
makes filing for bankruptcy more difficult

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Central Ideas of the Chapter

Credit is a powerful financial
management tool.
Serious financial problems result from
the misuse of credit.

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Glossary of Key Terms

Back

annual percentage rate (APR). The annual

cost of credit a lender charges.
bankruptcy. A legal state in which the courts
excuse a debtor from repaying some or all
debt. In return, the debtor must give up
certain assets and possessions.
closed-end credit. A loan that must be repaid
with finance charges by a certain date.

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Glossary of Key Terms

Back

collateral. Property that a borrower promises

to give up in case of default.
contract. A legally binding agreement
between a borrower and a creditor.
cosigner. A responsible person who signs a
loan along with a borrower thereby agreeing
to pay the obligation if the borrower fails to
do so.

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Glossary of Key Terms

Back

credit. An arrangement that allows

consumers to buy goods or services and pay
for them later.
credit card. Allows consumers to make
purchases or borrow money on a timepayment plan.
creditor. The party that supplies money,
goods, or services in a credit agreement.

Goodheart-Willcox Co., Inc.

Glossary of Key Terms

Back

credit report. A record of a persons credit

history and financial behavior.
creditworthy. A credit applicant judged to
have the assets, income, and tendency to
repay debt.
default. When a borrower fails to pay the debt
owed.

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Glossary of Key Terms

Back

easy-access credit. A short-term, high-interest

loan granted to borrowers regardless of credit
history.
foreclosure. The forced sale of a property.
garnishment. A legal procedure requiring a
portion of a debtors pay to be set aside by the
persons employer to pay creditors.

Goodheart-Willcox Co., Inc.

Glossary of Key Terms

Back

grace period. The time between the billing

date and the start of interest charges.
lien. A legal claim on a borrowers property
by a creditor who is owed money.
loan shark. Someone who loans money at
excessive rates of interest.
open-end credit. Allows the borrower to use a
certain amount of money for an indefinite
period of time.

Goodheart-Willcox Co., Inc.

Glossary of Key Terms

Back

pawnshop. A business that gives customers

high-interest loans with personal property,
such as jewelry, held as collateral.
payday loan. A short-term, high interest loan
that must usually be repaid on the borrowers
next payday.
principal. The amount borrowed on a loan.

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Glossary of Key Terms

Back

rent-to-own. A credit arrangement in which a

consumer pays rent for the use of a product
and eventually owns it.
repossession. A lender takes back collateral
when a borrower fails to repay a loan.
secured loan. A loan that requires collateral.
title loan. A loan made using the borrowers
car as collateral.

Goodheart-Willcox Co., Inc.