chapter 5 credit management what is credit? credit is created/extended when a consumer acquires...

Chapter 5 Credit Management

•What is Credit?Credit is created/extended when a consumer acquires money, goods, and services based on an agreement with lender called a LOAN.

The loan states that credit is extended for– a specified period of time with– a specified rate of interest


•The Bad News About Credit– Americans are becomingly increasingly

dependent on credit– Credit encourages people to live beyond

their means, leading to financial disaster


•Classifying Consumer Credit– Revolving or Open-ended

• Consumers make purchases up to certain limit

• Finance charge on unpaid balance

• Regular 30-day charge accounts (open-ended) balance must be paid off each month (Amex)

– Installment Loans• Repayment of loan plus interest on regular basis

• Home mortgage loan an example


•How Much Should You Borrow?– It is IMPORTANT to set DEBT LIMITS

Rule of thumb for borrowing– No more than 10 - 20% of take-home

pay should be used to pay installment debt

– Mortgage debt should be excluded in this calculation


•The Right Reasons for Borrowing

Purchasing large goods and services

Emergencies

Taking advantage of opportunities

Convenience

Establishing credit


•The Wrong Reasons to Borrow

Using credit to live beyond your means

Examples:• To meet basic living expenses• To make impulse purchases• To purchase short-lived goods and

services


Some Major Credit Sources


•National Credit Cards– Issued by large corporations as well as financial

institutions

– Consumer controls how to pay it off• Balance paid off each time -- usually no interest

is charged

• Balance not paid off in full -- finance charge incurred

– Still one of the most expensive sources of credit


•Retail Credit Cards– Good only in stores where issued– Rates comparable to those charged on bank

credit cards


•Consumer Finance Companies– Assume more risky loans and charge higher

interest ratesLoans can be made in small amounts Easier to receive a loan and more convenient than

using bank Loans are speedily processed


•Life Insurance Companies– Policy holders build up not only

protection, but also cash value over the years

– Amount = to cash value can be borrowed in form of a loan


•Brokerage Account Loans– Rates competitive with banks

– Amount borrowed a function of the value of securities held


•Personal Loans– Written agreements help reduce

misunderstandings– Agreement should specify:

• Terms of loan• Interest charged• Obligations of both borrower and lender

– Advisable ONLY if funds are not borrowed from traditional sources


•PawnbrokersPawn brokers accept valuables as collateral– Issue loans for 35 - 40% of valuables– Charge high interest rates (20 - 40%)– Demand quick repayment (usually within

60 - 90 days)– Should be used only as last resort


•Three C’s of Credit : CapacityCreditors examine:Current income vs. currentCurrent debtsNumber of dependentsAlimony and child support paymentFuture income potential


•Three C’s of Credit: Character -- Past credit Timeliness of payments Accuracy of information you provided

on income, employment, etc.. Stability


•Three C’s of Credit: CollateralCollateral -- something of Value

pledged as promise to repay the loanProtects creditors should loan not be

repaid


•Credit Bureaus– Clearinghouse of consumer credit

information– No judgments made by bureau on credit

worthiness of person– Information provided weighed differently by

different lenders


•Steps to Establishing Credit Open checking, savings account Install telephone in your name Obtain gas credit card Apply for bank credit card even if

offered only low limit Have parents co-sign loan Begin repaying student loan


•Denial of CreditSome reasons lenders may deny credit are:

• Not enough income vs. expenses

• Negative factors such as late payments in credit history• Several job changes

• Incomplete credit background

– If denied, lender must give written explanation


•Finance Charges– Finance charge -- difference between

amount repaid and original amount borrowed

– Annual percentage rate (APR) -- interest rate paid per dollar per year for credit


•Which Credit Card is Best for You?The answer depends on your credit card use.

Weigh the following attributes accordingly:

– If you pay off the balance each month• No annual fee• A grace period

– If you carry a balance each month• A low annual percentage rate


•Consequences of Credit Abuse:– Repossession of Property

• Failure to make a loan payment means the borrower defaults on a loan

• If borrower defaults, creditor can seize property and sell it to recover funds


•Consequences of Credit Abuse: – Wage Garnishment

• One of the strongest actions creditors can take

• Court order requiring portion of borrower’s wages paid directly to the lender

– Amount deducted by employer from paycheck– Deductions continue until debt repaid


•Bankruptcy

A legal process where • A person or business that cannot meet

financial obligations is relieved of debt

• Courts divide assets and income among creditors


•Repercussions of Bankruptcy– Borrowers not relieved of

• Back taxes • Alimony• Child support payments

– Bankruptcy judgment on person’s credit record for next 10 years

– Credit will be difficult to obtain for that time period


•First Bankruptcy Alternative –

Chapter 7 Filing

– Liquidation plan where assets are seized by court and sold

– Funds then prorated among creditors

– Usually creditors receive only small portion of funds owed them


•Second Bankruptcy Alternative -- Chapter 13 Filing

– Also known as the wage earner plan– Individuals establish three-year repayment

plan– Allowed to retain possession of their

property– Creditors receive 60 - 70% of amount owed

them

chapter 5 credit management what is credit? credit is created/extended when a consumer acquires...

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