5B Consumer Credit #2

Covered so far… Advantages and disadvantages of credit

Types and sources of credit

Credit capacity (how much you can afford)

Credit reports and scores

Still to cover… The cost of credit

Protecting your credit

Consumer credit protection laws

Debt problems and bankruptcy5-1

Objective 4Determine the Cost of Credit by

Calculating Interest Using Various Interest Formulas

• Finance charge – Total dollar amount you pay to use credit

– Includes interest costs and fees, such as service charges, credit-related insurance premiums, or appraisal fees

• Annual Percentage Rate (APR) – Percentage cost of credit on a yearly basis– Key to comparing costs when shopping for rates

It is important to shop around for credit

5-2

Tackling the Trade-Offs

• Term (length of loan) versus interest cost– Longer loan: higher interest rate; total cost

• Lender risk versus interest rate– Fixed rate: increases lender risk

• To reduce the lender’s risk and thus the interest rate you can:– Accept a variable interest rate– Provide collateral to secure a loan– Provide up-front cash– Take a shorter term loan

5-3

Secured Credit Cards

Secured Credit Card (or Collateralized Credit Card) – Backed by collateral in the form of a savings account opened at the financial institution that issues the card.

Example:

Deposit $1,000 with creditor to borrow $1,000

Calculating the Cost of Credit

• Simple interest– Computed on principal only without compounding

– The dollar cost of borrowing

– Interest = Principal x Rate x Time

• Simple interest on the declining balance– Interest is paid only on the amount of original

principal not yet repaid

• Add-on interest– Interest calculated on full amount of principal

– Interest added to original principal

– Payment = Total divided by number of payments to be made 5-5

Calculating the Cost of Credit

• Avoid minimum monthly payment trap– The longer to pay bill, the more interest you pay

• Avoid credit card fees– Annual Fee- fee charged each year just to have a

credit card (many are increasing; why?)

– Transaction Fee- fee charged to use a credit card, get cash advances, or make transfers

– Late Fee- fee assessed for making a late payment

– Bounced Check Fee- fee for NSF check payment

– Over-the-Limit Fee- fee charged (with cardholder’s permission) to exceed credit card limit

5-6

Objective 5Develop a Plan to Protect Your Credit and Manage Your Debts

Fair Credit Billing Act (FCBA, 1975)

• Notify creditor of error in writing within 60 days

• Pay the portion of the bill not in dispute

• Creditor must respond within 30 days

• Credit card company has two billing periods, but

no longer than 90 days, to correct your account

or tell you why they think the bill is correct

5-7

Protecting Your Credit

• Disputed item won’t affect your credit rating

while in dispute• Can withhold payment on damaged or shoddy

goods or poor services if purchased with a credit card

• Must make sincere attempt to resolve problem

with creditor – Contact merchant first and document it

Fair Credit Billing Act (FCBA, 1975)

5-8Has anybody ever used FCBA procedures?

Co-signing a Loan

Co-signing means guaranteeing a debt– Lender would not require a co-signer if borrower

were a good risk– Can you afford it if the borrower defaults?

• If borrower doesn’t pay, cosigner is liable for the full amount plus any late or collection fees

• If payment is missed, creditor can collect from the cosigner first

• Unpaid debts will appear on the cosigner’s credit report

5-9

Complaining About Consumer Credit

• First: Try to solve the problem directly with the creditor

• If that fails: Use formal complaint procedures

• Federal government administers laws and assists with complaint procedures

– Federal Reserve Board

– Federal Trade Commission (FTC)

5-10

Consumer Credit Protection Laws

• Truth in Lending and Consumer Leasing Acts– Requires disclosure of the cost of credit (APR)

• Equal Credit Opportunity Act (ECOA)– Prohibits discrimination in credit-granting decisions

• Fair Credit Billing Act– Provides rules for correcting billing errors

• Fair Credit Reporting Act– Provides rules for accessing/correcting credit reports

Your Rights Under Consumer Credit Laws– Complain to the creditor– File a complaint with the government– If all else fails, sue the creditor

5-11

Managing Your Debts

Warning Signs of Debt Problems

• Paying only the minimum balance each month

• Trouble even paying the minimum balance

• Total balance increases every month

• Missing loan payments or paying late

• Using savings to pay for necessities

• Getting second or third payment notices

• Borrowing money to pay old debts

• Exceeding the credit limits on your credit cards

• Denied credit due to a bad credit report5-12

Managing Your Debts

Debt Collection Practices

The FTC enforces the Fair Debt Collection Practices Act (FDCPA)

– Prohibits certain practices by debt collectors (e.g., early or late calls, calls at work, profane language)

– Does not eliminate legitimate debts; just controls the way that debt collectors work

– Does not apply to first-party debt collectors (original creditors); only to third-party collectors (independent companies)

5-13

Managing Your Debts

Consumer Credit Counseling Services (CCCS)

– Non-profit and supported by contributions from banks, merchants, etc.

– Provides education about credit

– Provides help with spending plan

– Provides debt counseling services for those with serious financial problems

– Can develop a debt repayment plan and negotiate reduced interest rates

5-14

Declaring Personal Bankruptcy

U.S. Bankruptcy Act of 1978

Chapter 7 = straight bankruptcy

Chapter 13 = wage earner plan

Bankruptcy should be the last resort, because of the damage to your credit rating; stays in a person’s credit

report 10 years vs. 7 years for other negative information

Personal bankruptcy is a legal process to distribute some or all assets among a person’s creditors due to an inability to repay debts.

5-15

Chapter 7 Bankruptcy

• Submit a petition to the court that lists assets and liabilities, and pay a filing fee

• Many, but not all, debts are forgiven

• Assets surrendered to pay creditors

• Can keep some assets (home, vehicle,..), depending on state/federal exemptions

• Intent = “A Fresh Start”

• Most bankruptcies are this type5-16

After Chapter 7

• You May No Longer Owe:– Retail store charges

– Bank credit card charges

– Unsecured loans

– Unpaid hospital or physician bills

• You Still May Owe... – Certain taxes and fines

– Child support and alimony

– Educational loans

– Debts from willful or malicious acts5-17

Bankruptcy Abuse Prevention and Consumer

Protection Act of 2005– Makes it more difficult for consumers to file a

Chapter 7 bankruptcy (means test)

– Debtors must wait 8 years from their last bankruptcy to file again

– Clamps down on “bankruptcy mills” that seek to game the system

– Includes provisions for consumer education on debt management and financial planning

5-18

Chapter 13 Bankruptcy

• Debtor with regular income proposes a plan

to eliminate his debts over time

• Debtor normally keeps most of property

• Information provided to the court the same as

under Chapter 7

• Plan may last up to five years

• Debtor makes payments to a court-appointed

trustee

5-19

Obtaining Credit after Bankruptcy

• May be more difficult

• But, creditors may consider the inability to

file bankruptcy again for 8 years

• Could be easier for Chapter 13 filers (who

have repaid some debt) versus Chapter 7

filers who made no effort to repay

• Likely to pay high interest rates (lower credit

score)

5-20

CARD Act Regulations

• 45 days’ notice before key changes in account terms (up from previous 15 days)

• Minimum payment illustrations on credit card bills (payoff cost and payment to repay in 36 months)

• “Universal default” practice was banned• Two-cycle balance billing was banned• “Teaser rates” must last at least 6 months• Consumers must “opt in” for over-the-limit fees• Bills must be mailed 21 days before due date• No more “late fee traps” (e.g., weekends, 8 am)

College Students and Credit Cards(CARD Act)

• Credit card companies are prohibited from offering free merchandise in exchange for credit card applications (on campus, campus events)

• No credit cards under age 21 unless cosigner or proof of income to make payments

• Maximum amount of credit < 21: greater of $500 or 20% of annual gross income in most recently completed calendar year

• Aggregate limit for ALL credit cards held by someone <21: 30% of annual gross income in most recent completed calendar year

Alternatives to Credit Cards for College Students

• “Authorized user” on parent’s credit cards and reimburse parents– Parents see everything you charge; may be fees

– Does not boost students’ credit much; parent is user

• Joint account with parents– Credit history reported to credit bureaus; builds credit

• Secured credit cards– Still need to follow CARD Act cosigner/income rules

• Prepaid debit cards– Not “credit”; use will not build credit history; high fees

– Less protection than credit cards if lost or stolen

Wrap Up

• Chapter Quiz

• Concept Check 5-4- Two Key Concepts and Credit Terms

• Concept 5-5- Correcting a Billing Error

• Helpful Advice for Others