Chapter 18Responsibilities and Costs of Credit

Ch. 18-1 Using Credit Responsibly

Responsibilities to Yourself◦ You must use credit wisely and not get into debt

beyond an amount you can comfortably repay◦ Never having enough money and always

scrambling to make your next payment is a stressful way to live

◦ If you cant make your payments a creditor may take you to court to have your wages garnished Garnishment- is legal process that allows part of

your paycheck to be withheld for payment of a debt◦ Don’t buy on impulses, shop around and do

research before buying

Responsibilities of Consumer Credit

Responsibilities to Yourself Cont.◦ Tying up future income should be done with

careful planning to maximize your purchasing power

◦ Comparison shop for credit and become familiar with the interest rates and due dates

◦ Have the right attitude about using credit Enter into each transaction in good faith and with the

expectation of meeting your obligations and keeping your credit reputation

Responsibilities of Consumer Credit

Responsibilities to Creditors◦ Opening an account is entering a relationship with

a store, bank or credit card company You are promising your honesty and sincerity in using

credit◦ You have the responsibility to limit your spending

to amounts that you can repay◦ By singing a credit application you agree to make

all payments promptly on or before a due date

Responsibilities of Consumer Credit

Responsibilities to Creditors Cont.◦ You are responsible for reading and understanding

the terms of all agreements◦ It is your responsibility to contact the creditor

immediately when you find a problem with the bill or discover defective merchandise

◦ If an emergency prevents you from making a payment you should contact the creditor to make arrangements to pay at a later date

Responsibilities of Consumer Credit

Creditors Responsibilities to You1. Assisting consumers in making wise purchases by

honestly representing goods and services2. Informing consumers about all rules and regulations,

interest rates, credit policies, and fees3. Cooperating with established credit reporting agencies,

making credit records available to the consumer and promptly fixing any mistakes

4. Establishing and carrying out sound lending and credit policies

5. Using reasonable methods of contacting customers who fail to meet their obligations and assisting them when possible with repayment schedules and helping to minimizes credit problems

Responsibilities of Consumer Credit

Most common type is the illegal use of a lost or stolen credit card or of credit card information intercepted online◦ You are only liable for up to $50, the merchant is

not protected from a loss Consumers as a whole ultimately pay higher prices

because of this

Protecting Yourself from Credit Card Fraud

Safeguarding Your Cards◦ It is your responsibility to protect your cards from

unauthorized use Tips to protect your cards

Sign them as soon as you get them Carry only the ones you need Keep a list of your card numbers, expiration dates, and

phone number and address of each company Notify creditors immediately by phone when your card is

lost or stolen and follow up wit a letter so that you have documentation

Watch your card during transactions and get it back as soon as you can

Protecting Yourself from Credit Card Fraud

Safeguarding Your Cards Tips to protect your cards

Tear up an carbon or carbonless paper that contains account info

Don’t lend them to anyone or leave them lying around Destroy expired cards by cutting them up Don’t give your numbers and expiration dates over the

phone to people or business you don’t know Keep your sales receipts and verify all charges on your

card statements promptly

Protecting Yourself from Credit Card Fraud

Protecting Your Cards Online◦ Buying on the Internet opens up the possibility for

criminals to steal credit card info◦ Software makers and online companies are fighting

these people constantly by developing new ways to offer secure electronic transmission of your info

◦ Ways you can protect yourself online Only deal with companies you know and trust Always look for your browser’s symbol that indicates a

secure site before entering info IE7 has a closed lock next to your address bar

Legitimate online merchants clearly state their privacy policy (how they are going to handle the info you give them)

Protecting Yourself from Credit Card Fraud

Protecting Your Cards Online◦ Ways you can protect yourself online

Many sites offer assurance by displaying the seal of a nonprofit watchdog group, such as the BBB or TRUSTe Sites are only allowed to display the seal if they follow the

guidelines of these watchdogs Phishing is a scam that uses online pop-up messages or

email to deceive you into disclosing your info “Phishers” send messages that appear to be from a business

that you normally deal with, ISP’s, banks, or credit card Co. They ask you to verify your bank account number, password,

card number or there personal info Never respond to these requests, if your bank or ISP needs

you to verify the information they will contact you by means other than email

Protecting Yourself from Credit Card Fraud

Credit is helpful if used wisely Before borrowing money ask these 3 questions

◦ Do I need Credit?-Can I afford credit?-Can I qualify for credit?

If you can say “yes” to any of these, follow these guidelines1. Accept only the amount of credit that you need

Unused credit is the remaining credit available to you(credit limit - the amount you have already spent)

can count against you because if your limit is much higher than what you typically use other creditors will be reluctant to loan money because even though you don’t use all of it you could and possibly could not pay it back

Can be temptations to use more credit than you need

Avoiding Unnecessary Credit Costs

If you can say “yes” to any of these, follow these guidelines2. Make more than the minimum payment

Minimum payments result in the max cost to you Mean you will remain in debt for a very long time Ex: $5,000 balance and your rate is 18% you make the min.

payment(of which is usually 2% of total) it would take you 33 years to pay it off resulting in paying $12,000 for a $5,000 loan

3. Don’t increase credit spending when your income increases

Instead of spending your extra income save it or invest it It is wiser to reduce existing debt or invest for future use

Avoiding Unnecessary Credit Costs

If you can say “yes” to any of these, follow these guidelines4. Keep the number of credit cards to a minimum

Credit counselors recommend carrying no more than 1 or 2 cards

If you have more you will be tempted to make more purchases

1 major card (Visa or MasterCard) is good at most businesses eliminates needing mult. Cards

5. Pay cash for purchases under $25 If pay cash for small purchases you won’t be surprised with a

big bill at the end of the month Paying cash will help you see how much you are spending

and typically will spend less doing so

Avoiding Unnecessary Credit Costs

If you can say “yes” to any of these, follow these guidelines6. Understand the cost of credit

Think about how finance charges, monthly payments, and length of time you will be committed to payments will affect your lifestyle

7. Shop for loans Type and source of your loan will make a big difference in cost Plan your major purchases carefully Never make decisions on the spur of the moment

8. Take advantage of rebate programs Rebate is a partial refund of an amount spent Some allow you to accumulate points that can be used for hotel

rooms, airline tickets, or cash back Don’t use these types of cards just to get the rebates!!!!

Avoiding Unnecessary Credit Costs

Ch. 18-2

Analyzing and Computing Credit Costs

1. Method of computing finance charges2. Source of credit

◦ Some lenders are better than others

3. Amount financed and length of time◦ More you borrow and time it takes = the more

finance charges you will pay

4. Ability to repay debt◦ Higher your creditworthiness is, the better your

rates will be

5. Type of credit selected◦ Different plans impose different charges

Why Credit Costs Vary

1. Collateral◦ Secured loans generally have fixed interest rates that are lower than

current variable rates charged on credit cards and open ended credit◦ Fixed-rate loan- are loans for which the interest rate does not

change over the life of the loan

2. Prime Rate◦ Interest rates charged for the use of credit are affected by this◦ Prime rate- is the interest rate that banks offer to their best business

customers, such as large companies

3. Economic Conditions◦ Borrowers pay more for the use of credit during inflationary economic

periods When prices are rising (inflation), then money is more in demand to buy

higher priced goods for which lenders charge higher interest rates

4. The business’s costs of providing credit◦ Businesses pass along their costs to their creditors via higher finance

charges and higher rates

Why Credit Costs Vary

Simple Interest Formula◦ Simple interest- is interest computed on the

amount borrowed (or saved) only, without compounding

◦ Assumes one payment at the end of the loan period◦ Cost is based on three things principal, interest rate

and the time money is borrowed for◦ Formula

Interest = Principal x Rate x Time Principal- is the amount borrowed or the unpaid portion of

the amount borrowed, on which the borrower pays interest Rate is expressed as a percentage Time is expressed as a fraction of a year

Computing the Cost of Credit

Annual Percentage Rate Formula◦ Use this type of formula for installment credit purchases

(boats, cars and furniture), when making payments over time

◦ Requires a down payment- part of the purchase price paid in cash up front, reducing the amount of the loan

◦ When buying a car many dealers ask for at least 10% down or will consider your trade in your down payment

◦ Each payment includes principal and interest◦ The difference between the total price and the cash price

is the finance charge◦ By law installment contracts must reveal the finance

charge and the APR◦ Formula

Computing the Cost of Credit

APR = 2 x n x F P (N + 1)

n = number of payment periods in one yearF = finance chargeP = principal or amount borrowedN = total number of payments to pay off loan

Credit Card Billing Statements◦ Cost of open-ended credit accounts varies with the

method creditors use to get the finance charge◦ Creditors must tell you the method they use to figure

out their finance charge◦ Finance charges are usually calculated based on the

monthly billing cycle◦ Finance charges are computed on the unpaid balance

after the billing date◦ Creditors must tell you when finance charges begin on

your account◦ Most creditors give you a 20-25 day grace period

before starting a finance charge

Computing the Cost of Credit

Credit Card Billing Statements◦ 4 different ways creditors can figure finance charges

1. Adjusted Balance Method Finance charge is only applied to the amount owed after you’ve

paid your bill each month Formula

Monthly interest rate x balance remaining after payment = finance charge added to next months balance

This type of method has the lowest finance charges

2. Previous Balance Method Finance charge is applied to the entire amount owed from the

previous month Formula

Monthly interest rate x previous monthly balance = finance charge added to next months balance

This type of method has the highest finance charges

Computing the Cost of Credit

Credit Card Billing Statements◦ 4 different ways creditors can figure finance charges

3. Average Daily Balance Method Most used type Creditors calculate your balance on each day of the billing

cycle Compute average daily balance by adding together all

daily balances and dividing by the number of days in the cycle (25 or 30)

Payments made during the billing cycle are used in figuring the average

Formula Average daily balance x monthly interest rate = finance charge

Computing the Cost of Credit

To figure the average daily balance(amount before payment)+(amount after payment)

25 or 30 days

Credit Card Billing Statements◦ 4 different ways creditors can figure finance charges

1. Two-Cycle billing Newest way companies are finding finance charges Method calculates the finance charge on the average daily

balance over the last two billing periods rather than just one Example situation

If you start with no balance, you make a purchase and you only pay part of your balance off at the end of the month. The following month you pay the entire balance. The month following those two months you would pay a finance charge for the two months you had balances.

The result is higher interest and no grace period You pay interest from the date of purchase Try to avoid these types of cards

Computing the Cost of Credit