ppt_ch06.ppt

Chapter Six

Credit Use and Credit Cards

Copyright ©Houghton Mifflin Company. All rights reserved. 6 - 2

Learning Objectives

1. Explain reasons for and against using credit.

2. Describe how people obtain and build a good credit reputation.

3. Compare and contrast the types of consumer credit and credit card accounts.


Learning Objectives (continued)

4. Recognize the impact of common (but not always beneficial) aspects of credit card accounts.

5. Manage your credit card and charge accounts to avoid fees and finance charges.


Reasons for and Against Using Credit

• Credit – any situation in which goods, services, or money are received in exchange for a promise to pay a definite sum of money at a future date.


Why People Use Credit

• For Convenience

• For Emergencies

• For Identification

• To Make Reservations

• To Consume Expensive Products Sooner

• To Enjoy the Good Life

• To Take Advantage of Free Credit


Why People Use Credit (continued)

• To Consolidate Debts

• For Protection Against Rip-Offs and Frauds

• To Obtain an Education


The Downside of Credit Usage

• Interest is costly

• It is tempting to overspend

• Use of credit reduces financial flexibility


Interest is Costly

• Interest – the price of credit.• Finance Charge – the total dollar

amount paid to use credit.• Annual Percentage Rate (APR) – the

cost of credit on a yearly basis as a percentage rate.

• Variable Interest Rates – go up and down (perhaps monthly) to reflect interest rate changes in the economy as a whole.


The Credit Approval Process: Applying for Credit

• Credit Application – a form or interview that requests information that sheds light on your ability and willingness to repay debts.


The Credit Approval Process: The Credit Investigation

• Credit Investigation – conducted by the lender and used to assign a credit rating to the applicant.

• Credit Rating – the lender’s evaluation of the applicant’s creditworthiness.

• Credit Report – credit history as reported by a credit bureau.

• Credit Bureau – company that gathers credit behavior information about consumers from lenders and sells reports on a credit applicant.


The Credit Approval Process: The Credit Investigation (continued)

• Credit Scoring (or Risk Scoring) – a statistical measure used to rate applicants on the basis of various factors deemed relevant to creditworthiness and the likelihood of repayment.


About FICO Scores

• FICO Scores – the factors that are used in them are shared openly by Fair, Isaac and Company on the company’s website:– payment history– amounts owed– length of credit history– taking on more debt and– types of credit used.


The Credit Approval Process: The Application Decision

• The lender decides whether to accept the application and under what terms

• Credit Agreement (or Note) – outlines the rules governing the account.

• Tiered Pricing – lenders may offer lower interest rates to applicants with the highest credit scores while charging steeper rates to more-risky applicants


Building a Credit History

• Establish both a checking account and a savings account.

• Have your telephone and other utilities billed in your name.

• Request, acquire, and use an oil-company credit card.

• Apply for a bank credit card.


Building a Credit History (continued)

• Ask a bank for a small short-term cash loan.

• Pay off student loans.


Managing Your Credit Bureau File

• Fair Credit Reporting Act (FCRA) – requires that reports contain accurate, relevant, and recent information, and that only bona fide users be permitted to review a file for approved purposes.


Managing Your Credit Bureau File (continued)

• If you find an error or omission, you should immediately take steps to correct the information:– Notify the credit bureau that you wish to exercise

your right to a reinvestigation under FCRA.– The bureau must reinvestigate the information

within 30 days.– If the information was erroneous, it must be

corrected.– If the credit bureau refuses to make a correction,

you may wish to provide a consumer statement.– Negative information in you file is generally not

reportable after a period of seven years.


Types of Consumer Credit

• Consumer Credit – nonbusiness debt used by consumers for expenditures other than home mortgages.

• Installment Credit – the borrower must repay the amount owed in a specific number of equal payments, usually monthly.

• Noninstallment Credit – includes single-payment loans and open-ended credit.


Types of Consumer Credit and (continued)

• Open-Ended Credit (or Revolving Credit) – credit is extended in advance of any transaction, so that the borrower does not need to reapply each time credit is desired.

• Credit Limit – the pre-approved maximum outstanding debt allowed on the credit account by the lender.


Credit Card Accounts

• Minimum Payment – must be made each month to cover interest and a small payment on the amount owed, if the borrower carries a balance from month to month.

• Principal – the amount owed.• Default – the borrower has failed to

make a payment of principal or interest when due or has not met another key requirement of a credit agreement.


Bank Credit Cards

• Bank Credit Card Account – an open-ended account at a financial institution that allows the holder to make purchases almost anywhere.

• Cash Advance – a cash loan from a bank credit card account.

• Convenience Checks – customers can use these checks as cash advances to make payments to others.


Bank Credit Cards (continued)

• Balance Transfer – a payment is used to make a payment on another credit card.

• Prestige Card – offer enhancements and require that the user possess higher credit qualifications.

• Affinity Cards – standard bank cards with the logo of a sponsoring organization imprinted on the face of the card.


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.


Retail Credit Card Accounts

• Retail Credit Card – allows a customer to make purchases on credit at any of the outlets of a particular retailer or retail chain.


Travel and Entertainment Cards

• Travel and Entertainment (T&E) Cards – allow holders to make purchases at numerous businesses, but the entire balance charged must be repaid within 30 days.


Other Forms of Open-Ended Credit

• Personal Line of Credit – a lending arrangement that allows the borrower access to a prearranged revolving line of credit provided by the lender.

• Home-Equity Line of Credit – uses the equity in the borrower’s home as collateral.

• Service credit – granted to consumers by public utilities, physicians, dentists, and other service providers that do not require full payment when services are rendered.


Figure 6.1: Credit Card Disclosure Information


Figure 6.1: Credit Card Disclosure Information (continued)


Teaser Rates and Default Rates

• Default Rate – a much higher APR that is assessed whenever a borrower fails to uphold certain rules of the account.

• Universal Default – occurs when a borrower is in default on one or more other loans or debts and is, thus, considered in default on a debt that is otherwise in good standing.


Preapproved Credit Card Offers

• Some credit card companies ‘prescreen’ people based on certain tests of creditworthiness

• Then they send applications or notices to these people


Annual and Transaction Fees

• Annual fee- a fee levied each year (usually $25 or $50)

• Transaction fee- a small charge levied each time a card is used

• This causes low-cost cards to sometimes become high-cost cards once all of the fees are assessed


Liability for Lost or Stolen Cards

• Protection available under the Truth in Lending Act that limits a cardholder’s liability if a card is lost of stolen

• The cardholder must notify the card issuer within 2 days of loss or theft

• After 2 days, the maximum liability is $50 prior to notification


Late-Payment, Bounced Check, and Over-the-Limit Fees

• Late payment charges of $50 are assessed if the cardholder is late in payment

• Bounced check fees are usually $50

• Over-the-limit fees are usually around $20-$50


Credit Card Insurance

• Credit Life Insurance – pays the unpaid balance of a loan, to the lender, in the event of the borrower’s death.

• Credit Disability Insurance – repays the outstanding loan balance if the borrower becomes disabled.

• Credit Unemployment Insurance


Managing Credit Cards Wisely


Figure 6.2: Sample Statement for a Revolving Charge Account


Credit Statements

• Billing Date- (sometimes called the closing date or statement date) is the last date of the month for which any transactions are reported; this is generally the same date each month

• Due Date- date, specified by the credit card company, of when they should receive payment– The period between the billing date and

due date is usually about 20-25 days


Credit Statements (continued)

• Transaction and Posting Dates- date on which the credit card holder makes a purchase or receives a credit

• Grace Period – the time period between the posting date of a transaction and the due date, within which any new credit card purchases made during the billing cycle will avoid finance charges.


Credit Statements (continued)

• Minimum Payments- to meet his/her obligations the cardholder must make a minimum payment each month; finance charges are assessed after

• Credit for Merchandise Returns and Errors- if the cardholder returns an item or a billing error has been made, the credit appears on the next month’s bill


Correcting Errors on Your Credit Card Statement

• Chargeback – the amount of the transaction is charged back to the business where the transaction originated.

• Goods and Services Dispute – asserts that the charges were for poor-quality goods and services and you made a good-faith effort to try to correct the problem with the merchant.

• Dunning Letters – notices that make insistent demands for repayment.


Correcting Errors on Your Credit Card Statement (continued)

• You should take several actions when disputing an item on a billing statement:– Send a written notice of the error to the

credit card insurer.– Provide photocopies (not originals) of any

necessary documentation.– Withhold payment for disputed items.– After the dispute has been settled, review

your credit bureau file.


Computation of Finance Charges

• Periodic Rate – the APR for a charge account divided by the number of billing cycles per year.

• Average Daily Balance – the sum of the outstanding balances owed each day during the billing period divided by the number of days in the period.


Golden Rules of Credit Use and Credit Cards

1. Protect your credit reputation just as you would guard your personal reputation.

2. Obtain copies of your credit bureau reports every year, and challenge all errors or omissions on them.

3. Obtain the lowest APRs possible when opening credit accounts. If necessary, move credit card balances to lower-cost accounts.


Golden Rules of Credit Use and Credit Cards (continued)

4. Pay your credit cards off each month. Never make convenience purchases on bank credit cards on which you carry a balance.

5. Always check your monthly billing statements against your receipts to ensure their accuracy. Challenge all discrepancies.

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