Credit and Going into Debt A. What is credit?

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1 Lesson 4 standards E.6.1 Explain the basic functions of money. E.6.2 Identify the composition of the money supply of the United States. E.6.3 Explain the roles of financial institutions. E.6.6 Explain how interest rates act as an incentive for savers and borrowers. E.6.7 Compare and contrast different types of financial investments.

2 Credit and Going into Debt A. What is credit? 1.) Credit = the receipt of money either directly or indirectly to buy goods and services with the promise to pay for them later 2.) Principal = the amount of money originally borrowed on a loan 3.) Interest = the amount of money the borrower may pay for the use of someone else s money 4.) Any time you receive credit, you are borrowing money and going into debt. You must pay interest for the use of someone else s purchasing power (that someone else may be a bank, credit card company, a store, etc)

3 B. Installment Debt 1. Installment debt is a loan paid back in equal payments over time. It is one of the most common types of debt 2. Usually paid for purchases of durable goods manufactured products that last longer than three years ex = cars, refrigerators, washers, dryers, furniture, etc 3. You can also borrow cash and pay it back in installments (monthly payments) 4. The length of an installment period is very important because it determines the size of the borrower s monthly payments and the total amount of interest to be paid. a.) longer pay back period have lower payments but higher interest 5. Mortgage an installment debt owed on real property such as houses, buildings or land. Makes up the largest form of installment debt in the country

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5 C. Why people use credit 1. As a necessity when buying durable goods 2. To satisfy an immediate need 3. To avoid waiting to enjoy the product 4. To spread the payments out over the lifetime of the item being bought

6 D. Deciding to use credit 1. Consider the benefit of having the product now instead of later a. It is basically a question of comparing costs & benefits; 1. The benefit of borrowing is being able to buy & enjoy the good or service now instead of later b. The cost is whatever you must pay in interest or lost opportunities to buy other items. 1. You don t have to accept every offer of credit

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8 Can a credit card be used to receive cash? A. Yes B. No

9 A debt owed on property is called a mortgage A. True B. False

10 Which of these are not a reason A. As a necessity people use credit? B. To fill immediate need C. To save money D. Buy nice things [Default] [MC Any] [MC All]

11 The amount of money originally A. Credit B. Principal C. Interest D. Profit borrowed on a loan [Default] [MC Any] [MC All]

12 Sources of loans & credit A. Types of Financial Institutions 1.) Commercial banks a.) Today, banks control the largest amount of money and offer the widest range of services ex = checking accts, savings accts, and individual loans 2.) Savings and Loan Associations (S&L s) a.) Like banks they accept deposits & loan money 1. S&L s make single-family & multi family mortgage loans 2. They finance commercial mortgages and auto loans 3. S&L s often have lower interest rates than commercial banks

13 3. Savings Banks a.) SB s were created to serve small savers who weren t being served by larger banks 1. Most savings banks lend money for home mortgages and also make personal and auto loans 4. Credit Unions a.) Owned and operated by their members to provide savings accounts & low interest loans only to its members 1. They primarily make personal, auto, & home improvement loans 2. They tend to offer higher interest rates on savings & charge lower interest rates on loans than other financial institutions 5. Finance Companies a.) They collect debt for store s installment loans and add a fee for collecting the debt b.) A consumer finance company makes loans to consumers at high rates of interest ex = people who use consumer finance companies are usually unable to borrow from other sources with lower rates because they haven t repaid loans in the past or have an uneven employment record

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15 B. Charge accounts 1. Enables consumers to buy goods & services from a particular company, store, etc & pay for them later Three types of charge accounts; a.) Regular charge account (30 day charge) 1. Has a credit limit 2. A 30 day billing cycle at the end of every 30 days the store sends a bill for the entire amount 3. No interest is charged, but the entire bill must be paid. If not, interest is charged on the unpaid amount b.) Revolving charge accounts 1. Have a minimum payment due each month & interest is charged on the outstanding balance allows for additional purchases even if bill isn t paid in full Has a credit limit & if you pay everything you owe each no interest is charged c. ) Installment charge accounts 1. Major items such as furniture, TV s appliances, autos are purchased through an installment charge account month Equal payments spread out over time Part of the payment is applied to the principal and part to the interest when payments are complete borrower owns product

16 C. Credit cards 1.) Like a charge account, but can be used in many different places and businesses throughout the U.S. and even foreign countries 2.) Credit cards are issued through banks and can be used to purchase items in businesses that accept them & can be used to borrow money up to a certain amount 3.) Have high interest rates due to a large number of delinquent loans. 4. )Some offer lower rates with special conditions to attract consumers

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18 Credit cards are issued by: A. Banks B. Credit agencies C. Stores [Default] [MC Any] [MC All]

19 With a revolving charge account, can additional purchases be made if there is a balance due? A. Yes B. No

20 D. Financial charges and annual percentage rates 1. Financial charge and Annual Percentage rate tell the same thing the cost of credit, but each is expressed a different way a. Finance charge 1. The cost of credit expressed in dollars and cents the entire cost of borrowing, including all interest and fees. 2. Finance charges can be computed in 4 different ways each method applies the interest rate to an account balance at a different period during the month. The different methods result in widely varying finance charges

21 b. Annual percentage rates (APR) 1. The cost of credit expressed as a yearly percentage 2. Knowing the APR allows consumers to compare costs regardless of dollar amounts or length of contract agreement. 3. The APR is usually larger than the interest rate because it takes into account any non-interest costs of credit such as a membership fee In general, if you plan on paying your credit card every month look for a card with a low or no annual fee. If you plan on carrying a balance from month to month, choose a card with a low interest rate.

22 E. Debit cards 1. Debit cards are not a loan 2. Debit cards transfer money electronically from a person s bank directly to the store, restaurant, etc when they purchase goods

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24 The cost of credit expressed in dollars and cents the entire cost of borrowing, including all interest and fees. A. Finance charge B. Annual percentage rate (APR) C. Interest [Default] [MC Any] [MC All]

25 Debit cards are a loan A. True B. False

26 Applying for credit A. Creditworthiness 1. When applying for credit, you usually fill out an application 2. The lending agency, store, bank etc hires a credit bureau, a private business to do a credit check 3. A credit check shows your income, any current debts, details of your personal life, and how well you have repaid debts in the past.

27 B. The credit rating 1. A CR tells how risky it is to lend money to a specific person or business it is either good, average or poor 2. Past history of credit use is important in deciding creditworthiness, but creditors look at three other factors a. Capacity to pay This is related to income & debt Ex = a spotty work record raises questions about your ability to pay Ex = if you already carry a large amount of debt, creditors are reluctant to loan you more

28 b. Character a person s reputation as a reliable and trustworthy person Ex = they may look at your education, any problems with the law, and any other factors that might indicate your strength of character c. Collateral the size of your personal wealth Ex = collateral is important because it indicates your past ability to save and accumulate. Also, even if you would lose your job, you can sell some of your belongings to make payments

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30 3. Secured loans are backed up with collateral in the event of non-payment 4. Unsecured loans are backed up with nothing more than a promise to repay based on a person s reputation alone, or it may require a cosigner who becomes responsible for repaying the loan in the event of non-payment

31 C. Responsibilities as a borrower 1. Pay on time if you never pay off your debt, the lending institution has to write it off and take a loss. These costs are passed on to all consumers in the form of high interest rates charged. 2. Repay all your debts, or you will suffer the consequences of a bad credit history 3. Keep complete records of all charges you make so you don t go over your credit limit. Also, notify the credit card company immediately if your card is lost or stolen. 4. If debt becomes unmanageable, try to pay on the high interest debts first and try to pay more than the minimum amount required.

32 Government regulation of credit A. The Truth in Lending Act (1970) 1. The 1 st law that expanded the govt s role in protecting users of consumer credit 2. Ensures that consumer are fully informed about costs and conditions of borrowing B. Fair Credit Reporting Act (1970) 1. Protects the privacy and accuracy of information in a credit check C. Equal Credit Opportunity Act (1974) 1. Those who provide credit can t discriminate solely on the basis of race, religion, national origin, gender, marital status, age or receipt of public assistance 2. After 1974, a woman no longer had to have her father or husband sign for her to get a credit card or other loan

33 D. Fair credit Billing Act (1974) 1. Set up a procedure for quick correction of mistakes that appear on consumer credit accounts E. Fair Debt Collection Practices Act (1977) 1. Prevents abuse by professional debt collectors; doesn t apply to banks or other businesses that collect their own account F. State Usury Laws 1. restricts the amount of interest that can be charged for credit, setting up maximum interest rates. 2. Interest ceilings (max rate to be charged) can lead to a shortage of credit hurting both the lender and the consumer

34 G. Personal Bankruptcy 1. Buying on credit is a serious consumer activity 2. For debtors who absolutely can t repay their debts, they may file for personal bankruptcy this should be a last resort. Certain debts such as taxes must still be paid. 3. Debtors give up most of what they own, which is then distributed amongst creditors 4. Creditors are not forced to forgive the entire debt (lenders will not be paid off, at least not in full, for what they are loaned out) 5. Bankruptcy proceedings remain on your credit record for 7-10 years during this time, it may be difficult to reestablish credit & to borrow money.

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36 An unsecured loan requires collateral A. True B. False

37 Declaring bankruptcy dissolves all debt A. True B. False