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1 THE SAM LETTER manchester capital management Welcome TO Manchester Capital s SAM: Stuff About Money! In this issue we re going to talk about Credit by looking into the lives of one SAM family. The goal of SAM is to educate. Since our firm s inception in the early 1980s, we have learned that the families we serve as their trusted wealth advisors usually consist of multiple generations with varying levels of knowledge about wealth management. Each issue of SAM will present a different topic that we hope you or someone in your family will find helpful. Enjoy! Arnie has just turned 16 and wants to buy a car. Arnie s big sister Sarah is 19 and ready to celebrate finishing her first year of college by going on a trip with her friends to Florida. They both need more money than they actually have in their bank account. What to do... You can help by choosing what they should do. Borrow money from Mom and Dad. The kids promise great grades, clean rooms, chores around the house with no complaining, and their entire beanie baby collection. Do it on their own by borrowing from a bank or credit company and paying the loan with money from their part-time jobs. Sounds scary, but they know that some of their responsible friends are doing this. They should give up. Getting a new car or going to Florida is a hoop dream anyway.

2 U Annual Fee: a flat fee charged each year by a credit card company just for holding the card Credit Report: record of a person s past borrowing and repaying, including late payments Credit Score: a three-digit score, ranging from 300 to 850, based on a credit report; higher scores are better Creditor: person/entity to whom money is owed Debtor: person who receives a loan and must pay it back Grace Period: the time from the date when a borrower promises payment and when payment is due Interest: the cost for using borrowed money Interest Rate: a percentage used to calculate the amount of interest, typically reported as an annual percentage rate (APR) Minimum Payment: the lowest amount a person is required to pay on a credit card bill each month 02

3 THE SAM LETTER manchester capital management If you chose Option 3: Splash some cold water on your face. What are you thinking?!!! Don t ever give up!!! A new car and Florida are reachable goals! Go back and choose a real option!! If you chose Option 1: Well Arnie and Sarah are some lucky kids. Most people would say family, as a creditor, would be the safest option for teenagers. Here is their chance to show their family they are responsible. They should write a thank you letter to their creditor and detail how they plan on paying the loan amount back. Arnie and Sarah write out the terms, the amount they owe and their plan for paying it back. They include paying interest as part of the plan if they really want to impress. They should be realistic too. If they know they will need some time before they can start paying back the loan, they should ask for a grace period. If you chose Option 2: Congratulations!!! Arnie and Sarah have taken their first step into the real world of CONSUMER DEBT. Sounds terrifying right? It s actually not, if they follow the rules. It can actually be quite liberating to be in charge of your finances. They are also taking a major step toward building a good credit history.

4 Arnie s car loan Arnie would like to get a new Corvette ZR1, but he s a smart enough guy that he knows that s way more than he can afford. After researching some more affordable cars and taking some test drives, Arnie decides to buy a slightly used Honda Accord for $15,000. Arnie s parents agree to contribute $5000 to the purchase. They are happy not to be his chauffeur anymore. Arnie needs to get a car loan for $10,000 from a bank. It would be best to go to a bank in which he or his parents already have an account. It s also a good idea to shop around for the best interest rate. For the year 2010, 5% is on the low end and 15% is on the high end. The interest rate is important because it could mean the difference of paying $2,645 interest at 5% or $8,548 at 15%. Let s do the math at two different interest rates. $10,000 at 5% interest for 5 years. That would make Arnie s monthly payment $ After paying off the $10,000, he would have paid an extra $1,323 in interest. $10,000 at 15% interest for 5 years would make Arnie s monthly payment $ After paying off the $10,000 he would have paid an extra $4,274 in interest. At the time of this newsletter going to print the average interest rate for a car loan was 6.5%. $10,000 at 6.5% interest over 5 years would make Arnie s monthly payment $ This is an amount Arnie can handle with the income he earns from his weekend job doing landscaping and painting. The total interest he would pay over 5 years would be $1,740. If Arnie makes all his payments on time and pays off the loan on the agreed terms, Arnie will start building himself a good credit score and will qualify for other types of credit in the future, such as credit cards and home loans. 04

5 THE SAM LETTER manchester capital management Sarah s trip to Florida Luckily, Sarah is over 18. She qualifies for a credit card. Sarah needs to be careful, though. Credit cards are designed to confuse you with their introductory offers and payment terms. Some credit card companies like to set up shop at college fairs, and they offer free t-shirts and other schwag if college students will sign up for an account. WARNING: WALK AWAY. The credit cards offered at these events are rarely good deals. Take the forms and compare them with credit card offers you can research at places like bankrate.com and creditcard.com. Think of the snowball effect signing up for cards at college fairs could cause. Sarah can get approved for all the credit cards she signed up for. She could just go on a shopping spree tomorrow and max out her credit cards. Sounds great, right? NO NO NO!!! If each credit card has a credit limit of $5,000, and she gets approved for three, that would technically mean she could have $15,000 in DEBT.

6 Carrying this much debt, when she has no way to pay it off, will definitely hurt her credit score. Okay, so hopefully Sarah didn t sign up on the spot. Now she can compare the card company offerings. Some cards may charge annual fees just for holding the card, and the cards will have different interest rates. Some cards will also offer flight miles, cash back, or awards like gift certificates to certain stores. As enticing as they sound, these offers should not be the main reason for choosing a card. These rewards are used to make the owner of the credit card want to spend more. Fees should be the top priority in choosing a card because they are what will cost you for using the card. Try to find a card with no annual fee, a low interest rate (8 12%), and a grace period of at least 21 days. Sarah decides to choose a card with an 11.99% annual interest rate. It does not have an annual fee. It has a credit limit of $4000. It also offers 5% cash back on some purchases. 5% doesn t seem like much, but compared to the other rewards this seemed to benefit her the most. So she will get $5 back for every $100 that she spends on certain items and at certain stores. Sarah goes to Florida and has a terrific time with her friends sightseeing and laying out on the beach. The total she charges to her credit card is $1250. Costs are $400 for her plane ticket, $500 for her share of a hotel room for one week, and $350 on food, shopping, and a ticket to Universal Studios. Her plane ticket was on an airline that qualifies for 5% cash back with 06

7 THE SAM LETTER manchester capital management use of her credit card, so she gets $20 ($400 x 5%) credited to her account. Her total credit card bill is $1230. The minimum payment due each month is 2% of the amount owed on the card each month (the balance) or $20, whichever is greater. Sarah makes the smart choice to pay more than the minimum. Sarah is able to pay $300 each month from money she earns from her part-time job as a sales clerk. It will take Sarah 5 months to pay off her credit card. She will pay $33 in interest over that time so the actual cost of her trip was $1263. Paying only the minimum would have been a mistake. It would have taken her almost 8 years to pay off the credit card, and she would have paid $622 in interest! Credit Score and Credit Reports We mentioned that Arnie and Sarah both want to build good credit scores. A credit score is a three-digit number based on your credit report. Most lenders use the FICO credit score, which ranges from 300 to 850. Higher scores like 700+ are better than low scores. Many lenders use 700 as a cutoff for giving borrowers the best rates and terms. Credit scores are often reviewed not only by lenders, but also by people like landlords and employers. If you apply to rent an apartment, a landlord may consider your credit score to determine how good you will be at paying rent on time. An employer may look at your credit score as an indication of whether or not you are responsible.

8 A credit score is based on a number of factors. The five most important are: 1. Your payment history. The more responsible you are paying bills on time, the higher your credit score. 2. How much you owe. A credit score reflects the total amount owed on all accounts you may have, including credit cards, student loans, home loans and car loans. The more you owe, the lower your credit score. 3. How long you ve had credit. Typically, the longer you ve had credit, the better for your credit score. 4. When you last applied for credit and how many times you have applied. Opening new accounts can hurt your credit score, particularly if you apply for lots of credit in a short period of time. 5. The types of credit on your credit report. Typically, the more types of credit (credit cards, student loan, car loan) you have, the better for a credit score. The credit score that Arnie builds with his car loan and the score that Sarah builds with her credit card will impact their ability to qualify for the best loan terms when they want to borrow to purchase a large item, such as a home. If you already have a credit history, you can get a free copy of your report at (Watch out for this site and others trying to sell you additional items!) By law, you are allowed to get one free credit report each year. You cannot obtain your credit score for free. The web site offers a credit report and credit score with an analysis of the credit score for $ Manchester, Vermont // 3657 Main Street // (P.O. Box 416) // Manchester, VT // {Tel} // {Fax} Montecito, California // 1155 Coast Village Road // Montecito, CA // {Tel} // {Fax}