Using Credit. services but do not require payments in full when the service is performed.

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Sharyl Long
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1 Using Credit How would you like to pay for this, cash or charge? Chances are you have heard this question asked. Cash or charge? is really asking you, the buyer, if you want to use the cash or the money you have in your wallet, checking or savings accounts, or if you want to charge or use credit to get the item(s) you want. When you pay for something you have choices in the way in which you pay. Cash is the actual use of money, or a check written from your checking account, to pay for an item. Credit is a service that allows you to get the item(s) you want or need today with the promise that you will pay for it in the future. But, credit also has strings attached. It is a convenience and a service that costs money. When you delay payment or borrow money to pay for a purchase, you are charged a rental fee for that privilege. The rental fee for using money or delaying payment is called interest. Types of Credit: The four main types of credit are service credit, loans, installment credit, and credit cards. Service credit is the credit that is granted by public utilities (such as power, telephone, and cell phone companies), physicians, dentists, and other people who provide services but do not require payments in full when the service is performed. Loans and installment credit are types of consumer credit. You, the consumer, pay the amount of money borrowed or cost of goods and services plus the finance charge. It is paid in equal payments, usually monthly. This type of credit is most often obtained from banks, savings and loan associations, credit unions, and retail business. Credit cards are a popular form of credit. They are offered by many retail stores, banks, and other businesses. A credit card is actually a card that identifies the holder as a person who has signed an agreement with the credit card company (for example: the bank, department store or oil company). The agreement allows you, the card holder, to pay your bill in more than one way: You can pay the entire bill by the due date noted on the statement and avoid paying any finance charge. If you do this, the use of credit will not cost you anything. Another option will be to pay only part of the bill. The minimum amount you can pay each month will be shown on the statement. If you do not pay the entire bill, the company adds a finance charge onto the amount you still owe.

2 The finance charge is referred to as the annual percentage rate (APR). A disadvantage of using credit cards is that instead of shopping to compare prices you may shop only at businesses that allow you to charge. Also, if you don t pay the entire balance by the due date, you will have to pay finance charges on what you still owe. Remember, a major problem with credit cards is that it is easy to overspend without knowing it. You may find that you bought more than you can afford to repay. Who Uses Credit? All of us use credit almost every day. Every time you make a phone call, turn on the lights, or eat before you pay at a restaurant you are using credit. When you use credit, you promise that you will pay for goods and services at a later date. And, you are responsible for having the money to pay your credit bill when it is due. Why Use Credit? Credit helps you to increase your buying power and to take advantage of sales or to buy things before prices increase. Credit can also provide money for emergencies. Keep in mind that credit reduces the amount of money you have to spend from your future income. It also makes it easier for you to spend money you do not have. If you misuse credit, the items you purchase could be repossessed, you could go bankrupt, or you could lose the opportunity to obtain credit when you really need it. Applying for Credit: When securing credit you will fill out an application. Before the credit is given, you will be asked to sign an agreement or a contract. Make sure you read and understand all the information on the agreement. Is there an annual fee to pay for the use of the credit card, what is the annual percentage rate and is there a late fee charged if your payment is late. By signing the agreement you are making promises of what you will be responsible for. The Credit Cardholders Bill of Right Act requires that individuals under age 21 show that they can repay the loan or have a cosigner who has such ability. When using credit, you have a responsibility: To pay back the amount of money you borrow or the cost of what you are buying. You may also pay an additional charge, interest, for the use of the money (Sometimes, if you repay all of what you owe within 30 days, you may not have to pay any additional charges.) To make your payments on time. If you are late with a payment, you may be asked to pay all of the money you owe immediately, or you may pay a late fee. To not sell items you are buying until all payments are made. The item is not yours until you have paid for it. To be responsible for any damage done to what you have bought on credit if you must return it. Before using credit, you should be sure you can meet these responsibilities. How you meet or do not meet these responsibilities is part of your credit history. Your credit history will be used to determine if credit should be given to you in the future. Use of credit can help you have the things you need or want, but you still have to pay for what you buy with credit. It takes careful planning and should be used responsibly.

3 What is the Cost of Using Credit? Regardless of the type of credit you use it is important to know the cost of using credit. By remembering two terms, you can find out how much you are paying in credit costs and be able to compare the cost of credit from different sources. The average credit card balance is based on 5% of your income. This is the typical family s credit card balance. ¹ You will need to make 4% minimum payment on your credit debt.² The two terms are the Finance Charge and Annual Percentage Rate (APR). The finance charge is the total dollar amount you pay to use credit. It includes interest costs and other costs such as service charges. The APR is the percentage cost of credit for a year and is your key to comparing costs. Many times you will see it referred to as APR or annual percentage rate. The following chart shows a comparison of costs for using a credit of $500 at different interest rates and for different lengths of time. Purchase Price plus Finance Charges Interest Rate 6 months 12 months 24 months 19.8% $547 $585 $637 18% $542 $577 $622 16% $537 $568 $606 14% $532 $559 $590 12% $528 $550 $575 What Credit Costs: You are thinking of buying a television that costs $500. You do not have the $500 and will be using a credit card to make the purchase. Assume that you have no other charges on your credit card and will not make any during the time you are paying for your purchase. Answer the following questions. Use the chart above to determine your answers. 1. How much would you pay in interest 12% and you pay for your television within one year? 2. How much would you pay in interest 19.8% and you pay for your television within one year? 3. How much would you pay in interest 19.8% and you pay for your television within two years? 4. What is the total difference in dollars between paying for the television in 24 months rather than paying for it in 6 months assuming that the interest rate is 18%? 5. If your friend was going to use a credit card to buy an item costing $500 what advice would you give him/her and why?

4 What is a Credit Score? The credit score is a three-digit number used by lenders in evaluating your creditworthiness or how likely you are to pay your debts. Using these credit scores, lenders determine if you qualify for a loan, what interest rate you will pay, and set a credit limit for you. Credit scores are also used to determine your ability to get a car loan, the premium on your auto or homeowners insurance, and even your ability to get a job. The Fair Isaac Corporation, known as FICO, created the first credit scoring system. Threefourths of all lenders use FICO scores when considering requests for loan or credit. How Is My FICO Score Calculated? The formula used is based on several factors: Payment History (35%) This indicates how you have paid your bills in the past. Outstanding Debt (30%) This shows how much you owe on your accounts, number of accounts with balances, and how much of your available credit you are using. Length of your Credit History (15%) Your score will increase the longer you have credit showing responsible credit management. Recent Inquiries on your Report (10%) -- This factor takes into consideration people who are rate shopping for the best mortgage or car loans. The only time shopping really hurts your score is when you have recent credit issues, such as late payments or bills sent to collections. Types of Credit in Use (10%) -- The best scores will have a mix of both revolving credit (credit cards) and installment credit (mortgages and car loans). Consumers with a variety of experiences are better credit risks. ¹Federal Reserve 2004 Survey of Consumer Finances. ²Minimun payment is 2-4% of the credit card balance. OCC References: Better Business Bureau. Tips On Consumer Finance and Credit Board of Governors of the Federal Reserve System. Choosing a Credit Card Your Credit Report Bureau of Consumer Protection, Federal Trade Commission. Choosing and Using Credit Cards Fair Isaac Corporation. Your Credit Scores Federal Citizen Information Center. Your Credit Score Resources: Credit Card Smarts. University of Illinois Extension More For Your Money website. University of Illinois Extension What s My Score. VISA Prepared by: Ellen I. Burton, Extension Educator, Consumer and Family Economics, University of Illinois Extension Revised by: Susan Taylor, Extension Educator, Consumer and Family Economics, University of Illinois Extension B Copyright 2010 University of Illinois Board of Trustees State County Local Groups United States Department of Agriculture Cooperating University of Illinois Extension provides equal opportunities in programs and employment.

5 Instructor s Answer Guide to Using Credit Answers to the questions at the end of the fact sheet. 1. $50 ($550 - $500 = $50) 2. $85 ($585 - $500 = $85) 3. $137 ($637 - $500 = $137) 4. $80 ($622 - $542 = $80) 5. Possible Answers: a. It is best to use the credit card that charges the lowest interest rate. b. Pay for the purchase as quickly as you can, because the longer it takes you to pay, the more money it will cost you. c. Ask them if it is the best buy or are they just buying it because the store where they found it would take the kind of credit card they have. d. Ask them if they will be able to make the payments on time. e. Ask them if they will have to do without something they must have to make the payments for the television. f. Ask them if this is truly a need or is it a want. Instructor s Note: You may want to invite a loan officer to talk about loan applications, what they look for before approving a loan, and the importance of making payments on time. Copyright 2010 University of Illinois Board of Trustees State County Local Groups United States Department of Agriculture Cooperating University of Illinois Extension provides equal opportunities in programs and employment.

In comparison, borrowing from a bank or building society is a business transaction with clearly defined rules to follow.

In comparison, borrowing from a bank or building society is a business transaction with clearly defined rules to follow. Teacher s notes money from friends/family People can borrow money from a friend or family member, in which case the arrangements for paying the money back are entirely up to the individuals. Although friends