Unit 4 Using a Credit Card Name Date Objective In this lesson, you will learn to explain and provide examples of the benefits and disadvantages of using a credit card. This lesson will also discuss the following: The differences between a credit card, a charge card, and a debit card The advantages and disadvantages of using a credit card or cash The concepts of annual fee, fixed rate, variable rate, annual percentage rate, grace period, late fees, finance charges, balance, and minimum payment How to research available credit card offers and compare their terms How to calculate finance charges and total amount due on a monthly credit card bill How to calculate the time it would take to pay off a credit card balance Links Advantages and Disadvantages of Credit http://redirect.platoweb.com/337453 Credit Card Statement http://redirect.platoweb.com/337454 Online Calculator http://redirect.platoweb.com/337455 Introduction As a child, you may have read stories or watched movies about magical genies. Typically, the hero of the story rubs a rusty lamp or opens an old bottle to free a grateful genie, who happily fulfils the hero s every wish and fancy. It builds him a grand house, fills the house with all sorts of nice things, and flies him across continents. After reading such stories, you may have wanted a genie of your own. Genies don t exist, but a credit card is something like a genie. You can use it to buy things when you need them and Using a Credit Card 1 of 11 Copyright 1995 2009 PLATO Learning, Inc. All rights reserved. PLATO, Straight Curve, and Academic Systems are registered trademarks of PLATO Learning, Inc. PLATO Learning is a trademark of PLATO Learning, Inc. PLATO, Inc. is a PLATO Learning, Inc. company.
pay later. While it can t fly you across continents, it can certainly buy you an airline ticket. It can also help you get a loan to buy a house or a car. Although using a credit card might feel like having your very own genie, you must always remember one big difference: ultimately, you will have to pay for your purchases and loans. So it is very important that you learn exactly what a credit card is and how to use it wisely. This lesson will teach you just that! Section 1: Credit Cards, Charge Cards, and Debit Cards Rosa will be entering college next year. She desperately wants a credit card because she thinks it will help her have everything she wants, just like all those people in credit card commercials. So you can imagine her delight when her parents tell her that they have decided to get her a credit card. Rosa: I can t believe that I m finally going to have my own credit card! I just can t wait to go shopping and buy things with my new card! Rosa s Dad: Hey, hold on! We re happy you re excited. But you need to know more about how to use your credit card responsibly before you get one. Rosa: What s there to learn? I just have to swipe it to buy things, right? Rosa s Mom: No, dear. There s more to cards than you think. First, you need to know what credit is. It s basically an agreement to get money, goods, or services now in exchange for a promise to pay in the future. So whenever you use your card, you are buying something on credit. You will have to pay the card issuer later. Rosa: Wait a minute. What s a card issuer? Rosa s Mom: Well, a credit card is issued by a bank that authorizes payment for purchases. The bank charges you interest on your outstanding balance. It will send you a statement every month showing you what you ve spent and what you owe. You can choose to pay the entire balance or only part of it. If you choose to pay only part, the bank will charge you interest on your remaining balance. Visa, MasterCard, and Discover are some examples of credit cards. Rosa: Is that all I need to know? Rosa s Dad: No, you should learn to use your card responsibly. Statistics show that students will leave college with an average of $2,700 in credit card debt. That is not a great way to start your life out of college. Rosa: Ok, I get it now. I need to be really careful about how I use my credit card and make payments regularly. Using a Credit Card 2 of 11
Rosa s Mom: You could also get a charge card instead of a credit card if you want. Rosa: What is a charge card? Rosa s Mom: It is similar to a credit card, but you need to pay the full balance when you receive your monthly statement. You also don t have to pay interest on a charge card, but you will most likely have to pay an annual fee for it. American Express and Diners Club cards are examples of charge cards. Rosa s Dad: While we re at it, let me tell you about debit cards. A debit card is another kind of card that banks issue. It lets you to access your bank account without having to go to the bank. You can also use it to withdraw cash from an automated teller machine (ATM) or to buy things at a store. The difference between it and a credit card is that when you pay for something with a debit card, the amount is deducted from your bank account right away. It means you re paying with your own money and not credit. Directions Fill in the descriptions of the three kinds of cards in the table below. Type of Card Description Credit Card Charge Card Debit Card Using a Credit Card 3 of 11
Section 2: Credit Cards versus Cash Rosa is rather confused with all this information. She is beginning to wonder whether using a credit card is a good idea. She wants to know if she should just stick to using cash. So, she browses the Internet and reads books to help her understand the advantages and disadvantages of each. She writes down the results of her research as follows: Advantages of a Credit Card You can buy things without actually having the cash. You can use it to establish credit or build credit history. You can report the loss of your card to the card issuer, thereby minimizing any financial loss. You can get discounts and earn rewards with some credit cards. Disadvantages of a Credit Card You can get carried away with impulse spending. You may pay more than the cost of the items you buy if interest or fees are added on. You may lose track of how much you ve spent, which can lead to financial difficulties. Advantages of Cash You see exactly what you are spending. You are less likely to indulge in impulse buying. You don t have to pay any interest. Disadvantages of Cash If you don t have enough cash, you can t immediately buy the item you want. Cash can easily be lost or stolen. Cash is bulky to carry. You can see that the disadvantages and advantages of cash and credit cards are nearly equal. But there is one important point in favor of credit cards. You can establish credit by using your credit card and making payments on time. If you have consistently paid on time, your credit is good and you earn a high credit rating. Good credit history and high credit ratings can help you buy a house or car someday. On the other hand, using your credit card to spend too much and accumulate too much debt can lead to bad credit and a low credit rating, which can keep you from getting a mortgage or qualifying for a car loan. Using a Credit Card 4 of 11
Directions List at least two advantages each of using a credit card and using cash. Test your understanding by taking a quiz on the advantages and disadvantages of credit. Section 3: Credit Card Terms and Conditions Before you decide to apply for a credit card, you need to understand the meaning of various terms associated with it. Here s a table that explains these terms. Term Explanation Annual Fee The annual fee is the yearly cost of owning the card. The bank bills this fee directly to your statement, which ranges from $0 to $300. It will be posted to your statement when you open the account and added each year on the anniversary of opening your account. APR (Annual Percentage Rate) The APR is the yearly rate of interest. It is the cost of carrying a balance on a loan and is expressed as an annual percentage. The law requires lenders to disclose the APR. Using a Credit Card 5 of 11
Late fees Minimum payment Balance Fixed Rate/Variable Rate Grace Period Finance Charge Late fees are charged if your payment doesn't reach the card company by the due date. To be sure your payment arrives on time, mail it at least five days before it's due. The minimum payment is the smallest amount of your balance that you can pay by the due date and still meet the terms of your card agreement. Some people mistakenly think that the minimum payment is the only amount you owe. But remember that you actually owe the full balance. If you pay only part of your balance, you'll be charged interest on the part of the balance that you don't pay. The balance is your total account debt as of the statement date. It includes any unpaid balance from the previous month; new purchases since the closing date of your last statement, and any cash advances you may have taken. Fixed interest rates are APR rates that stay the same or fixed; variable interest rates are APR rates that move up and down. The grace period is the number of days you have before a credit card company starts charging interest on new purchases. Note that not all credit cards have grace periods. The finance charge is the charge for using a credit card. It includes interest costs and other fees. If you research credit cards, you will find advertisements for a variety of cards. Here s an example: Use X credit card to build your credit history! X Student Card Terms and Conditions No Annual Fee 0% Introductory APR* on Purchases for 6 Months Easiest Online Account Management Options Using a Credit Card 6 of 11
This advertisement has some really attractive terms and conditions. But are these terms really as great as they sound? Can you just look at this advertisement and decide to apply for the card? No, you need to read the fine print carefully before you make a decision. For example, the advertisement says that there will be no APR for 6 months. You might want to know what the APR will be after six months of use. You may have to call the issuing bank to find out. You know that APR is a yearly rate. You can calculate the amount owed in interest per month by dividing the APR by 12. For example, if the APR is 12%, the monthly rate is 1%. Or, if the APR is 18%, the monthly rate is 1.5%. Directions Match these terms related to credit cards to their definitions. Write the term in the space next to its definition. Terms Definition The yearly cost of owning the card The yearly rate of interest The smallest amount of your balance that you can pay by the due date and still meet the terms of your card agreement The total account debt as of the statement date Jamie has applied for a credit card. The APR of the card is 20%. What will be the monthly interest rate? Using a Credit Card 7 of 11
Section 4: Credit Card Statements Rosa has been using her credit card for two months. The bank that issued her card has sent her a credit card statement. The statement looks something like this: Credit Card Statement Name Rosa Credit Line $1,000 Previous Balance $0.00 Account Number xxxx xxxx xxxx xxxx Available Credit $638.57 Purchases $386.43 Statement Date 08/12/2009 New Balance $381.43 Payments $30.00 Payment Due Date 09/10/2009 Minimum Payment Due $15.00 Finance Charge $25.00 Transaction Number Date Description Amount 1 07/10/2009 Books $120.50 2 07/12/2009 Supermarket $65.25 07/14/2009 Payment $30.00 3 08/01/2009 Clothing store $200.68 Different banks use different formats to prepare credit card bills or statements. View one more example of a credit card statement. Now roll your mouse over the headings on the right to see a description of the various parts of a statement. You have seen that the finance charge is the charge for using a credit card and that it includes interest costs and other fees. Although the bank calculates this amount and prints it on your bill, you need to understand the calculation process. Study these terms and their explanations before you learn how to calculate the finance charge: Credit Line Term Explanation The card company or issuer puts a credit limit on your account when it approves you for credit. The credit line is the maximum balance you can carry on your card. Daily Periodic Rate The daily periodic rate is the APR divided by 365 or the amount of interest you pay each day. So if your APR is 12%, your daily periodic rate is 0.03%. Using a Credit Card 8 of 11
Average Daily Balance Days in Cycle The average daily balance is the average amount that exists on an account over a period of time. This number is calculated by adding daily balances over a period of time and dividing by the total number of days in that period. The days in cycle refers to the number of days between statement dates. A billing cycle is generally about 25 days. Now that you have seen these important terms, you can calculate monthly finance charges using this formula: Monthly Finance Charge = Average Daily Balance x Daily Periodic Rate x Days in Cycle For example, your average daily balance is $30.00 and the days in cycle are 25. You need to find out the daily periodic rate before you calculate finance charges. If your APR is 20%, your daily periodic rate will be 20%/365 or 0.05%, which as a decimal is 0.0005. You can now substitute the values in the formula as follows: Monthly finance charges = 30 x 0.0005 x 25 = $.3750 or 38 cents Directions Calculate the monthly finance charge based on the following data: Average daily balance = $40.00 Daily periodic rate = 0.06% (state as a decimal) Days in cycle = 25 As you can see, finance charges can add up quickly! Using a Credit Card 9 of 11
Section 5: Credit Card Payments Rosa has a balance of $500 on her credit card statement. We know from looking at the statement that her APR is 18%, and her minimum payment due is $15 per month. How long will it take Rosa to pay off her balance if she pays the minimum payment each month? You can fill in the necessary values in this great online calculator to find out. It also gives you the payment schedule, part of which is reproduced here. It will tell you that Rosa will need 45 months to pay off her balance. Besides, she will have paid $198.24 in interest! Event Credit Payment Interest Principal Balance $500.00 $0.00 $0.00 $500.00 Payment 1 $15 $7.50 $7.50 $492.50 Payment 2 $15 $7.39 $7.61 $484.89 Payment 3 $15 $7.27 $7.73 $477.16 Payment 4 $15 $7.16 $7.84 $469.32 Payment 5 $15 $7.04 $7.96 $461.36 Payment 6 $15 $6.92 $8.08 $453.28 Payment 7 $15 $6.80 $8.20 $445.08 Payment 8 $15 $6.68 $8.32 $436.75 If you pay only the minimum payment each month, you will take an extraordinarily long time to pay your bill. So, the best way to avoid this situation is to pay an amount much larger than the minimum payment value. You can fill in increasing values of the minimum payment value in the online calculator to see how paying more every month brings down your payment time. And remember, if you pay the entire balance every month, you will owe no interest except on cash advances. Directions Event Credit Payment Interest Principal Balance $500.00 $0.00 $0.00 $500.00 Payment 1 $100.00 $7.40 $92.60 $407.40 Payment 2 $100.00 $6.23 $93.77 $313.63 Payment 3 $100.00 $4.79 $95.21 $218.42 Payment 4 $100.00 $3.02 $96.98 $121.44 Payment 5 $100.00 $1.86 $98.14 $23.30 Payment 6 $23.64 $0.34 $23.30 $0.00 Grand Total $500 $523.64 $23.64 $500.00 $0.00 Using a Credit Card 10 of 11
Study this payment schedule and answer the following questions. a. How long will it take to pay off this credit card? b. How much will the interest be? Section 6: Summary Credit is basically an agreement to get money, goods, or services now in exchange for a promise to pay in the future. A credit card is a card issued by a bank authorizing payment for purchases. Using credit cards wisely helps you establish credit or build a credit history. Good credit history and a high credit rating can help you buy a house or car someday. You need to read all terms and conditions carefully before you apply for a credit card. You need to know what terms such as APR and minimum payment mean so that you can manage your credit card account wisely. Using a Credit Card 11 of 11