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Culture Documents
CH 4 Consumer Credit
CH 4 Consumer Credit
Consumer Credit
It wants its cardholders to develop a spending habit by using the credit card regularly in the
first three months so that they will keep using the card in the future.
An interest rate of 2% per month is equivalent to an interest rate of 26.8% per year. This rate
is very high for a personal loan.
A credit card is a form of revolving consumer credit because within the pre-set limit,
consumers can withdraw and repay the money anytime. No fixed deadlines or number of
payments to repay the loan in full are involved. Consumers can repay the loan by irregular or
lump-sum payments and the repayment period can be flexible and lengthy.
Q2
Affinity cards are credit cards that are jointly offered by a financial institution (e.g., a bank)
and a non-financial group (e.g., a university, a retailer or airline). Affinity cardholders can
enjoy discounts and other benefits on purchases with their credit cards.
Q3
Credit cards are convenient and safe for consumers as they do not have to carry large sums of
cash around. When they need to buy something but do not have enough cash, they can simply
pay with a credit card. People can avoid the trouble of looking for an ATM or delaying their
purchase.
Q4
From a consumers point of view, an overdraft facility can prevent a cheque from being
dishonoured due to careless mistakes by the account holder (e.g., writing a cheque without
depositing the money in the current account). In addition, an overdraft arrangement can
provide short-term liquidity to consumers who are temporarily short of cash.
Q5
(a)
The loans offered are non-revolving loans because the borrower is required to repay the
(i) AAA credit card. This is because the MP3 player costs $2,500, which is less than the
minimum loan amount of $3,000 for the BBB credit card.
(ii) BBB credit card. As the remote-controlled car costs $3,000, I can obtain an interestfree loan with the AAA credit card or the BBB credit card. The maximum repayment
period on the BBB credit card is 24 months, longer than that of the AAA credit card
(18 months). This means that the monthly payment on the BBB credit card is lower.
Thus, the BBB credit card is preferable.
Q6
The major advantage of non-revolving credit is that it forces the borrower to plan for the
repayment, for example, how much he can afford to pay in each instalment.
Q7
(a)
(b)
Year
(1)
(2)
(3)
(4)
(5)
Q8
Interest ($)
5,000.00
400
3,890.34 (2)
311.23
2,691.91
215.35
1,397.6
(5)
(1)
(4)
111.81
(3)
1,294.31
1,397.85
Q9
The simple interest method is the most favourable to consumers because the total interest
payment is the lowest. The discount method is the least favourable to borrowers. With the
same loan amount, the money actually received by the borrower is the lowest under the
discount method. Besides, the total interest paid is higher than that under the simple interest
method.
Q10
Non-revolving credit forces an individual to estimate in advance how much can be repaid
each month and how long it will take to pay back the loan. Therefore, a person will not carry
the debt for too long and will eventually pay it off within a reasonable period.
Q11
Some credit cards (or loans) may charge different interest rates on different amounts of
outstanding balances. Consumers need to estimate their average balance to know the
appropriate interest rates applicable to them.
Q12
As lenders often state their interest rates in different ways (monthly or annual), consumers
should work out the total interest payments under different plans for comparison.
Q13
A credit record is a detailed report of the credit history of an individual and whether he has
filed for bankruptcy. It helps lenders evaluate the financial strength of credit applicants. This
helps them make appropriate decisions on loan approvals and reduce their risk of bad debts.
It is easier for borrowers to borrow money from lenders and possibly at lower interest rates
if they have good credit records.
Q14
Q15
Positive data include total credit exposure, total available credit and the credit limit of
unsecured and secured facilities, while negative data contain default details.
Q16
A budget helps an individual review his spending habits and distinguish between regular and
irregular consumption needs. When he checks the budget against his actual spending, he can
see if there are any consumption problems.
Loan balance
$
10,000
9,847.5
9,697.32
9,549.44
Monthly payment
$
250
246.19
242.43
238.74
Monthly interest
$
97.5
96.01
94.55
93.11
Jun
Jul
Aug
Sept
Oct
Nov
Dec
9,403.81
9,260.4
9,119.18
8,980.11
8,843.17
8,708.31
8,575.51
8,444.73
235.10
231.51
227.98
224.50
221.08
217.71
214.39
211.12
91.69
90.29
88.91
87.56
86.22
84.91
83.61
82.34
Total: 1076.70
I would choose the instalment loan because the total interest payment is the lowest.
As I cannot afford the monthly instalment loan payment, I would choose either a credit card
or a revolving loan. Among these two choices, a revolving loan is preferable because the total
interest payment is lower.
Assessment
MCQ
1
2
3
4
5
6
7
8
9
10
11
12
C
C
D
B
B
C
D
A
A
A
D
B
13
14
15
B
Year
1
2
Loan
balance ($)
Interest
(= A 0.08)
($)
Yearly
payment ($)
Principal
repayment
(= C B) ($)
480.00
249.19
729.19
3,365.11
3,365.11
6,000.00
3,114.89
2,885.11
3,115.91
3,114.89
Short Questions
16
Revolving consumer credit does not involve a fixed number of payments for repaying the
loan in full. Examples include credit cards and overdraft facilities. Non-revolving consumer
credit refers to personal loans which involve a fixed number of payments for repaying both
the loan principal and interest. Examples include car loans and tax loans.
17
Under the simple interest method, interest is calculated on the outstanding loan balance. As
the number of payments made increases, the outstanding loan balance declines. The amount
of interes paid also becomes lower and lower. Thus, total interest payments under the simple
interest method are lower than those under the add-on interest method and the discount
method (interest charged on the amount borrowed).
18
It is convenient for consumers to use revolving credit for small purchases. They can avoid
high interest costs by repaying the loan within the one-month interest free period. For
expensive items, non-revolving credit is more appropriate as it forces an individual to
estimate in advance how much can be repaid each month and how long it will take to pay
back the loan. Therefore a person will not carry the debt for too long and will eventually pay
it off within a reasonable period.
19
Plan for consumption: Individuals should understand how much they can afford to consume.
They should draw up some guidelines on consumption (e.g., when to use credit and when to
use cash).
Prepare a budget and check it against actual spending: Individuals should review their
spending habits and distinguish between regular and irregular consumption needs. They
should prepare a budget and check it against their actual spending every month. If there is a
big difference, they should find out the reasons.
Use consumer credit with discipline: Individuals may use consumer credit for convenience,
but not for buying things that they cannot afford.
Avoid a sudden increase in credit card applications: A sudden increase in credit card
applications may cause CRAs to suspect that the individual is in financial trouble.
Consider the repayment ability: Individuals should think about their ability to pay back debts
before applying for credit cards or loans. They should not apply for credit cards or loans just
for the gifts.
Pay all bills on time: CRAs do not care why people do not pay their bills. These people might
have been too busy or simply lost their bills, but CRAs will just think that they were unable to
pay. Any past due accounts will most likely result in a downgrade of a persons credit score.
If an individual has a good personal credit record, it is easier to borrow money from lenders,
possibly at lower interest rates.
20
Application Problems
21
(a)
22
(b)
(c)
(d)
(e)
(a)
(b)
Year
Loan
balance
Interest
Annual
payment
Principal
repayment
$30,000
$2,400
$11,641
$9,241
$20,759
$20,759
$1,661
$11,641
$9,9810
$10,779
$10,779
$862
$11,641
$10,779
(c)
(d)