Chapter 1: Introduction

Credit
- funds provided by a creditor to a borrower that will be repaid by the borrower in the future with interest (Madura)
- a contractual agreement in which a borrower receives something of value now and agrees to repay the lender at a later date-
generally with interest (Investopedia)
CREDIT DEBT
- how we handle our financial life - what you acquire when you actually borrow
- ability to borrow - a loan or obligation

Traditionally, the financial services industry was the only one to use credit scores (auto-loans and mortgages).
o to determine the cost and terms of money borrowed
More recently, other industries have started using credit scores.
o Insurance companies o Dating sites
o Landlords o Hospitals
o Employers

Basis for Lending Decisions

 The ability to repay your loans. If you have no income, no lender will lend you money.
 The willingness to use your resources to do so. Not everyone who has money is responsible with it.

The 5 Cs of Credit
 Character. A borrower’s willingness to pay bills on time
 Capacity. A borrower’s ability to pay bills
 Capital. Assets owned by the borrower
 Collateral. A specific asset of some value that the borrower pledges to the lender. It can be taken away by the lender and sold
to satisfy the debt, if the borrower does not pay the loan.
 Conditions. Economic conditions beyond the borrower’s control that could affect the ability to repay the loan.

CREDIT REPORT CREDIT SCORE

- details a person’s credit history, specifically as it related to - a risk score assigned to an individual that indicates
the ability to pay financial debt obligations creditworthiness and likelihood to repay a loan
- a report from one of the credit bureaus with financial and - all the information on a person’s credit report run through
demographic information about a specific person a complex algorithm to generate one number

Credit Reporting Agencies

o Equifax
o Experian Your three credit reports may look somewhat different from
o Transunion one another because not all companies report to all three
major bureaus.
Credit Monitoring Services
- These services claim to monitor all three of your credit reports and to:
o Notifying you monthly about activity
o Repair your poor credit
o Restore your identity should it be stolen
- They offer free services to get you to view their website, then they offer other services, which they charge for.

What makes up a credit score?

 Payment history – 35%
 Amounts owed – 30%
 Length of credit history – 15%
 New credit – 10%
 Types of credit – 10%

FICO (Fair Isaac Corporation)

- produces the majority of credit scores used in lending and other financial decisions
- use date from the 3 major credit bureaus, with their own proprietary algorithm, reduce the date to a three-digit score
- scores can range from a low of 300 to a high of 850
- historically, a score of 760 or above has been considered the best risk
There is no magic “fix” for a bad credit score if the information on your report is accurate. Improving your score will take time and
discipline.
The Underwriting Process
- the process of reviewing a customer’s risk level by conducting a thorough review of their creditworthiness along with other
financial documents
- Underwriters go through 3 steps in reaching a decision:
o Evaluate how risky you are as a borrower
o Decide if and how much they are willing to lend
o Determine the interest rate
- When using credit report and credit score to determine worthiness, lenders consider each of the 5 Cs of credit and how much
available credit you have relative to your income.

10 Tips to Help Improve a Credit Score

1. Pay your bills on time.
2. Pay down own debt.
3. Pay down credit cards.
* Try to keep the balance on each to no more than 30% of your available credit.
4. Get a credit card, if you don’t have one already.
* Use it on occasion, and pay it off before the due date.
5. Get an installment loan, such as car loan or personal loan.
6. Check your credit report and get the following errors fixed:
* Negative items older than 7 years (10 years for bankruptcy)
* Accounts handled by bankruptcy that still show as unpaid
* Incorrect credit limits reported as lower than actual
* Late payments, collections, or accounts listed as “settled,” “paid derogatory,” or “paid charge-off,” if these are not correct.
7. Use your older credit cards.
* The length of older accounts is important.
8. Ask to have late payments erased if you have been on time for several months.
9. Dispute negative information that is older than 3 years.
10. Avoid closing unused accounts.

Lending Decision
- also referred to an 'Agreement in Principle'
- an assessment by a mortgage provider of your basic income details and expenditure
- tells you whether or not they would be able to lend to you and how much they would be able to lend

In determining if a loan will be approved, banks typically look at:

o 3 years of audited financial statements, plus the current YTD financial statement
o budget/forecast financial projections for the borrower
o unrestricted operating revenue, expenses and excess trend

5 Common Requirements When Evaluating Loan Applications

 Credit Score and History
- credit scores range from 300 to 850 and are based on factors like payment history, amount of outstanding, and length of credit
history
- many lenders require applicants to have a minimum score of around 600 to qualify
 Income
- minimum income requirements vary by lender
- evidence of income may include recent tax returns, monthly bank statements, pay stubs, and signed letters from employers;
self-employed applicants can provide tax returns or bank deposits
 Debt-to-income Ratio
- DTI is expressed as a percentage and represents the portion of a borrower’s gross monthly income that goes toward their
monthly debt service
- used to predict a prospective borrower’s ability to make payments on new and current debt
- less than 36% is ideal; some will approve a highly qualified applicant with a ratio up to 50%
 Collateral
- if applying for a secured personal loan, lender will require you to pledge valuable assets
- secured personal loans can also be collateralized by other valuable assets, including cash accounts, investment accounts, real
estate, and collectibles
 Origination Fee
- though not part of the qualification process, many lenders require borrowers to pay personal loan origination fees to cover the
 costs of processing applications, running credit checks and closing. These fees usually range between 1% and 8% of the total
loan amount, depending on factors like the applicant’s credit score and loan amount.
Loan Application Documents
o Proof of Identity
o Employer and Income Verification
o Proof of Address

Credit Report Credit Score

- provides a detailed information about a consumer’s - calculated based on the information on that report
finances

A credit score is a three-digit number used to convey a

consumer’s creditworthiness-or the likelihood they’ll make
on-time bill payments. Every consumer has a FICO score and
VantageScore, though FICO scores are more commonly used
by lenders, and there are multiple versions tailored to different
types of products.

Credit scores are calculated based on the information in a consumer’s credit report, such as their payment history, age of credit and
credit mix. FICO scores are calculated based on the following categories:
 Payment history. Accounts for 35% of the calculation. Includes on-time payments and any derogatory marks resulting from
late payments or default.
 Amounts owed. Also known as credit utilization. Amounts owed on a consumer’s accounts-as compared to their total credit
limits-make up 30% of a credit score calculation.
 Length of credit history. Translates into 15% of credit scores. The longer a consumer has had active accounts in good standing,
the stronger this portion of their credit profile.
 New credit. Applying for a new loan or credit card typically results in a hard inquiry on a consumer’s credit report. These
inquiries account for 10% of the credit score calculation.
 Credit mix. Rounding out the final 10% of a consumer’s credit score. The types of account a borrower has. Consumers with
more diverse debts-like a mis of revolving and installment accounts-perform better in this category.

Chapter 2: Assessing & Securing Credit

Credit
- funds provided by a creditor to a borrower that will be repaid by the borrower in the future with interest
Types:
Non-installment credit – provided for a short period of time (e.g. department store credit)
Installment credit – provided for specific purchases, with interest charged on the amount borrowed
Revolving open-end credit – provided up to a specific maximum amount based on income and credit history. Interest is charged
each month on the remaining balance
Advantages: Disadvantages:
- helps build a good credit score - excessive spending (easier to avoid considering costs
- eliminates the need for carrying cash or writing checks when using credit)
- free financing if you pay in full each month - a large accumulation of debt (especially when making
- monthly statement for recordkeeping only the minimum payment)
- can make purchases you can’t afford

Credit Rights
- Equal Opportunity Act helps protect debtors from unethical creditors
- Financial Reform Act of 2010 established the Consumer Financial Protection Bureau
o regulates online checking accounts, credit cards, and student loan
o to ensure accurate consumer information and prevent deceptive practices
o may also regulate credit rating bureaus
Impact of Credit Payments on Saving
Credit History
- often begins with timely payment of utility bills
- built by paying bills in a timely manner

Credit Insurance
- can cover payments under adverse circumstances

Credit Bureaus
- provide credit reports documenting your credit payment history
- primary credit bureaus are Equifax, Experian, and Trans Union
- free credit reports available annually
- accounts turned over to collection agencies, as well as resolution of these accounts
- all account information, both open and closed accounts, are included
- list of companies that have requested your credit report

Parts of Credit Report Provided by Credit Bureaus

1. report number, date, and name to distinguish this report from others
2. identifying information such as name, spouse’s name, birthdate, Social Security number, addresses, occupation, etc.
3. potentially negative information from public records such as bankruptcy and tax liens

Due to different scores among bureaus, they don’t always have access to the same information.

Improving Your Credit Score

o catch up late payments and reduce debt National Distribution of FICO Scores
o review household budget and cut back on necessary
expenses
o destroy credit cards, but keep accounts open
o call creditors if unable to make payments on time

Reviewing Your Credit Report

o review at least twice a year for accuracy, to correct
errors, to identify deficiencies
o make sure report is accurate
o review the types of information used by lenders
o see what kind of information lowers credit rating and
try to eliminate deficiencies

Identity Theft
- occurs when an individual, without permission, uses your identifying information for his or her personal gain
- goal may be to acquire money or goods or to establish a new identity for criminal purposes
- impacts about 15 million people each year, costing about $16 billion
Costs:
 Personal Costs
- feeling of violation and insecurity / problems getting a job / being hounded for debt that isn’t yours / turned down for credit
 Financial Costs
- average individual loss is over $1,000 / time and money to repair the damage / individuals will spend an average of 200 hours
dealing with damage control necessitated by identity theft
 Tactics:
 Shoulder Surfing. Used when an identity thief stands close to you in a public place and reads the number of your credit card as
you conduct business
 Dumpster Diving. Used when an identity thief goes through your trash for discarded items that reveal personal information that
can be used for fraudulent purposes
 Skimming. Used when a store employee steals your credit card number by copying the information contained in the magnetic
strip on the card
 Shimming. Where thieves insert a device called a shimmer into an ATM slot which reads the information contained on the card
 Pretexting. Used when an identity thief poses as an employee of a company with which you conduct business, to solicit your
personal information
 Phishing. Used when pretexting happens online
 Pharming. Like phishing, but targeted to larger audiences and directs users to bogus websites to collect their personal
information
 Abusing legitimate access to records
 Crime rings
 Violating your mailbox. Both incoming and outgoing mail can provide personal information

Chapter 3: Managing Credit

Types of Credit Cards
 MasterCard, Visa, and American Express
MasterCard and Visa. Allow financing
 Retail (or proprietary) Card
- honored by a specific retail establishment (e.g., retail stores and gas stations)
- limits purchases to a single merchant

Credit limit Grace Period

- maximum amount of credit allowed - period between time of purchase and when payment is
due
Overdraft protection
- allows purchases beyond credit limit Interest Rate
- may be fixed, variable, or tiered
Prestige Cards - new regulations more favorable to users
- issued by a financial institution to individuals who have
an exceptional credit standing (e.g., gold or platinum Cash Advances
cards) - high transaction fees
- no grace period and high interest

Finance Charge
- the interest that you must pay as a result of using credit
 Average Daily Balance Method. Interest charged on ADB at the end of every day in the billing period
E.G., Because your daily balance was $700 over the first fifteen days and $500 over the last fifteen days, your average daily
balance was $600 over the thirty-day billing period. Using a monthly interest rate of 1.5%, your finance charge is:
$600 x 0.15 = $9.00
 Previous Balance Method. Interest charged on the balance at the beginning of the new billing period
E.G., It is calculated by applying the monthly interest rate to the $700 outstanding at the beginning of the new billing period.
Using a monthly interest rate of 1.5%, your finance charge is:
$700 x 0.15 = $10.50
 Adjusted Balance Method. Interest is charged based on the balance at the end of the new billing period
E.G., It is calculated by applying the monthly interest rate to the $500 outstanding at the end of the new billing period. Using a
monthly interest rate of 1.5%, your finance charge is:
$500 x 0.15 = $7.50

You can estimate repayment on credit cards using simple interest rate and annual percentage rate (APR), which allow comparison
among potential lenders:
 Simple Interest Rate. The percentage of credit that must be paid as interest on an annual basis
 Annual Percentage Rate. The simple interest rate including any fees charged by the creditor

Impact of interest rate on the amount you owe: the larger the interest rate, the higher the interest payments
Impact of financing period on credit payments: total interest rate depends on the length of the financing period

Statements typically sent at the end of the billing cycle: o Minimum payment
o Previous balance In reviewing your credit card statement,
o Purchases o Always scrutinize statement for errors
o Cash advances o Dispute any errors, but pay correct charged in a timely
o Payments manner
o Finance charge o Customer service number and/or dispute instructions
o New balance included on statement

The Credit Card Act o summary of provisions

- passed in 2009; contains provisions to protect Consumer Financial Protection Bureau
consumers - created in 2010 as part of Financial Reform Act
o conditions for fees - goal is to enforce consumer finance laws
o advance notice to change interest rate - makes sure consumers receive full disclosure of
o promotional interest rate guidelines information to help them make financial decisions
o payment period
o credit limit
o disclosure about paying balance due
o restrictions for cardholders less than age 21

Tips on Using Credit Cards In resolving an excessive credit balance,

1. Use a credit card only if you can cover the bill 1. Spend as little as possible
2. Impose a tight credit limit 2. Consider ways to increase income
3. Reduce credit limit when the economy weakens 3. Borrow from a family member
4. Pay credit card bills before investing money 4. Get a debt consolidation loan
5. Pay off credit card debt before other debt 5. Sell assets for cash
6. Avoid credit repair services 6. Reduce everyday expenses

Personal Bankruptcy
- a plan proposed to the court in which you can repay at least a portion of your debt and pay attorney and filing fees

Chapter 4: Managing Debt

Debt
- something, usually money, that is owed to a person, lender, etc.
- owing money to somebody else for products/services provided to you, that you did not pay for yet, is debt (even if interest-free)
Types:
Mortgages, Car loans, Student loans, Personal loans

Debt allows the economy to appear very large, but also creates more risk in the economy.

Characteristics of Debt
o Allows you to buy things now instead of waiting
o Interest is a fee to borrow money
o Whether you pay now or later, it is still debt (no payments for 6 months, 12-months same as cash, 0% interest)
o Debt consolidation loans are still debt
o Paying the money you owe + any interest, is the only way to pay off your debt

Reasons people get into debt: In avoiding debt,

o Keeping up with the Joneses (to show that one is as o Focus on what you have, not what you don’t have.
good as other people by getting what they have and o Focus on goals to avoid unnecessary spending.
doing what they do) o List what you expect to have and prioritize that list.
o Using money to punish o Share your financial goals with your partner and have
o Emotional difficulties regular discussions about those goals.
o Unrealistic expectations o Do not fall for monthly payment trap. Small payments
o Lack of communication add up; think about the overall cost.
o Increasing finance charges
 GOOD DEBT
The asset or thing you purchased with the debt should:
1. Appreciate in value
2. Last longer than the term of the loan
3. Provide positive financial leverage
- value gained from acquiring >cost of borrowing
All 3 characteristics must be present for debt to be considered
good debt.
BAD DEBT
It is a bad debt if the asset or item finance with debt:
1. Depreciates in value
2. Does not last as longer as the term of the debt
3. Generates negative financial leverage
All good debt requires all 3 characteristics to be present. Bad
debt only has to have one of the 3 characteristics.

Consumer Loans
- any loan to a consumer, including mortgages, car loans, and credit cards
- however, most people think of personal loans when they hear consumer loans (i.e., credit cards, personal loans, consumer lines
of credit, retail loans, payday and car title loans)
- some of the most expensive
- least borrower-friendly
- more are coming from a greater number of questionable lenders

Different Types of Consumer Loans

LENDER
LOAN PRODUCTS
Commercial Banks Credit Unions Consumer Finance Companies Savings & Loan Companies
Automobile Loans
Credit Cards
Home Improvement Loans
Mortgages
Personal Loans
Second Mortgages
Medical Loans

Commercial Banks Consumer Finance Companies

- Accept deposits and issue loans
- National Banks must be member of the Federal Reserve
System
- State-chartered banks have state-regulating agencies
- Residential mortgages are a relatively small part of
their portfolio
Credit Unions
- Member-owned, not-for-profit cooperatives
- Generally, they only lend money to members
- National credit unions are regulated by the National
Credit Union Administration
- State-chartered credit unions are regulated at the state
level
- Residential mortgages are a relatively small part of
their portfolio
- Do not accept deposits; they only loan money
- Regulated by the state in which they operate
- Do not have to abide by the same rules as credit card
issuers
Savings & Loan Companies
- Regulated by the Office of Thrift Supervision
- Primarily focused on mortgages
- Must have 65% of their assets invested in residential
mortgages and other consumer-related assets in some
instances

The 2009 Credit Card Accountability, Responsibility, and Disclosure Act

- Credit card companies can no longer solicit college campuses by offering free items to get students to sign up
- Elimination of questionable practices, such as universal default and two-cycle billing
- Requires bills to be sent at least 21 days before payment is due
- Requires payments to be credited up to 5pm on the due date
- Adds multiple restrictions on fees and rates

Schumer Box
- table of information on credit card applications that summarizes important information:
 Annual fee, Interest fee, Grace period, other fees

Additional Terminologies
 Billing cycle. The period between credit card billing statements
 Cash Advance. Cash loan from a credit card
 Credit Line. The maximum amount that can be borrowed on any single credit card
 Finance charge. Interest charged on the balance on a credit card within the current cycle
 Introductory Rate. A special lower interest rate used to attract new customers
 Minimum payment. The lowest amount of money that can be paid on a balance each month to prevent account from going into
default
 Personal loan. Loans based only on the promise to repay and do not require any collateral
 Consumer line of credit. An arrangement between a bank and a customer that allows the customer to borrow up to a certain
amount, that they can access at any time
 Retail loan. A loan attached to a specific item purchased, offered by either a retail store or a third-party finance company; you
borrow a fixed amount that you repay over a specified period of time
 Payday loan. A small short-term loan that is unsecured and is usually due upon the borrower’s next payday
 Car title loan. A short-term loan where borrowers use their car title as collateral. If they do not repay, the lender can take
possession of the car and sell it to meet the debt obligation

How Debt Collection Agencies Operate Basic Collection Laws

1. Buy past due accounts for pennies on the dollar o Must call during convenient hours
2. Attempt to collect debt, as well as interest, penalties, o Discreet mail contact
and late fees o Can call spouse (or parents, if minor)
3. You can settle for original debt or less (never pay o Can call others to find you, but cannot tell others about
penalties or late fees) your debt
4. All correspondence should be via certified email (to o Not allowed to contact you after you give written
document everything) notification for them to stop