Personal Finance

Chapter 4
 Introduction to
Consumer Credit
 Learning Objectives
 Define consumer credit and analyze its advantages
and disadvantages.
 Differentiate among various types of credit. Assess
your credit capacity and build your credit rating.
 Describe the information creditors look for when
you apply for credit.
 Identify the steps you can take to avoid and correct
credit mistakes.
 Describe the laws that protect you if you have a
complaint about consumer credit.
 What is Consumer Credit

CREDIT is an arrangement to receive cash,

goods, or services now and pay for them in the
future.

CONSUMER CREDIT is the use of credit for

personal needs (except a home mortgage) by
individuals and families.
 Financing Alternatives and Trade-offs
THREE WAYS CONSUMERS CAN FINANCE
PURCHASES.
• Draw on savings.
• Use present earnings.
• Borrow against expected future income.

TRADE-OFFS WITH EACH ALTERNATIVE.

• Depleting savings reduces emergency funds.
• Spending current income on luxuries will eventually
reduce future well-being.
• Spending future income now reduces funds available
for future expenses.
 Uses and Misuses of Credit
Before you use credit for a major purchase, consider
these questions:
• Do I have the cash for the down payment?
• Do I want to use my savings for this purchase?
• Does the purchase fit my budget?
• Could I use the credit I need in some better way?
• Can I postpone this purchase?
• What are the opportunity costs of postponing this
purchase?
• What are the dollar and psychological costs of using
credit for this purchase?
 Importance and Advantages of Credit
CONSUMER CREDIT IMPORTANCE.
• A major force in American economy.

ADVANTAGES OF CREDIT.
• Immediate access to goods and services.
• Permits purchase even when funds are low.
• A cushion for financial emergencies.
• Advance notice of sales.
• Easier to return merchandise.
• Convenient when shopping.
 Importance and Advantages of Credit

One monthly payment.

Safer than cash.
Needed for hotel reservations, car rentals, and
shopping by phone.
Can take advantage of float time and grace period.
May get rebates, extended manufacturer’s warranties,
or emergency medical evacuation for travelers, and
other bonuses.
Indicates financial stability.
 Disadvantages of Credit

 Temptation to overspend.
 Failure to repay loan may result in loss of income,
valuable property, and your good reputation.
 Misuse of credit can create serious long-term
financial problems, damage to family relationships,
and a slowing of progress toward financial goals.
 It does not increase total purchasing power.
 Credit costs money.
 Types of Credit

CLOSED-END CREDIT.
• Single loan for a specific purpose and a
specified amount that you pay back in a specified
period of time and in payments of equal amounts.
• Installment sales credit, installment cash credit,
and single lump-sum credit.
• Mortgage, automobile, and installment loans for
furniture or appliances.
 Open-End Credit
 Use as needed until reaching line of credit
maximum.
 You pay interest and finance charges if you do
not pay the bill in full when due.
 Credit cards issued by department stores, bank
credit cards, overdraft protection, incidental
credit, and revolving check credit (bank line
of credit).
 Credit Cards

 7 out of 10 U.S. households carry one or more credit

cards.
 About half of all credit card users are convenience
users and pay balances in full each month.
 Others are borrowers, carrying a balance over and
paying finance charges.
 Some use cards for cash advances, paying a
transaction fee and interest.
 Co-branding — linking a credit card with a business
trade name offering points or rebates on products and
services.
 Smart Cards and Debit Cards

SMART CARDS.
• Have an embedded computer chip.
• Combine credit cards, a driver’s license, a health care
ID with your medical history and insurance information,
etc.

DEBIT CARDS.
• Often called bank cards, ATM cards, cash cards, and
check cards.
• Electronically subtracts from your account at the
moment you make a purchase (no delay in payment).
 Stored-Value (or Gift) Cards

 Are prepaid cards.

 Resemble a debit card.
 Used in lieu of paper gift certificates.
 Used for business purposes (payroll, travel
expenses, government benefit payments).
 Retailer bankruptcy can make the cards
worthless.
 Travel and Entertainment Cards
 These cards are not really credit cards.
 Monthly balance is due in full.
 Diners Club or American Express cards.
 American Express is now also issuing credit
cards.
 Smartphones and Home Equity Loans
SMART PHONES.
• Use of mobile phone to make purchases, called
mobile commerce.

HOME EQUITY LOANS.

• Based on the difference between current market value
of your home and the amount owed on the mortgage.
• Borrow up to 85% of the appraised value of the home
less amount still owed.
• Interest on loan is tax deductible.
• It is set up like a revolving line of credit
 Debit/Credit Card Fraud
PROTECTING YOURSELF AGAINST DEBIT/CREDIT
CARD FRAUD.
• Sign new cards as soon as they arrive.
• Treat cards like money and keep them in a secure place.
• Shred anything with your account number on it.
• Don’t give your card number over the phone or online unless
you initiate the call and don’t write it on postcards.
• Get card and receipt after every transaction and check for
billing statement errors.
• Notify the card issuer if you don’t get your billing statement
or if your card is lost or stolen.
 Making Purchases Online
 Use a secure browser.
 Keep records of online transactions.
 Review monthly bank and credit card statements.
 Read policies of the websites you visit concerning
refunds, site security, and privacy.
 Keep personal information private unless you know
who is gathering it and why.
 Give payment information only to businesses you
know and trust.
 Never give your password to anyone online.
 Do not download files sent to you by strangers.
 Measuring Your Credit Capacity
Assess your credit capacity and build your credit
rating.

CAN YOU AFFORD A LOAN?

• Ask yourself if you can meet all essential expenses
and still afford the monthly loan payments.
• Ask yourself what do you plan to give up in order to
make the monthly payment?
• Are you prepared to make this trade-off?
 Debt Payments-To-Income Ratio
Debt Payments-to-Income Ratio.
• Divide your monthly debt payments by your net
monthly income.
• Do not include your house payment in your monthly
debt payments total as it is a long-term liability.

your monthly debt payments

net monthly income
• Consumer credit payments should not exceed a max of
20% of your net (after-tax) income.
 Calculating Debt Payments-To-Income Ratio

Example.

If your monthly net income is $2,136 (gross income

less taxes and monthly IRA contribution) and your
monthly installment credit payments total $426
(includes credit cards and auto loan), then your debt
payments-to-income ratio is 19.94%.

$426 / $2,136 = 19.94%

 Debt-To-Equity Ratio

Debt To Equity Ratio.

• Divide your total liabilities by your net worth.
• Do not include the value of your home and the
amount of its mortgage in total net worth.

= Should be < 1
 Cosigning a Loan
The creditor will give you a notice that tells you…
• You are being asked to guarantee the debt, so consider
if you can afford it if the borrower defaults.
• If the borrow does not pay, you may have to pay up to
the full amount and also any late or collection fees.
• If a payment is missed, the creditor can collect the debt
from you without first trying to get it from the borrower.

Some studies show that three of four cosigners are

asked to wholly or partially repay the loan.
 If You Do Cosign

If you do cosign, consider...

• Can you afford to pay the loan? If not, your credit
rating could be damaged.
• Liability for this debt may prevent you from getting
other credit that you want.
• If you pledge property, you could lose it if the loan
goes into default.
• Check your state’s law to learn about cosigner’s
rights.
• Request that a copy of overdue-payment notices be
sent to you.
 Credit Rating

BUILDING AND MAINTAINING YOUR CREDIT

RATING.
• A good credit rating is a valuable asset that should be
nurtured and protected.
• Limit your borrowing to your capacity to repay.
• Live up to the terms of contracts.
• Check to see what is in your credit report as most
creditors rely on credit reports in considering loan
applications.
 Building and Maintaining Your Credit
CREDIT BUREAUS.
• Consumer Reporting Agencies (CRAs) collect
information about consumers.
• Experian, TransUnion, and Equifax.
• The Consumer Financial Protection Bureau gets
about 36,000 complaints about credit bureaus each
year.
WHO PROVIDES DATA TO CREDIT BUREAUS?
• Bureaus get information from banks, court records,
finance companies, merchants, credit card
companies, and other creditors.
 Building and Maintaining Your Credit

WHAT IS IN YOUR CREDIT FILES?

The credit bureau file contains your name, address,
Social Security number, and birth date. It may also
include the following information:
• Your employer, position, and income.
• Your former address.
• Your former employer.
• Your spouse’s name, Social Security number,
employer, and income.
• Whether you own your home, rent, or board.
• Checks returned for insufficient funds.
 Fair Credit Reporting

FAIR CREDIT REPORTING ACT.

• This act regulates the use of credit reports.
• Requires the deletion of obsolete information.
• Gives consumers the right to have erroneous data
corrected.
• Only authorized persons have access to your report.
• Adverse data can be reported for seven years;
personal bankruptcy for ten years.
 Who May Obtain a Credit Report?

Only properly identified persons for approved

purposes.
• Ex: to prospective employers in compliance with a
court order, underwriting of insurance, or some other
legitimate business need, or in determining eligibility
for a license or other benefit granted by a government
agency.
 Time Limits on Adverse Data

Most of the information in your credit file may be

reported for only seven years.
• May be reported for 10 years if bankruptcy has been
declared.
• Unpaid tax liens can be reported for 15 years.

After 7, 10, or 15 years, a credit reporting agency can’t

disclose the information in your credit file unless you
are being investigated for a credit application of
$75,000 or more or for an application to purchase life
insurance of $150,000 or more.
 Incorrect Information in Your Credit File

Mistakes may occur even though credit bureaus are

required to follow reasonable procedures.

When notified, a bureau must investigate the proposed

inaccurate data.

If you contest an item on your credit report, the

reporting agency must remove the item unless the
creditor verifies that the information is accurate.
 Applying for Credit
Describe the information creditors look for when you apply for credit.
The Equal Credit Opportunity Act (ECOA) starts all credit applicants off
on the same footing. It states that race, color, age, sex, marital status, and
certain other factors may not be used to discriminate against you in any
part of a credit dealing.
• Credit rights of women are protected under the ECOA.
 Applying for Credit

WHAT CREDITORS LOOK FOR: 5 Cs.

• Character — Do you pay bills on time?
• Capacity — Can you repay the loan?
• Capital — What are your assets and net worth?
• Collateral — What property do you have to pledge that the lender can
repossess if you default on the loan?
• Conditions — What economic conditions could affect your ability to
repay the loan?
*Additionally, age, public assistance, housing loans, and FICO and
VantageScore may be assessed.
 What if Your Application is Denied?
1. Ask questions.
2. ECOA gives you the right to know the specific
reasons for denial.
• If the denial is based on a credit report, you are
entitled to know the specific information in the credit
report that led to it.
3. After you receive this information from the creditor,
you should contact the local credit bureau to find out
what information it reported.
4. You may ask the bureau to investigate any
inaccurate or incomplete information and correct its
records.
 How to Improve Your Credit Score
1. Get copies of your credit report — review for
accuracy.
2. Pay your bills on time.
3. Understand how your credit score is determined.
4. Learn the legal steps to take to improve your credit
report.
5. Beware of credit-repair scams.
 Avoiding and Correcting Credit Mistakes

 LO6-5: Identify the steps you can take to avoid and

correct credit mistakes.

FAIR CREDIT BILLING ACT.

• Passed in 1975.
• Sets procedures for promptly correcting billing
mistakes, refusing to make credit card or revolving
credit payments on defective goods, and promptly
crediting your payments.
 In Case of a Billing Error
 First, call your creditor.
 If dispute exists, notify creditor of error in writing
within 60 days.
 Include your explanation of the error and your
account number to the billing inquiries address.
 They must respond within 30 days. Credit card
company has two billing periods but no longer than
90 days to correct your account or tell you why they
think the bill is correct.
 Your credit rating is not affected while item is in
dispute.
 Your Credit During the Dispute
 A creditor may not threaten your credit rating while you are
resolving a billing dispute.
 Once you have written about a possible error, a creditor is
prohibited from giving out information that would damage
your credit reputation to other creditors or credit bureaus.
 Until your complaint has been answered, the creditor may
not take any action to collect the disputed amount.
 After explaining the bill, the creditor may report you as
delinquent on the amount in dispute and take action to
collect if you do not pay in the time allowed.
• Even so, you can still disagree in writing.
 Defective Goods or Services
 You may withhold payment on any damaged
or shoddy goods or poor services if you have
paid for them with a credit card as long as you
have made a sincere attempt to resolve the
problem with the merchant.
 Identity Crisis

WHAT TO DO IF YOUR IDENTITY IS STOLEN.

• Contact the fraud department of each of the three
major credit bureaus.
• tell them to flag your file with a fraud alert.
• include a statement that creditors should call you for
permission before opening any new accounts in your name.
• Contact the creditors for any accounts that have been
tampered with or opened fraudulently.
• File a police report and keep a copy in case your
creditors need proof of the crime.
 Identity Crisis

 Tear or shred personal information before placing

in trash.
 Close bank accounts immediately if you believe an
identify thief has accessed them.
 Cancel checks and ATM card if compromised.
 Contact the Privacy Rights Clearinghouse
 Complaining About Consumer Credit

Describe the laws that protect you if you have a

complaint about consumer credit.

If you have a complaint about credit, first try to solve

the problem directly with the creditor.
If that does not work, there are more formal complaint
procedures.
There are a variety of major federal consumer credit
laws.
 Your Rights Under Consumer Credit Laws

 If you believe you have been refused credit due to

discrimination, you can
• Complain to the creditor and let the creditor know you
are aware of the law.
• File a complaint with the government.
 Thanks
Any
Questions?