In Unit 4 we will see the importance of using and managing credit effectively in the financial planning process.

In Unit 4 we will see the importance of using and managing credit effectively in

the financial planning process.

What is Credit?• Credit is the amount of financial

trust extended to you by a lender.

• The amount that is extended is based on your ability and willingness to repay.

Alarming Statistics• In 1990, the average credit card debit for those

households that carried a balance was about $2,550. At the end of 2003, that balance averaged about $7,520 – an increase of nearly 200 percent!

• In 1999, for the first time in almost 50 years, U.S. households started spending more than they took in. What started as a small deficit of about $50 billion among households quickly spiked to a deficit of more than $350 billion in the second quarter of 2004.

• Bankruptcies set another record in 2003, with 1.6 million personal filings

Sources: foxnews.com and msnbc.msn.com

The Costs of Credit

• Interest

• Finance Charge

• Annual Fee

• Annual Percentage Rate (APR)

The Costs of Credit

• Interest

• Finance Charge

• Annual Fee

• Annual Percentage Rate (APR)

Interest is the amount you pay to use someone else’s money. The higher the interest rate, the greater the costs of using credit.

The Costs of Credit

• Interest

• Finance Charge

• Annual Fee

• Annual Percentage Rate (APR)

A Finance Charge is the actual dollar cost of using credit, which is calculated by a lender.

The Costs of Credit

• Interest

• Finance Charge

• Annual Fee

• Annual Percentage Rate (APR)

An Annual Fee is a yearly charge for the privilege of using credit.

The Costs of Credit

• Interest

• Finance Charge

• Annual Fee

• Annual Percentage Rate (APR)

The APR is the amount it costs you a year to use credit, expressed as a percentage rate. It includes the interest, transaction fees, and service charges.

Credit Costs – Loan Length

Figure 5.2

$100,000

$215,926

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000

30 Year Loan

Interest

Principal

Bought 1House but Paid for 3

Credit Costs – Interest Rate

$100,000 $100,000

$215,926

$164,155

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000

10% 8%

Interest

Principal

Savings of $51,771

Activity

Loan Balance: $1,000

APR: 19%

Monthly Payment: $20

How long would it take to pay off the below loan?

Limits on Credit – Rules of Thumb

A maximum of 20% of your take-home pay after taxes should go toward all your loan payments

A maximum of 33% of your take-home pay should go toward the mortgage payment.

With most cards, you can make purchases and pay the balance before any interest or finance charges apply. This time period (usually 25 days) is

known as ………?

Grace Period

Where can you apply for or get credit?

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What are Some Questions One Should Consider Before Taking

on Additional Debt?

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Credit Card Disclosure Requirements

• The APR

• How APR will be determined if it is a variable rate

• The Annual Fee

• Method for computing balance

• Amount of minimum finance charge

• Transaction fee for purchases

Credit History

• The record of a person’s payment activity, or also known as a Credit Report.

• Damage to your credit report can follow you for up to 7 years.

• Bankruptcy can stay on your credit report for 10 years.

The Four C’s of Credit

• Collateral– An Asset of value that lenders can take from

you if you don’t repay the loan as promised.• Capacity

– Can you repay the Debt?• Character

– Will you repay the Debt?• Capital

– If you can’t/don’t repay the Debt, what do you have of value to repay?

Building Credit History

• Always have a well-managed checking account• Open a savings account and make regular

deposits• Borrow money using a savings account as

collateral• Be on time with payments• Always pay your bills on time or early• Always try to pay the balance or the most you

can afford

Loan Term

• The length of time a loan lasts.

• Longer term – more cost

• Shorter term – less cost

Fair Credit Reporting Act

You have the right to get a copy of your credit report by writing a credit bureau. If you have been turned down, you can find out reason from your credit report.

Information on Credit Report

1. Identifying Information

2. Credit Information

3. Public Record Information

4. Inquiries

Financial Consequences of Debt

• Obligates your future income• Can be expensive• Can lead to overspending• Getting into Debt is easier than getting

out• An overwhelming amount of debt

could lead to Bankruptcy

Credit Benefits

• Access to Cash in an Emergency

• Protection

• Opportunity to Build Credit

• The Ability to Use it Now

• Safety and Convenience

• Special Offers

• Earn Bonus Points or Miles

Credit Risks

• Costs• Overspending• Debt• Identity Theft

Bankruptcy

• Bankruptcy gives a person deeply in debt a plan to get out of that debt.

• Besides the filer, who else suffers when someone files bankruptcy?

Bankruptcy

• Chapter 7 – erases most of your debt (financial counseling)

• Chapter 13 – pay back some debt with more time (court oversees repayments)

Getting Out from Excessive Debt

• Spend less than you earn. You can then apply the additional money to pay off debt.

• If you have several loans, try to at least make the minimum required payments on all of them.

• Focus on paying off the higher interest rate loans first.

• Speak with a nonprofit credit counselor

Exercise 5.3A Plan to Get Out of Debt

a. A car loan with a balance of $6,000, monthly payments of $250, and an interest rate of 8.9%

b. A bank credit card with a balance of $800, minimum monthly payments of $20, and an interest rate of 19.5%

c. A student loan with a balance of $30,000, monthly payment of $175, and an interest rate of 6%

d. A store credit card with a balance of $2,300, minimum monthly payments of $70, and an interest rate of 15.9%

e. A credit union credit card with a balance of $3,500, minimum monthly payments of $110, and an interest rate of 12%

Take a closer look at the different interest rates!

Correct!!Focus First On the Debt with the

Highest Interest Rate

A bank credit card with a balance of $800, minimum monthly payments of $20, and an interest rate of 19.5%