Module 2A – BORROWING: Using Credit Wisely

Pages 3-30

I.CREDIT– a tool to buy something NOW & pay for it later (+ interest/finance charges)

  • This is NOT a “debit” card

A.Why use credit?

Convenience – no cash needed

Increased spending power to buy expensive items (can pay over time—house or car)

Records (proof of buying) & Protection (if something goes wrong w/your purchase)

Emergencies

B.Benefits of using credit

Can use item while still paying for it

Regular spending and PAYING on credit builds a good credit rating

  • Will qualify you for deals on loans, credit cards, insurance, etc.

Can take advantage of sales & bargains(Macy’s & Kohl’s)

Can earn rewards (“points” or cash-back--Discover)

Credit contributes to economy (speeds up the circular flow)

Can borrow to invest & make a little money (in a business or property)

C.TERMS to Study!

Having “CREDIT” – someone is willing to loan you money

CREDITOR– the person or company LENDING the money

DEBTOR– the person/company BORROWING the money (“in debt” to the creditor)

COSIGNER

  • a 2nd person on the credit card or loan who agrees to repay the loan if the borrower or debtor does not pay – he/she is financially responsible to pay the debt
  • needed if the debtor (1st signer) isn’t credit-worthy OR if debtor is 20 yrs. old or younger
  • must have a good credit rating, stable job, and/or own property

APR – Annual Percentage Rate % (per year)

FINANCE CHARGES (interest paid by YOU) – the additional amount (in dollars) paid back to the creditor for using credit

1.Terms for CREDIT CARDS Only:

a.Annual Fee – a yearly fee just for HAVING a credit card ($25-$350+)

b.You are given a “ceiling” credit limit(maximum) on how much you can charge

The more they trust you (higher credit rating you have), the higher the limit

Visa or MasterCard -- $500; Dillard’s -- $200

c.Over-the-limit fees – when you spend OVER what your “approved” limit is.

d.Grace periods are in place so interest doesn’t get charged to your purchase for 20-30 days. Payment is due in this number of days after receiving your bill.

e.Minimum Payment Due – smallest amount that must be paid each month; never make only the minimum payments.

f.Minimum Finance Charge for each month there is a balance on the account.

g.Cash Advances (3%-5% fee)

  • You have $0 in your account (you’re BROKE), so you go to the bank with credit card & have bank advance you money from the card
  • Finance charges start THAT DAY!
  • You are receiving CASH when the card is swiped
  • Must pay a higher APR
  • Do this as a last resort!!

h.Balance Transfers (3%-5% fee) – you transfer a credit card debt (charges 18% APR) to another credit card (charging 0% APR); finance charges MAY start that day!!

i.Transaction Fees(3%-5% one-time charge) will apply for cash advances, international purchases,balance transfers.

2.Terms for LOANS Only:

a.Collateral– property (car, house, or savings accounts) that you own that “backs” up a loan; it will be taken away from you if you don’t pay the loan; for “secured” loans

b.Down Payment – CASH paid upfront (today) to reduce the amount that you borrow

  • Required for people who have bad credit scores

c.Principal – the amount borrowed; amount of the original loan; Cost of the item minus the down payment = principal

Car costs $10,000, requires $1,500 “down”

10,000 – 1,500 = $8,500 LOAN amt.

d.Loan Term – the length of time you will make payments on the loan; AKA: maturity date

e.Per Diem – per day interest dollar amount added to your debt; happens on car & house loans (installment loans); highest amount at beginning of loan, its gets lower as you pay down the debt

f.Pre-payment penalties– a penalty charged when you pay off your loan earlier than the agreed upon time (read the fine print)

g.Amortization Tables(coupon book)

1.Lenders figure an average payment amount per month

  • Total debt, including finance charges, is divided by months of the loan = monthly payment

2.IF you pay on time, you will know exactly what your final payment would be

3.IF you pay late, you will add months onto the loan, or a higher final payment

4.Based on “per diem” (per day) of interest being added onto the principal balance

II.Calculating Interest

A.Simple Interest(p. 10)

I = P x R x T

I = Interest or finance charge in DOLLARS

P= Principal (original amount) borrowed

R= Interest rate (APR) converted to

decimal;5% = .05

T= Length of the loan (time) in YEARS

B.Compounding Interest(p. 11 or TI-84 calculator TVM Solver)

Complex formula on p. 11, or follow instructions on worksheet for your TI-84 calculator

C.TYPES OF APR’s

1.Introductory Rates– “teaser” rates on credit cards, then goes up after 6+ mths

2.Fixed Rates– will stay the same during the life of the loan (installment loans), therefore monthly payment amounts stay the same

3.Variable Rates– adjustable rates that change according to the changes in the economy; on credit cards AND loans

III.How do I get approved for credit cards & loans?

A.The 5 C’s of Credit:

1.Collateral – an asset of value that “backs up” the loan in case of non-payment; car or house.

2.Capital –your bank accounts—any money there?; personal items of value that can be given up in case of non-payment

3.Capacity – history of employment & your current job; is there potential for a salary increase?; are you “capable” of paying?

4.Character – credit bureau (report card of your bill-paying); looks at your credit score (FICO score) for 7 years

5.Conditions – when lenders consider the current economy or your past credit troubles if you can prove you are moving past a bad experience (divorce or unemployment); you explain your history & reasons for financial troubles & how you are doing better now

B.Credit Bureaus/Reporting Agencies

EquifaxTransUnionExperian

1.Organizations that keep records on people who have used credit

2.They gather the FACTS about how you pay your bills, under your social security number

3.Records are confidential – only authorized people can see it

e.g. YOU, landlords, potential creditors, employers

NOT: Your parents, teachers, doctors

4.Assign you a credit score (FICO): 0 to 850 – the higher the number, the better bill-payer you are

5.Credit scores should always be above 750; if it falls below 500, highly unlikely to get a loan or a credit card.

6.Free “yearly” credit report (since 2004) at:

or call 1-877-322-8228

  • Can get ONE report from EACH credit bureau

7.Must have credit “open” in order to have a score (18+ years of age)

8.History stays on there for 7+ years from the date of the last transaction!

9.Don’t marry anyone with bad credit!

IV.TYPES OF CREDIT

Must be 21 yrs. old (need a cosignerif 18, 19, or 20)

  • Must apply for approval via “application”
  1. Traditional Credit Cards (Revolving Credit)
  • Have limits(credit limit) as to how much you can spend (outstanding balance cannot go over this amount)
  • Should be paid off within 3 months!
  • NOT attached to a bank account
  1. Single-purpose cards
  • Retail store accounts (Kohl’s, Dillard’s)
  • A great way to start building your credit!
  • Can only use at THE STORE mentioned
  • Has the highest interest rate (APR) – 21.99%+
  • No annual fees
  • Can make payments over time on outstanding balance
  • Low starting limit ($200)

2.Multi-purpose Cards

  • Visa, MasterCard, Discover
  • Can use them everywhere! (in every store)
  • Annual Fees ($25+)
  • APR ranging from 0% to 30+%
  • “Prepaid” gift cards with the “Visa, MC”

symbol

  • Can make payments over time on

outstanding balance

  • Starting limit is $500

3.Travel & Entertainment cards

  • American Express, Diners Club
  • Higher annual Fees ($100+)
  • Must be paid in full each month
  • An excellent “training” card
  • Are NOT accepted everywhere!!

B.Loans – Closed-ended credit(p. 18)

  • Payments at the beginning of the loan are mostly going to pay for interest, not principal (see Amortization schedules) so always pay MORE than minimum amount due!
  • Installment Loan – a loan that is paid back in equal, monthly payments; includes finance charges in every payment

Total amount of principal + calculatedfinance charges divided by months to pay it off = monthly payment

$15,000Cost of car

+ 5,000Finance charges(based on 3%, 5 yrs= 60 mths)

$20,000divide it by 60 =

$333.33 IF you made EVERY payment ON the due date

1.SECURED LOANS – collateral (property) needed to “back up” the loan in case you don’t pay it back

a.Car Loans – up to 6 years, but I recommend only up to 3 years!! 12-72 months

b.Mortgage Loan(1st mortgage) – a loan for property (house/land)

  • usually for 15 – 30 years
  • Requires a downpayment of 10% or 20+% (cash upfront)
  • has closing costs (expenses needed to get the loan finalized $500-$5,000)

Pays for: Credit checks, appraisals, inspections

  • FHA (FederalHousing Administration) – Loans for 1st-time home buyers; only have to give a 10% downpayment; strict on house inspection
  • PMI (Private Mortgage Insurance) – Property insurance because the loan is for more that 80% of the appraised value of the house; an extra amount added to EACH monthly payment
  • Adjustable Rate Mortgage – (ARM) the interest rate changes as the economy fluctuates; variable rate

c.Home Equity Loan (2nd mortgageorLine of Credit) – typically a “line of credit”; Pre-approved for a dollar amount but can use it whenever you want—spend it as you need it via checks or debit card

Use for: College tuition, weddings, home remodeling

The total of your 1st mortgage + the 2nd mortgage MUST be 80% of the house’s value or less

2.UNSECURED LOANS – nothing needed to secure the loan; no collateral to back it up!

NOT a good idea to get for a vacation!

  • School Loans – get the money during school but payments are deferred (put off) until after graduation (with interest): More on this in Module 3

V.Hazards of using credit

A.Overbuying on credit cards– purchasing when not needed or cannot afford (should pay off within 3 months)

Follow the 20-10 Rule! (p. 20)

  • Annual Net Income– amount borrowed is less than 20% of annual net income

$16,500 x .2 = $3,200

  • Monthly Net Income– amount of monthly payments is less than 10% of monthly net income

B.Overuse of credit – charging TOO MUCH; you have multiple cards; monthly payments pile up

C.If you miss a payment or it’s late, it will LOWER your credit rating (“report card” on bill-paying)

D.Costs money to use credit (FINANCE CHARGE)

E.BIGGEST problem in our society right now!!

Be careful of:

Reverse Mortgages

  • For homeowners over 62 years old
  • Creditor PAYS the homeowner monthly installments so they have cash flow to pay expenses
  • NOT recommended to get a lump sum!!
  • Don’t have to pay back the “loan” until house is sold.
  • Must stay up-to-date on property taxesinsurances

VI.Where to Go for Credit or Loans

Commercial banks (National or State/Local)

“Thrifts” (Savings & Loans financial institutions—Third Federal Savings & Loan)

They give the lowest % rates!

The BEST place to get loans from, typically

Credit Unions (for union employees--PSE)

They give the lowest % rates!

The BEST place to get loans from, typically

Consumer Finance companies/Payday Loan companies (Beneficial OR “Cash Into Loans”)

Charge the highest in % rates—30%!

WORST place to go!

Pawnshops – if don’t make it back there, your item will be sold

Borrow against life insurance policies – but then you don’t have the full value of your life insurance policy!

BUT: What about these deals???

“1 year, same as cash!”“90 days of no payments”

Furniture Stores, Appliance Stores, Home Depot

OK to do but entire balance MUST be paid in full on the expiration date OR entire amount of interest must be repaid.

Always CALL to get your final balance for the last payment

Creative “fees” includes hidden costs that “should” be disclosed in fine print . . .

Always read the fine print of ANYTHING you sign!!

MOVE TO MODULE 3 NOTES:

a.Subsidized Loans (federal loans) – Interest does NOT have to be paid during school; “supported”; must start repaying 6 months after graduation

  • can pay the interest on the loan while still in college

e.g. Stafford Loans

b.Unsubsidized Loans – “unsupported”

  • must pay the interest as you go through your education
  • it is recommended to get this type of loan as a last resort, as monthly payments are required during college
  • Must pay the interest on the loan while still in college

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