H.E. 5-103 MONEY MANAGEMENT How to Types of Credit Credit is available in several forms: home equity Manage Credit loan, service credit, loans, installment credit, and credit cards. You may borrow money to purchase a home. That is called a mortgage. A mortgage is a debt used to Credit is a service that lets purchase property. It has two parts, the note and the mortgage. The note is the IOU that states the terms you buy now and pay later. under which you promise to repay the borrowed money. The mortgage, or deed of trust, is the property You use someone else’s you pledge as security to the lender. That means he or she can take over your mortgage if you fail to make your money to buy something you payments. want to use now. Credit A home equity loan is a modern version of the second mortgage. Your home is used as security for a means using your money loan for items that require a sizeable amount of cash. This type of loan may be used to finance expenses such from future paychecks to pay as major home improvements, college expenses or large medical bills. for something you buy now. You use service credit when you use your telephone, electricity or gas for a month. You don’t have to pay for using the services until the end of the month. When you borrow, A consumer cash loan is a type of credit that you promise to do the following: involves three parties. You borrow cash from a second s pay back the amount of money you borrow plus the party (ABC Bank) to buy an item from a third party (the additional charge for using that money for several XYZ Department Store). Let’s say you want to buy a months; stereo that costs $1,200. You don’t have $1,200 in cash, so you borrow the money from your local bank. You, in s pay back your debt regardless of personal crises or turn, give the borrowed money to the XYZ Department unexpected situations; Store for the stereo. s make your payments on time; A consumer cash loan or personal loan may be secured or unsecured. Unsecured loans are loans s not sell any item that has been used as collateral you can get on the basis of your signature and good until all payments have been made; credit rating. These loans are generally under $3,000. s give back what you are buying if you can’t finish Secured loans are made by pledging personal paying for it; assets or by cosigning with another person. A loan that is secured with personal assets such as stocks, bonds, a s take responsibility for any damages done to the item car, or the item you purchase provides the lender with that you bought on credit if it has to be returned to the property in case you fail to make your payments. If you store. cosign, the person who signs the loan with you agrees to pay off the loan if you don’t. Consumer loans are The finance charge is the total price you have available through banks, credit unions, small loan to pay to borrow money. The finance charge is made companies, insurance companies, friends, or relatives. up of two parts, interest and carrying costs. Interest With installment credit, you can borrow is the portion of the finance charge you pay for actually money and repay in equal weekly or monthly amounts. borrowing the money. Carrying costs are the You can also arrange your payment so the loan is due expenses the lender has to charge for the service of in 30, 60 or 90 days. Revolving charge accounts allow providing credit to you. Some of the lender’s charges you to borrow at any time, in any amount up to a include bookkeeping, credit investigation, and mainte- maximum credit limit such as $300. nance fees. If you choose to carry credit life, credit Credit cards are a popular form of credit. accident and health, or credit property insurance, that Credit cards may be divided into two types: is also added to the borrowing cost. - Single purpose cards such as retail department Because credit costs vary so much from lender to store cards and major oil company cards are limited to lender, the annual percentage rate (APR) is used use in that store or with the oil company. to state the cost of credit. The APR gives a way to - Comprehensive cards are widely accepted by compare credit costs on an equal basis. hotels, motels, restaurants, airlines, major department stores, and other businesses. Examples of comprehen- sive cards are American Express, Visa, and Factors Affecting Mastercard. You are usually assessed a yearly fee for using the charge card. Credit Costs The cost of credit depends on the following: s who you borrow from, How Much s your credit rating, Does Credit Cost? s how much you borrow, and When you buy on credit, you use someone else’s money so you can buy something now. The price you s how long you take to repay. pay for using that money is called interest. The price you pay to borrow money varies from creditor to Who You Borrow From creditor. So, shop around, and ask the following Different creditors charge different rates for questions: borrowing. Before you borrow, compare costs at three or more places. s What is the annual percentage rate? s What is the total cost of the loan in dollar amounts? Your Credit Rating s How long do you have to pay off the loan? Your credit rating shows your ability and willing- s What are the number, amounts, and due dates of ness to repay a debt. It is measured by your record of payments? paying bills. It is determined by how prompt and s What is the cost of extending the time period for reliable you have been in making past credit payments. paying back the loan? A good credit rating helps you qualify for credit s What is the cost of late charges for overdue pay- and helps you get credit at a lower cost. ments? s If you pay the loan off early, are there any pre- payment penalties? How Much You Borrow s Does the loan have to be secured? If so, what The less money you need to borrow, the less the collateral is required? credit will cost. s What is the cost of credit life or other insurance that For example, let’s say you want to buy a used car is being offered or that may be required? for $6,000. You want to pay for it in two years. The s Are there any other charges you have to pay? annual percentage rate is 18 percent. Compare the cost of credit between borrowing the entire $6,000 and When shopping for credit, remember two terms: making a $1,000 down payment or a $2,000 down finance charge and annual percentage rate. If you payment (see Table 1). As Table 1 shows, if you have remember these terms, you can find out how much you no down payment and borrow the entire $6,000, the will pay for credit and can compare the costs of credit finance charge is $1,189. If you borrow $5,000, the among the various lenders. finance charge is $991. If you borrow $4,000 the cost is $793 — $396 less than with no down payment. So you see, the bigger the down payment you make, the lower the finance charge you have to pay. A bigger down payment reduces your monthly payment. 2 Table 1. s Credit life insurance pays off the loan if the How Down Payments Can Reduce the Cost borrower dies. of Borrowing $6,000 (18% APR). s Credit accident and health insurance ______________________________________________________________________________________ insures that your payments will be made even though Down Amount Monthly Total Total Payment Financed Payment Finance Cost you become ill or disabled and can’t work. (rounded) Charge s Credit property insurance will pay for the ___________________________________________________________________________________ goods if they are stolen or destroyed. $ 0 $ 6,000 $ 300 $ 1,189 $ 7,189 Since credit insurance is relatively small compared to the loan, it’s an often overlooked item. Read all loan ___________________________________________________________________ and credit contracts more closely to see if this insur- 1,000 5,000 250 991 6,691 ance is included, under what conditions, and at what _________________________________________________________________ costs. It’s to the lender’s advantage to get you to sign for 2,000 4,000 200 793 6,793 credit insurance. Lenders are like insurance agents. ________________________________________ _________________________________________ They make a commission on each policy sold. But consumers often don’t want it, may not need it, and How Long You Take to Repay often don’t realize they are buying it. The longer you take to repay your debt, the more Some consumers quickly sign— but do not read— you will pay. A longer repayment period may lower their loan contracts because they need the money and your monthly payment but add to the total cost of do not feel they are in a position to ask questions. borrowing. For example, let’s say you want to buy the Other consumers may feel that if they turn down credit same $6,000 car at 18 percent annual percentage rate insurance, they may harm their chances of being with no down payment. The cost will vary with how approved for credit. So they sign without question. long you take to pay. Compare the costs for two, A consumer already adequately covered by life, three, or four years of financing (see Table 2). The total health and disability insurance at work or through a cost over two years would be $7,189. For four years it private plan may not want the extra coverage. If you would be $8,460. The difference is $1,271. are already covered by one of these plans, payments Take the shortest amount of time to will continue to be made on the loan even though you repay a debt and make the highest monthly may become ill or disabled or die. Similarly, a person on payment you can safely afford. social security or in the armed forces would have an _________________________________________________________________ income even if disabled, so again credit disability Table 2. insurance would not be needed. How Length of Time to Repay Can Reduce the Cost of Review your present insurance coverage. If it is Borrowing $6,000 (18% APR). adequate, there is no reason to buy more. If the _____________________________________________________________________ amount of the loan is small, you may not need credit Time Amount Monthly Total Total insurance coverage at all. To Financed Payment Finance Cost Repay (rounded) Charge __________________________________________________________________________ Where to Go for a Loan 2 years $ 6,000 $ 300 $ 1,189 $ 7,189 When you need to borrow money, you don’t want ______________________________________________________________ to just walk into the first lending institution you see and borrow money. Look around to find the lender who 3 years 6,000 217 1,809 7,809 can give you the least expensive loan. _________________________________________________________________ Here are the places you can borrow money: 4 years 6,000 176 2,460 8,460 _______________________________________________________________________ s a credit union, s a local bank, s your life insurance company, Credit Insurance When you apply for credit, you will frequently be s a finance company, offered credit insurance. Credit insurance is often sold s a savings and loan company, by banks, savings and loan associations, small loan companies, department stores, automobile dealers, s a pawn shop, and others at the time they grant credit. s an illegal lender or loan shark. Different kinds of credit insurance protect you in different ways: 3 Should You Use Credit? Will You Be Before buying an item on credit, ask yourself if you can justify using credit rather than waiting to buy the Granted Credit? item with cash. Have you ever wondered how banks or other __________________________________________________________________________ lending institutions decide if they will lend you money? The Cost— Before a bank or other lending institution will lend you money, they try to determine if you are a good s Is it worth the extra cost to buy on credit? credit risk. The lending institutions look at the following s Is this something I really need? factors to judge your ability and willingness to repay s Is this something I have planned in my your debts: budget? - income, s Can I make the payments? - occupation, s Have I tried to be exact in estimating my - stability in life, other expenses? - credit history, - age, ___________________________________________________________________________ - assets. The Risk— s What if I get sick or have an accident? Income Could I still pay? s Do you have a steady source of income? s Is it worth losing the money I have paid if I s How large is your income? miss a payment or cannot finish paying for the s How dependable is your income? item? s What are the demands on your income? s How many dependents do you support? s Do I want to risk repossession, a bad credit s What are your outstanding debts? history or legal action if I can’t pay for all of it? Occupation ____________________________________________________________________________ s Do you have a good employment record? The Obligation— s Are you self employed? s Can I afford to tie up my future income? s Are you regularly or seasonally employed? s Am I borrowing from a fair and honest s How long have you been employed? person? s What is your occupation? Businesses have found that people in certain occupations are more likely to s Do I understand what the contract says? repay debts than others. s Will I still want to be paying for this item for the length of the contract? Stability s Would it be wiser to save my money and s Do you display stability in your life? buy this later? s How long have you lived at your current residence? s How long have you been employed at your present _________________________________________ _________________________________________ job? s Do you own your residence? Credit History s Have you paid your bills in the past? s Do you pay bills on time, late, or not at all? Age s Are you young (18-24)? s Do you have a poor repayment record? s If you answer yes to both of the above questions, you may not be considered credit worthy. Applicants may not be rejected on the basis of age alone. 4 Assets Disadvantages s Do you have checking and savings accounts? s The use of credit adds additional cost to the original s Do you have property or investments that could be purchase price of an item. used as security or collateral? s With credit, you may buy more than you can afford. However, if you do not pay for the items, the store can repossess or take them back. Will You Be s You may be discouraged from comparison shopping Turned Down to get the best buy. If you only have credit at one store, you may miss bargains at other stores where you don’t for Credit? have credit. The Federal Reserve Board is responsible for s If you don’t understand the credit contract, you may administering federal credit policy. The board has agree to something you don’t really intend to. suggested that creditors offer the following reasons for s Overuse and abuse of credit can lead to a poor credit denying credit: rating. s The use of credit ties up money out of paychecks in s credit application incomplete, the coming months. s insufficient credit references, s By using credit, you may tie up income needed for s unable to verify credit references, necessities. s temporary or irregular employment, s unable to verify employment, s length of employment (you may not have worked at Reducing the one job long enough), s insufficient income, Cost of Credit s excessive debts, You can reduce the cost you pay for credit if you: s inadequate collateral, s Make as large a down payment as possible. s too short a period of residence, s Borrow the least amount possible. s temporary residence, s Shop around for the lowest annual s unable to verify residence, s no credit file, percentage rate. s insufficient credit file, s Pay back the loan as fast as you can; pay s garnishment, attachment, repossession or lawsuit, back in less time, such as one year instead of s bankruptcy. two. s Arrange the highest monthly payment you Buying on Credit can afford. s Pay your bills on time, which protects your Advantages credit rating. s If you lack the discipline or time to save money, s Only use credit when you really need it. credit is a way to buy consumer goods. s Credit is handy and convenient. s Credit allows you to use an item while you are paying Married Women for it. s If the purchased item needs repairing or replacing, and Credit you could hold up your finance payment until you Married women often use credit accounts listed in receive appropriate action from the seller. their husband’s name. They think they have credit in s Establishing a good credit rating will make it easier their own name. In reality, the credit is only being for you to get credit for emergencies. reported in the husband’s name. s Credit is a type of forced savings. If you spend $10 a What about your credit history? Do you have your week doing laundry outside your home, the $10 could own credit identity, or is everything reported in your be used to pay for a washer. After the washer is paid husband’s name? for, you won’t have the $10 laundry bill. If you were suddenly divorced or widowed, would s If you carry credit cards, you can carry less cash. you be able to borrow money, get a credit card, or rent s You can satisfy immediate needs. an apartment? If you don’t have your own credit s You can take advantage of sales even though you history, you may find yourself in a financial jam. can’t pay for items right then. The Equal Credit Opportunity Act gives women a way to establish their own credit history and identity. Your own credit means a separate account or loan in 5 your own name— not a joint account with your eligible for a small loan. Remember: pay it back husband or a duplicate card on his account. promptly! You have a right to your own credit, based on your own credit records and earnings. You may not be denied credit just because you are a woman, or just Keep a because you are married, single, widowed, divorced, or separated. Good Credit Rating Use your own name when you apply for Pay your bills promptly. If you have trouble credit. If Mary Ann Jones married Richard Smith, she making payments, visit your creditor. Try to work out a could choose Mary Ann Jones, Mary Jones, Mary Ann solution. Perhaps you can make smaller payments or Smith, Mary Jones Smith, Mary Ann Jones Smith or delay payments for awhile. Mary Smith. Any of these names are legal. Just pick Do NOT avoid your creditor. Don’t act as if you one and use it consistently so there is no indication of have no intention of paying your bill. This will hurt your fraud. DO NOT use your social title— Mrs. Richard credit rating seriously and make it hard for you to get Smith. That credit information would go in your credit again. husband’s file. Make sure that accounts you share with Can I Find Out About your husband are being reported under BOTH your name and your husband’s name. My Credit Record? To make sure that all accounts are being credited to Credit bureaus maintain credit records. You can your history, write your creditors and request that find out your credit record by contacting each of the credit information also be reported in your name. In the three credit bureaus in writing. You will be required to letter, include your husband’s name as it appears on identify yourself to each bureau’s satisfaction, and you the billing statement, your address, the account may be charged a small fee. There is no fee within thirty number, and your name as it should appear in the days if you have been turned down for credit, employ- credit file. ment or insurance because of information contained in a report. Your written request should include: Establishing a ___ your name, ___ address, Credit History ___ previous address (if within last two years), Here are some steps you can take to establish ___ social security number, your credit history and show creditors you are credit worthy. ___ date of birth, s Open a checking and savings account in ___ current employer, and your own name. This alone doesn’t prove you are ___ your phone number. credit worthy, but it does indicate that you can handle money in a businesslike manner. If a spouse is also checking, information on both people s Open a retail charge account. Start an must be included and both must sign the request. account in your own name at your local drug store or The credit bureau gathers and sells credit informa- dress shop. Charge some purchases and pay your bill tion about consumers. When a creditor asks a credit promptly. bureau for a report, the bureau sends the creditor s Apply for a bank credit card. Banks often whatever information it has on file about you. The require that you have a savings account with the bureau typically reports: institution or a cosigner before they will issue you a s how many and what kind of credit accounts you card. They give you a limit on the amount you can have, charge. This amount increases as your income and s how you pay your bills, and credit history improve. s whether you’ve ever filed bankruptcy or been sued. s Take out a small loan. You may not be eligible The bureau gets its information from creditors who for enough to buy a car, but you probably will be have accounts with the bureau or from daily court records. Adapted from “Money Management: How to Manage Credit,” by Esther McAfee Maddux, Extension Home Economist, University of Georgia Cooperative Extension Service. Approved for use in Kentucky by Suzanne Badenhop, Family Resource Management Specialist. Educational programs of the Kentucky Cooperative Extension Service serve all people regardless of race, color, age, sex, religion, disability, or national origin. Issued in furtherance of Cooperative Extension work, Acts of May 8 and June 30, 1914, in cooperation with the U.S. Department of Agriculture, C. Oran Little, Director of Cooperative Extension Service, University of Kentucky College of Agriculture, Lexington, and Kentucky State University, Frankfort. Issued 4-94; Last Printed 6-96, 2000 copies; 2500 copies to date Copyright © 1997 by the University of Kentucky Cooperative Extension Service. This publication may be reproduced in portions or its entirety for educational or non- profit purposes only. Permitted users shall give credit to the author(s) and include this copyright notice.
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