CHAPTER 5 - DOC by keara

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									Chapter 05 Consumer Credit: Advantages, Disadvantages, Sources, and Costs

CHAPTER 5 SUMMER OUTLINE I. WHAT IS CONSUMER CREDIT (p. 139)     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 of individuals and families.

The Importance of Consumer Credit in Our Economy (p. 139) All economists recognize consumer credit as a major force in the American economy. The movement of the baby boom generation into the age group that tends to use credit most heavily has added to the growth of consumer credit.

Uses and Misuses of Credit (p. 139)  There are many valid reasons for using credit:  a medical emergency  an immediate need for a car  buying now to protect against rising prices Consider the trade-offs:  Do I have cash to make the purchase?  Do I want to use my savings for the purchase?  Does the purchase fit my budget?  Could I postpone my purchase?  What are the opportunity costs of postponing the purchase?  What are the dollar costs and the psychological costs of using credit?

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Effective use of credit can help us satisfy our wants and needs. Misused, credit can result in default, bankruptcy, and loss of reputation.

Advantages of Credit (p. 140)  Buy and enjoy now and pay from future income  Purchase goods even when funds are low  Advance notices of sales  Order by phone or to buy on approval  Easier to return merchandise  Shopping convenience  No need to carry large amounts of cash  Simplified bookkeeping of expenses  Use of credit cards as identification when cashing checks  Rebate offers on purchases  Cash bonus based on total purchases during the year  Credit indicates stability and responsibility Disadvantages of Credit (p. 141)      Credit costs money Credit may cause overspending Credit may result in loss of merchandise or income Credit ties up future income Financial and Personal Opportunity Costs

An intelligent decision to use credit demands careful evaluation of your current debt, future income, the added cost, and the consequences of overspending.

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Chapter 05 Consumer Credit: Advantages, Disadvantages, Sources, and Costs

II. TYPES OF CREDIT (p. 142)  There are two types of consumer credit—closed-end credit and open-end credit.

Closed-end credit (p. 142)    Closed-end credit is used for a specific purpose and is for a specified amount. Mortgage loans, automobile loans, and installment loans for purchasing furniture or appliances are examples of closed-end credit. The three most common types of closed-end credit are: * installment sales credit * installment cash credit * single lump-sum credit

Open-end Credit (p. 143) Open-end credit is a form of credit that many retailers use. You have an option to pay the bill in full within 30 days without interest charges or of making stated monthly installments based on the account balance plus interest. Revolving check credit is a prearranged loan for a specified amount that the consumer can use by writing a special check. SOURCES OF CONSUMER CREDIT (pp. 143)  Financial institutions, the sources of credit, come in all shapes and sizes. They play an important role in our economy, and they offer a broad range of financial services. Loans (p. 144)  Inexpensive Loans: Parents or family members; money borrowed on financial assets held by a lending institution.  Medium-Priced Loans: Commercial banks, Savings and Loans, and credit unions.  Expensive Loans: The most expensive loans are available from finance companies, retailers, and banks through credit cards. Finance companies often lend to those who cannot obtain credit from banks or credit unions. The interest ranges from 12% to 25%.  Home Equity Loans: Use these loans only for major items, such as education, home improvements, or medical bills. Interest paid on home equity loans is tax deductible. 

Credit Cards (p. 146)     Credit cardholders who pay off their balances in full each month are called convenience users. Cardholders who do not pay off their balances every month are known as borrowers. Don’t confuse credit card with a debit card. The debit card debits your account at the moment you buy goods or services, while the credit card extends credit and delays your payment. Protect yourself against debit/credit card fraud. Travel and Entertainment (T & E) cards are not really credit cards, because the monthly balance is due in full.
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Chapter 05 Consumer Credit: Advantages, Disadvantages, Sources, and Costs

III. 

APPLYING FOR CREDIT (P. 148) The only way to determine how much credit you can assume is to first learn how to make an accurate and sensible personal or family budget.

Can You Afford a Loan? (p. 148)  Before you take a loan, ask yourself whether you can meet all of your essential expenses and still afford the monthly loan payments.

General Rules of Credit Capacity (p. 148)  Debt Payments-to-income ratio is calculated by dividing monthly debt payments (not including house payments) by net monthly income.  Experts suggest that you spend no more than 20 percent of your net (after-tax) income on credit payments. Debt-to-Equity ratio is calculated by dividing total liabilities by net worth, but do not include the value of your home and the amount of its mortgage.  If your debt-to-equity ratio is about 1, you have probably reached the upper limit of debt obligations.

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The Five Cs of Credit (p. 149)   Most lenders build their credit policies around the five Cs of credit: character, capacity, capital, collateral, and conditions. The Equal Credit Opportunity Act (ECOA) gives all credit applicants the same basic rights.

Other Factors Considered in Determining Creditworthiness (p. 150)    Age. The Equal Credit Opportunity Act is very specific about how a person’s age may be used as a factor in credit decisions. Public Assistance. You may not be denied credit because you receive Social Security or public assistance. Housing Loans. The ECOA covers applications for mortgages or improvement loans.

Your Credit Report (p. 152)  Most lenders rely heavily on credit reports when they consider loan applications.

Credit Bureaus (p. 152)  The three major credit bureaus, Experian, TransUnion, and Equifax, maintain more than 200 million credit files on individuals. These credit bureaus can produce a report about your past and present credit activity.

What if Your Application is Denied? (p. 152)  Ask questions if your application if denied. The ECOA gives you the right to know the specific

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Chapter 05 Consumer Credit: Advantages, Disadvantages, Sources, and Costs

reasons for denial. What’s in Your Credit Files (p. 154)  The credit bureau file contains your name, your address, your social security number, and your birth date.

Fair credit Reporting (p. 154)  The Fair Credit Reporting Act regulates the use of credit reports, requires the deletion of obsolete information, and gives the consumer access to his or her file and the right to have erroneous data corrected.

Who may obtain a Credit Report? (p. 155)  Your credit report may be issued only to properly identified persons for approved purposes. Your friends and neighbors may not obtain information about you.

Time Limits on Adverse Data (p. 155)  Most of the information in your credit file may be reported for only seven years.

Incorrect Information in Your Credit File (p. 155)  When you notify the credit bureau that you dispute the accuracy of information, it must reinvestigate and modify or remove inaccurate data. If dispute is not resolved, you may place a statement of 100 words or less in your file. What Are the Legal Remedies? (p. 155)  .        The provisions of the Fair Credit Reporting Act allow consumers to sue any consumer reporting agency or user of reported information. THE COST OF CREDIT (p. 156) Two concepts to remember are the finance charge and the annual percentage rate.

The Finance Charge and the Annual Percentage Rate (APR) (p. 156) The finance charge is the total dollar amount paid to use credit. It includes interest costs, service charges, credit-related insurance premiums, and appraisal fees. Annual percentage rate is the percentage cost (or relative cost) of credit on a yearly basis. The APR is the key to comparing credit costs. All creditors must state the cost of their credit in terms of the finance charge and the APR.

Tackling the Trade-offs (p. 157) Term versus interest costs: the longer the term for a loan at a given interest rate, the greater the amount that must be paid in interest charges. Lender risk versus interest rate: the greater the risk for the lender, the higher the cost of credit. Variable interest rate, a secured loan, a large down payment, and a shorter-term loan are less expensive.

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Chapter 05 Consumer Credit: Advantages, Disadvantages, Sources, and Costs

Calculating the Cost of Credit (p. 158)   The two most common methods of calculating interest are compound and simple interest formulas. Simple interest is the interest computed on principal only and without compounding; it is the dollar cost of borrowing money.  The simple interest formula is: I = P  r  T. The APR formula is: APR = 2  n  1 P(N+1)  Simple interest on the declining balance. When more than one payment is made on a simple interest loan, the method of computing interest is known as the declining balance method.  Add-on interest: When the add-on interest method is used, interest is calculated on the full amount of the original principal.  Cost of open-end credit. Creditors use various systems to calculate the balance on which they assess finance charges.  Cost of credit and expected inflation. Lenders, seeking to protect their purchasing power, add the expected rate of inflation to the interest they charge. V. PROTECTING YOUR CREDIT (p. 160)    Billing Errors and Disputes (p. 160) The Fair Credit Billing Act sets procedures for promptly correcting billing errors, for refusing to make credit card or revolving credit payments on defective goods, and for promptly crediting your payments. If you think your bill is wrong or you want more information about it, notify the creditor in writing. Pay all the parts of the bill that are not in dispute. Creditors must acknowledge your letter within 30 days.

Protecting Your Credit Rating (p. 161)  A creditor may not threaten your credit rating while you are resolving a billing dispute, and until your complaint has been answered, the creditor may not take any action to collect the disputed amount.

Defective Goods and Services (p. 161)  The Fair Credit Billing Act provides that you may withhold payment on any damaged or shoddy goods or poor services that you have purchased with a credit card, as long as you have made a real attempt to solve the problem with the merchant.

Identity Crisis: What to Do if Your Identity is Stolen (p. 161)    Contact the fraud departments of each of the three major credit bureaus. Contact the creditors for any accounts that have been tampered with or opened fraudulently. File a police report

Protecting Your Credit From Theft or Loss (p. 162)    Tear or shred any papers that contain personal information before you throw them out. If checks have been stolen or misused, stop payment on them. If debit card is stolen or lost, cancel it and get another with a new PIN.

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Chapter 05 Consumer Credit: Advantages, Disadvantages, Sources, and Costs

Protecting Your Credit Information on the Internet 

(p. 162)

Make sure that your transactions are secure and your personal information is protected.

Consigning a Loan (p. 162)   As many as three or four cosigners are asked to repay the loan. If you cosign, consider the following before you cosign. 1. 2. 3. 4. 5. Be sure you can afford to pay the loan. Your liability for this loan may keep you from getting other credit that you may want. You could lose the property you have pledged. Check your state law. Request that a copy of overdue payment notices be sent to you.

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Chapter 05 Consumer Credit: Advantages, Disadvantages, Sources, and Costs

COMPLAINING ABOUT CONSUMER CREDIT (p. 163)  First try to resolve the problem directly with the creditor. Only if that fails should you bring more formal complaint procedures.

Consumer Credit Protection Laws (p. 163)   *Truth in Lending and Consumer Leasing Acts *Equal Credit Opportunity Act *Fair Credit Billing Act *Fair Credit Reporting Act *Consumer Credit Reporting Reform Act The Federal Reserve System has set up a separate office in Washington—the Division of Consumer and Community Affairs—to handle consumer complaints. Your Rights Under Consumer Credit Laws (p. 163)    Complain to the creditor. File a complaint with the government. If all else fails, sue the creditor. You may also take legal action against a creditor. If you decide to file lawsuit, here are important consumer credit laws you should know:

MANAGING YOUR DEBTS (p. 164)  If you cannot make your payments, contact creditors at once and try to work out a modified payment plan with them. Do not wait until your account is turned over to a debt collector.

Warning Signs of Debt Problems (p. 164)  Referring to over indebtedness as the nation’s number one family financial problem, a nationally noted columnist lists the following as frequent reasons for indebtedness: *emotional problems *the use of money to punish *the expectation of instant comfort *keeping up with the Joneses *expensive indulgence of children *misunderstanding or lack of communications *the amount of the finance charge Excessive indebtedness may result in heavy drinking, a neglect of children, marital difficulties, and drug abuse. But help is available to those who seek it. Debt Collection Practices (p. 165)  The Federal Trade Commission enforces the Fair Debt Collection Practices Act, which prohibits certain practices by agencies that collect debts for creditors. 

Financial Counseling Services (p. 165)

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Chapter 05 Consumer Credit: Advantages, Disadvantages, Sources, and Costs

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A Consumer Credit Counseling Service is a local, non-profit organization affiliated with the National Foundation for Consumer Credit. It provides debt-counseling services for families and individuals with serious financial problems.

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The CCCS aids families with serious debt problems by helping them manage their money better, and through education. Anyone overburdened by credit obligations can phone, write, or visit a CCCS office. The CCCS requires that an application for credit counseling be filled, and then an appointment is arranged for a personal interview with the applicant.

Other Counseling Services (p. 165)  Counseling services are also available from universities, military bases, credit unions, local county extension agents, and state and federal housing authorities.

Declaring Personal Bankruptcy (p. 167)  Debt burden, unemployment, divorce rates, and household net worth are all indicators of personal bankruptcies. However, the Bankruptcy Recovery Act of 1978, which made personal bankruptcy easier, is also considered an important cause of the increase in personal bankruptcies.

The U.S. Bankruptcy Act of 1978: The Last Resort (p. 167)   In a Chapter 7 bankruptcy, a debtor is required to draw up a petition listing his or her assets and liabilities. Chapter 7 bankruptcy grants a debtor a chance to make a fresh start in life. Chapter 13 bankruptcy. A debtor with a regular income proposes to a bankruptcy court a plan for extinguishing his or her debts from future earnings.

Effect of Bankruptcy (p. 169)   Different people have different experiences in obtaining credit after they file a bankruptcy case. Some find obtaining credit more difficult. The bankruptcy law prohibits your employer from discharging you simply because you have filed a bankruptcy case.

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