Credit Management

GENERAL ISSUES

Introduction
Many of you have probably received
credit card offers (either on campus or through the mail) if you are a college student About 90% of college sophomores have credit cards Proper use of a credit card can help establish a solid credit history Improper use can take years to heal
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What is Credit?
Receiving money, goods, or services on
the basis of an agreement that the borrower will repay the lender with a specified time period at a specified rate of interest Today, total consumer credit is about $2 trillion (excludes home mortgages and home equity loans) Americans carry over one billion credit cards Over one million Americans file for personal bankruptcy each year (twice as

Types of Consumer Credit

Revolving credit

Consumer can make a number of different purchases, up to a certain credit limit A minimum payment is due each month and interest is charged on the unpaid balance (average is 14%/year) Consumer borrows a fixed amount and repays the principal plus interest at regular intervals (usually monthly)
Lender usually holds title to asset until final payment is

Installment loans

made

Mortgage loans and home equity loans

Mortgage is an installment loan secured by real estate

Typically have a term of 15 or 30 years
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Deciding How Much to Borrow

Failure to set debt limits is one

reason why people get in trouble with credit cards

Guideline: No more than 10 to 20% of your take-home pay should go toward repayment of installment or revolving credit (exclude mortgage payment)
National average is about 14%
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The Right Reasons for Borrowing

Purchasing large, important goods and
services

House Car College education Loss of job Death of relative (plane tickets on short notice are expensive)
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Dealing with emergencies

The Right Reasons for Borrowing

Taking advantage of opportunities

Good sale on computer (you are saving for one anyway) Easy to pay with a credit card (pay off your balance every month) when doing day-to-day shopping

Convenience

Establishing or improving your credit

rating

Good way for a college student to establish a credit rating

The Wrong Reasons for Borrowing

Living beyond your means

Do you have to use your credit card to pay your basic living expenses (because you cant afford not to)?
Buy groceries Buy clothes Buy gasoline Pay your taxes

Sources of Consumer Credit

Financial institutions

Commercial banks, savings banks, credit unions University alumni associations, sports franchises, etc., are issuing credit cards with their logo (can be used anywhere a regular bank-issued card is accepted)
These organizations receive a fee from the issuing

National credit cards

bank

Retailer-specific credit cards (such as Sears and JCPenney)

Can only be used at a specific store
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Sources of Consumer Credit

Consumer Finance Companies

Company specializing in consumer loans

Example: Household Finance Make relatively short-term loans Charge high interest rates Generally unsecured Application forms are easier to fill out than

a banks Takes a short period of time to receive approval

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Sources of Consumer Credit

Life insurance companies and

investment companies

Policyholders may be able to borrow against their life insurance policy (up to the amount they have paid in premiums)

May be able to borrow money from

your investment firm via your brokerage account
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Sources of Consumer Credit

Personal loan from family and

friends

Always treat these in a businesslike manner

Lots of potential for interpersonal conflict

Pawnbrokers

Issues loans for a very low percentage of an items face value Item is held as security until the loan is repaid in full 12 Should be viewed as a lender of last

Applying for Credit

How creditors evaluate loan applications

1. Capacity (Cash Flow)

Can you afford to repay the debt? Examines current income (and expected future

earning potential) vs. current expenses Are you a good credit risk?

2. Character (Integrity
Do you live within your means or above it? Do you pay your bills on time? Do you demonstrate stability? 4. Capital

3. Collateral (assets)
Property to secure a loan

5. Conditions
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The Role of Credit Bureaus

Credit bureau a clearinghouse for
consumer credit information

Whats in your credit file?

Identifying information Your credit history

Including whether or not you pay your bills on time Bankruptcies, lawsuits, criminal convictions

Information of public record

You may request a copy of your credit record at any time

If youve recently been denied credit, the credit

reporting service must provide you a copy free of charge

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What to Do If Youre Denied Credit

The lender must provide you with a

written explanation

Try negotiating with the lender

Ask for a lower loan amount

Try another lender

Different lenders have different lending

policies

Some are more lenient than others

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Calculating Total Finance Charges

Lenders are required to clearly state the
finance charge and annual percentage rate (APR)

Finance charge total dollar amount charged for credit

Function of

Amount you borrow APR Term of loan

Annual percentage rate interest rate paid per dollar per year for credit Principal the amount borrowed

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Choosing the Lowest-Cost Credit Card

Four main areas to consider

Annual fee
Ranges from $0 to $50 annually

Late payment and other fees Annual percentage rate Grace period how long you have to pay for new purchases without having to pay interest charges
Ranges from 0 days to 30 days

If you pay your bill in full every month, get a card with no annual fee and a grace period of at least 25 days This way you wont pay interest charges
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Choosing the Lowest-Cost Credit Card

Many credit card companies offer a

low interest rate for a short time period (to lure you incalled a teaser rate), and then raise the interest rate substantially Or the company may offer a great rate unless one payment is late and then the rate rises substantially

Read the fine print

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Credit Abuse
If you abuse your credit, it can have
lasting repercussions

Repossession collection of collateral by the lender

May not settle the debt if market value of asset

doesnt cover amount of loan still outstanding

Remaining debt is called deficiency judgment

Wage garnishment a portion of borrowers wages is paid directly to lender by the employer
Requires a court order
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Credit Abuse

Bankruptcy borrower is relieved of debts, court divides assets/income among creditors Action of last resort Virtually eliminates chances of securing future credit Over one million Americans file for bankruptcy each year Most are voluntary filings Chapter 7: assets are seized by court and sold, funds are prorated among creditors (after court costs/legal fees)70% of bankruptcies Creditors usually receive only small percentage of whats owed Chapter 13: individuals establish a three-year plan of debt repayment Debtor retains possession of property Creditors usually receive 6070% of whats owed
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Credit Abuse
Bankruptcy doesnt eliminate all forms of
debt

Student loans Back taxes Child support Alimony

Bankruptcy shouldnt be considered a

quick fix

Remains on your credit record for ten years Wont get reasonable credit terms during that time May be difficult to rent an apartment, obtain 21

Credit Counseling and Credit Repair Services

A credit counselor is a trained
professional who helps you develop a budget and arrange a program of debt repayment

Nonprofit Consumer Credit Counseling Service

Funded by lenders and credit card companies

(vested interest in repayment)

Credit repair doctors often claim they can

erase your bad credit

Cant deliver on their promisesdont use them

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