Comprehensive Guide to Consumer Credit and Loans

annual percentage rate (APR)

cost of credit on a yearly basis stated as a percentage rate.

Consumer credit

dedebt that someone incurs for the purpose of purchasing a good or service. This includes purchases made on open-end credit, including lines of credit and credit cards, and some loans like those for vehicles and televisions.

Open-end credit

a form of credit extended in advance of any transactions and typically involve repeated transactions, like a credit card.

Credit limits

maximum amount of spending and outstanding debt allowed on the account. Vary with the perceived creditworthiness of the borrower.

grace period

This is the period of time a creditor gives you to pay your new charges without incurring a finance charge and having to make a payment on the new balance. It usually runs from the end of a billing cycle to the next payment due date.

finance charge

the dollar cost of credit or the cost of borrowing. The creditor charges us for the cost of extending credit, it can include interest accrued as well as other charges, such as financial transaction fees.

Service credit

a form of open-end credit and is granted to consumers by public utilities, physicians, dentists, cable, cell phones, and other service providers that do not require full payment when services are rendered, instead we pay for them later.

ex. our electric company allows us to use electricity all month and then sends us a bill that may not be due for 10 to 20 days.

Service credit usually…

carries no interest, although penalty charges and interest may apply if payments are made late. Service may be cut off for continued slow payment or nonpayment of the debt.

Travel and entertainment (T&E) cards

open-end credit issued by non-banks indicating that the holder has been granted a line of credit. It enables the holder, often a businessperson, to make purchases, like food and lodging when traveling.

T&E Cards Examples

American Express, Diner’s Club, Discover, and Carte Blanche, and these are also known as corporate cards.

retail sellers and businesses

These include department stores, clothing stores, oil companies, and car rental agencies that issue plastic cards that only may be used as open-end credit at one of their locations. Often, the balance on the account must be paid in full when the statement is received, and it cannot be rolled over from one billing cycle to the next. Or, the account is open-end credit as described above.

retail credit cards

credit cards offered by retail companies to enhance loyalty among customers.

Ex. Target, Macy’s, Lowe’s, and ExxonMobil.

Bank Credit Cards

credit cards that are issued by commercial banks and other financial institutions, such as Visa or MasterCard, and Discover. Used for electronic commerce through the Internet and for banking transactions through ATMs.

cash advances

withdrawn funds up to an approved credit limit on Bank credit cards. Obtained by credit card customers from an ATM or over the counter at a bank or other financial agency, up to a certain limit. often incur a fee of 3 to 5 percent of the total amount being borrowed. When made on a credit card, the interest on a cash advance is often higher than the interest assessed on credit card transactions.

convenience check

activates Cash advances.

Card blocking

the reserving of a portion of a credit or debit card balance for the cost of services not yet rendered. Credit card blocking is most common in the hospitality and rental car industries.

Credit Cards have…

higher interest rates (around 18 percent per year) than most consumer loans or lines of credit.

prestige cards

Bank credit cards often with a precious metal in the brand name such as “gold,” “silver,” or “platinum.” These accounts require that the user possess superior credit qualifications and they offer enhancements such as higher credit limits and special services. Prestige cards usually carry annual membership fees.

affinity cards

standard bank cards but with the logo of a sponsoring organization like an alumni association or professional organization, imprinted on the face of the card. The issuing financial institution typically donates a small percentage of the amounts charged to the sponsoring organization.

default

the failure of a borrower to make a scheduled interest or principal payment. Default also occurs for other reasons, like when we exceed one or more of our credit limits.

revolving line of credit

an arrangement that establishes a maximum credit limit that the lender will permit the person to borrow.

smart card

any plastic card about the size of a credit card with an embedded microprocessor chip, electronic memory, and a battery. Can provide personal identification, authentication, data storage, and application processing. A smart card (some are made from paper or cloth) can be loaded with data and used for phone calls, highway tolls, electronic cash payments, and other applications, and then periodically refreshed for additional use.

Unsecured personal loan

line of credit available on an as-needed basis. This low-interest cash advance system is accessed by writing special checks. This process avoids having to apply for a new loan every time one needs extra money for a particular purpose. Repayment is in installments usually over two to five years.

home equity credit line (second mortgage)

a loan in which the borrower uses the equity of their home as collateral.

collateral

something pledged as security for repayment of a loan, to be forfeited in the vent of a default

overdraft protection line of credit

kicks in when a customer writes a check for more than the amount available in their account. While it allows customers to escape paying overdraft fees, overdraft protection does charge interest on the amount loaned.

credit statement (or billing statement)

a periodic report that credit card companies must issue to credit card holders showing their recent transactions, balance due, and other key information.

Billing cycle

time period between when credit statements are sent to borrowers, which is usually about one month

statement date (billing date or closing date)

the last day of the month for which any transactions are reported on the statement.

payment due date

the specific day by which the credit card company should receive payment for it to be on time. The payment due date is the same calendar day of the month. payments are due at least 21 days after they are mailed from the issuer.

Transaction Date

The date on which a credit cardholder makes a purchase or receives a credit.

Posting Date

the month, day, and year when a credit card issuer processes a credit card transaction and adds it to the cardholder’s account balance. often one to three days later from transaction date

Minimum Payment

Amount due monthly on a credit card statement that is no smaller than the amount required by the creditor.

Transaction Fees

Fees charged to the account whenever the card is used for a balance transfer or cash advance.

Credit Receipt

This is written evidence of the items returned that notes the specific amount of the transaction. The amount of the merchandise credit is charged back to the credit card company and eventually to the merchant.

Penalty Rate (Default Rate)

the very high interest rate charged by the credit card issuer when a borrower violates the card’s terms and conditions. It could be 25 or 35 percent or more.

Periodic Rate

the APR for a charge account divided by the number of billing cycles per year (usually 12).

ex. periodic rate = 1 1/2 per month from an APR of approximately 18 percent (APR=18/12)

Rewards Credit Cards

one that pays the cardholder cash back or airlines miles for future use, these programs can be complicated, with specific eligibility rules. 1 to 6 percent cash back on a variety of purchases.

Average Daily Balance

This is the sum of the outstanding balances owed each day during the billing period divided by the number of days in the period.

ex. Outstanding Balance = 1000 times (APR=18/12) = $15

Unauthorized Use

Occurs when someone steals, borrows, or uses our card or account number without permission.

Credit Card Liability

The Truth in Lending Act limits a credit cardholder's liability up to $50 in the event of unauthorized use.

Teaser Rate (Introductory Rate)

the annual percentage rate charged by the credit card issuer during an initial period. Federal law requires that teaser rates must stay in effect for six months after the account is opened. The initial teaser rate can be from 0 to 2.9 percent but will be higher after the introductory period.

Credit card issuers make such an offer:

(1) to get their card into our wallet so we will use it plus they earn fees from the merchants we buy from both now and after the introductory period;

(2) to encourage us to move any credit card balances we might have to their company via a credit card balance transfer so they receive interest and fees from our activity; and

(3) to charge a higher annual percentage rate after the introductory period.

Card Registration Service

notify all companies with which we have debit and credit cards in the event of card loss. In addition, most services will request a replacement card and some advertise that they will reimburse us for fraudulent charges made. card registration services can range in price from $50 to $240 a year.

Credit Insurance

policy purchased by a borrower that pays off one or more existing debts in the event of a death, disability, or in rare cases, unemployment. grossly overpriced

Chip and Pin Technology (EMV)

reduced identity theft for lost and stolen credit cards because each transaction generates a unique code used in approval making them harder to counterfeit.

EMV

Europay, Master-Card, and Visa, the three companies that originally created the chip standard.

chips…

are not used in telephone and online purchases

Chargeback

the law provides that customers may dispute charges to their credit card when goods or services are not delivered within the specified time frame, goods received are damaged, or the purchase was not authorized by the credit card holder.

Dunning Letters

Notices that make insistent demands for repayment.

Action Steps for Billing Errors

1. Notify the merchant involved of the error. Disputes about the quality of goods and services are not “billing errors,” so the dispute procedure does not apply. However, it is often a merchant that caused an error and the merchant is in the best position to clear up most errors.

2. Write to the creditor at the address given for “billing inquiries” (not the address for sending payments), and include name, address, account number, and a description of the billing error. Provide photocopies of any necessary documentation. Keep the originals to challenge any finding by the company that no error occurred. Alternatively, write online using the card issuer’s website.

3. Send a letter so that it reaches the creditor within 60 days after the first bill with the error was mailed. It is a good idea to send the letter by certified mail, and ask for a return receipt so we have proof of what was mailed to the creditor. Include copies (not originals) of sales slips or other documents that support the billing error. Keep a copy of the dispute letter.

4. Withhold payment for disputed items. It is our right to withhold payment on the disputed amount (and related charges) during the investigation. We are required to pay any part of the bill not in question, including finance charges on the undisputed amount.

Sales Finance Company

a company that is an affiliate of a retail store or product manufacturer that provides loans to make purchases at the retail store or of the manufacturer’s products, like General Motors. The buyer completes the paperwork at the seller’s place of operation, not directly with the sales finance company.

Traditional Sources of Consumer Loans

Source: Banks

Types of Loans: Vehicles, homes, home improvement, home equity, personal, education, credit and cards, personal loans

Interest Rate: Low to medium

Source: Savings and loans banks

Types of Loans: Vehicles, homes, home improvement, home equity, personal loans

Interest Rate: Low to medium

Source: Credit unions

Types of Loans: Vehicles, homes, home improvement, credit and debit cards, personal loans

Interest Rate: Low to medium

Source: Sales finance companies

Types of Loans: Vehicles, consumer products

Interest Rate: Low to high

Source: Consumer finance companies (small loans)

Types of Loans: Vehicles, consumer products, personal loans

Interest Rates: High

Closed-End Credit

full amount owed must be paid bank by the borrower by a set point in time. When the loan is paid in full, the account is permanently closed

Single-Payment Loan

a loan repaid with one payment at the end of a specific period of time

Installment Loan

a system of credit that is repaid by the borrower in regular installments, such as equal monthly payments that include interest and a portion of principal.

Loan Contract (or loan agreement)

a document that evidences a loan. It often includes rules, type and value of collateral pledged, interest rate and fees, and how the loan is to be repaid and over what time period.

Promissory Note

financial instrument in which the borrower promises in writing to pay a determinate sum of money to the lender, either at a fixed or determinable future time or on demand of the payee, under specific terms.

Unsecured Loan

loan issued and supported only by the borrower’s creditworthiness, rather than by a type of collateral, because it is obtained without the use of property as collateral for the loan.

Signature Loan (“good faith loan” or “character) loan.”

unsecured personal loan because it is not secured by the equity in one’s home (as in a home equity loan) or by some other personal property or asset (such as a vehicle loan).

Student Loan

a form of unsecured credit that is designed to help students pay for college tuition and books and sometimes living expenses. It differs from other types of loans in that the interest rate may be substantially lower and the repayment schedule may be deferred while the student is still in school. Student loans may be obtained from the federal government or a private lender.

Security Agreement

a legal claim that identifies whether the lender or borrower retains control over the item being purchased.

Secured Loans

A loan where the borrower has pledged some asset as collateral to guarantee the loan.

Lien

a legal right to keep possession of property belonging to another person until a debt owed by that person is discharged. Usually recorded in a county courthouse

Cosigner

when a person (the cosigner) accepts the legal obligation to make payment on another person’s debt should that person default.

Acceleration Clause

clause in a credit contract that allowed a lender to require a borrower to repay all of an outstanding loan if certain requirements aren't met, such as missing one or more repayments

Deficiency Payments Clause

a loan requirement stating that if one defaults on a secured loan, not only can the lender repossess whatever is secured, but if the sale of that asset does not cover what is owed, the borrower can also be billed for the difference.

ex. repossessed vehicle = $11,000 ; sold by the lender = $10,000 ; lender incurs in attorney and collection fees = $400 ; Billed = $1,400 (11,000-10,000=1,000+400)

Recourse Clause

defines what actions a lender can take to get money from a borrower in the case of default A common such action would allow the lender to garnish one’s wages to pay off a debt.

Variable-Rate Loan

an interest rate on a loan fluctuates over time because it is tied to an underlying benchmark interest rate that changes periodically.

Prime Rate (sometimes the benchmark);

interest rate banks charge their most credit-worthy customers.

Interest Rate Caps

limits in credit contracts that prohibits how much the interest rate can increase over the life of the loan.

Fixed-Rate Loan

contract calls for the interest rate on a loan to remain fixed for the entire term of the loan.

Payday Lenders

(illegal in some states) - businesses that grant credit when they honor a personal check but agree not to deposit the check for a week or longer (until ‘payday’). The fees for check cashing are often 20 percent or more of the amount of the check

Rent-to-Own Program

offered through a rent-to-own store provides a mechanism for buying an item with little or no down payment by renting it for a period of time, after which it is owned. Items include furniture, appliances, and electronic entertainment.

Pawnshop

business that offers secured loans to people with items of personal property used as collateral that the borrower turns over to the pawnshop. the annual combined “interest” amounts to 84 percent .

Secured Credit Card (or collateralized credit card)

a type of credit card that requires a fee to open, and it is backed by a savings account used as collateral on the credit available with the card. Money is deposited and held in the account backing the card. The limit, often $500 to $1,000, will be based on one’s credit history and the amount deposited in the account.

Truth in Lending Act (TIL)

Requires lenders to disclose to credit applicants both the interest rate expressed as an APR and the finance charge.

Calculate Installment Payments

Formula: (loan/1,000) times amount from table.

Calculate Finance Charge

Formula: (monthly payment times number of months) - original amount borrowed.

Declining-Balance Method

Used by credit unions to calculate interest on all loans and it's always used for credit cards and home mortgages.

Add-On Method

Predominates on installment loans at banks, saving banks, and consumer finance companies when financing when financing automobiles, furniture, electronics, and other credit requiring collateral

Declining-Balance

A method of calculating the annual percentage rate for installment loans where the interest assessed during each payment period (usually each month) is based on the current outstanding balance of the installment loan.

Minimum payment warning box

The box on credit card statements must show how long it would take to pay off the card’s balance by making only the minimum payments, and how much we’d need to pay each month to clear the balance in 36 months.

periodic interest ratee

is the monthly ratee applied to the outstanding balance of a loan and is obtained by dividing the annual interest rate by the number of billing periods in the year.

2. The Add-On Method Favors the Lender

add-on interest method

interest is calculated by applying an interest rate to the amount borrowed times the number of years.

Where I = PRT

I - Interest of Finance Charges

P - Principal amount borrowed

R - Rate of interest (simple, add-on, or discount rate)

T - time of loan in years

n-ratio

A method of estimating the annual percentage rate for installment loans where it is an add-on loan.

Prepayment Penalty

This is an additional fee imposed by many loan agreements where a borrower pays off a loan early, before its scheduled pay-off date.

Rule of 78s (also called the sum of the digits) method

the most widely used method of calculating a prepayment penalty It is a technique of allocating the interest charge on a loan across its payment periods. Under the rule of 78s, periods are weighted by comparing their numerical values to the sum of all the digits of the periods.

Discount Method

used by creditors whereby the interest amount for an entire loan period (plus other charges, if any) is deducted from the principal at the time a loan is disbursed.