Consumer Credit

Credit - an arrangement to receive cash, goods, or services now and pay for them in the future

  • Consumer credit - the use of credit for personal needs (except a home mortgage) by individuals and families, in contrast to credit used for business purposes

Uses and Misuses of Credit

  • Using credit increases the amount of money a person can spend

  • The trade-off is that it decreases the amount of money that will be available to spend in the future

  • When effectively used, can help you have more and enjoy more

  • When misused, can result in default, bankruptcy, and loss of creditworthiness

Advantages

  • Provide up to a 50-day “float”

  • The time lag between when you make the purchase and when the lender deducts the balance from your checking account when payment is due

Disadvantages

  • Temptation to overspend

  • Security - something of value to back the loan—failure to repay a loan may result in loss of income, valuable property, and your good reputation

    • Court action and bankruptcy

  • Misuse can lead to

    • Long-term financial problems

    • Damage family relationships

    • Delay progress toward financial goals

    • Approach credit with caution, don’t spend more than your budget

  • Does not increase total purchasing power

  • Credit purchases must be paid out of future income, which ties up the use of future income

  • If income does not increase → ability to repay credit commitments will diminish

  • Before purchasing, consider if they have lasting value, or consider your type of income

  • Young people are vulnerable

Types of Credit

  • Two types

    • Closed-end credit - pay back one-time loans in a specified period of time and in payments of equal amounts

    • Open-end credit - loans are made continuously, and you are billed periodically for at least partial payment

Closed-End Credit

  • Mortgage loans

  • Automobile loans

  • Installment loans for purchasing furniture or appliances

  • The seller holds title to the merchandise until the payments have been completed

  • 3 types of closed-end credit

    • Installment sales - a loan that allows you to receive merchandise, usually high-priced items such as large appliances or furniture

    • Installment cash - a direct loan of money for personal purposes, home improvements, or vacation expenses. You make no down payment and make payments in specified amounts over a set period

    • Single lump-sum - a loan that must be repaid in total on a specified day, usually within 30 to 90 days

      • Generally, but not always, used to purchase a single item

Open-End Credit

  • Issued by a dept. store, to make purchases at different stores, charging a meal at a restaurant, and using overdraft protection are examples

  • Don’t open this credit to make only one purchase

  • Line of credit - the maximum dollar amount of credit the lender has made available to you

  • Interest - a periodic charge for the use of credit

    • Pay the bill in full within 30 days without interest charges

    • Set monthly installments based on the account balance plus interest

  • Revolving check credit - also called bank line of credit, this is a prearranged loan for a specified amount that you can use by writing a special check

Credit Cards

  • Average cardholder has more than nine credit cards (okay, r u kidding me rn?)

  • Convenience users - cardholders who pay off their balances in full each month

  • Borrowers - who do not pay off their balances every month

  • Finance charge - the total dollar amount you pay to use credit

    • Borrowers carry balances beyond the grace period and pay finance charges

Six rules for using your store credit card wisely

  1. Watch your overall spending during the holidays

  2. Pay your bill on time

  3. Understand the differences between zero-interest and deferred-interest promotions

  4. Limit the number of cards you apply for

  5. Don’t get close to your credit limit

  6. Act fast if you can’t pay your bills

Loans

  • Inexpensive loans - loans with low interest or no interest, can complicate family relationships

  • Medium-priced loans - moderate interest—from commercial banks, savings and loan associations, and credit unions

    • Borrowing from credit unions has several advantages

  • Expensive loans - easiest to obtain but also expensive, interest rates from 12 to 25 percent

Applying for Credit

  • Equal Credit Opportunity Act (ECOA) starts all credit applicants off on the same footing

    • States that race, color, age, woman or man, marital status, and certain other factors can’t be used to discriminate

General Rules of Credit Capacity

  • Debt Payments-to-Income Ratio - calculated by dividing your monthly debt payments (not including house payment, which is a long-term liability) by your net monthly income

    • Experts suggest you spend no more than 20% of your net (after-tax) income on consumer credit payments

    • 15 percent or less is much better

  • Debt-to-Equity Ratio - dividing total liabilities by your net worth