Personal Financial Planning - Consumer Credit (Part 1)

Consumer Credit

Introduction to Consumer Credit

  • 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, excluding home mortgages, by individuals and families.

Learning Objectives

  • Define consumer credit and analyze its advantages and disadvantages.
  • Differentiate among various types of credit.
  • Assess your credit capacity and build your credit rating.
  • Describe the information creditors look for when you apply for credit.
  • Identify the steps you can take to avoid and correct credit mistakes.
  • Describe the laws that protect you if you have a complaint about consumer credit.

What is Consumer Credit?

  • Consumers can finance purchases by:
    • Drawing on their savings.
    • Using present earnings.
    • Borrowing against expected future income.
  • Consumer credit is a major economic force.

Use and Misuses of Credit

  • Before using credit for a major purchase, consider:
    • Do I have the cash for the down payment?
    • Do I want to use my savings for this purchase?
    • Does this purchase fit my budget?
    • Could I use the credit I’ll need in some better way?
    • Can I postpone this purchase?
    • What are the opportunity costs of postponing this purchase?
    • What are the dollar and psychological costs of using credit for this purchase?

Advantages of Credit

  • Current use of goods and services.
  • Permits purchase even when funds are low.
  • A cushion for financial emergencies.
  • Advance notice of sales.
  • Easier to return merchandise.
  • Convenient when shopping.
  • One monthly payment.
  • Safer than cash.
  • Needed for hotel, car reservations, and shopping online.
  • Can take advantage of float time/grace period.
  • May get rebates, airline miles, or other bonuses.
  • Indicates financial stability.

Disadvantages of Credit

  • Temptation to overspend.
  • Failure to repay loan may lead to loss of income.
  • It does not increase total purchasing power.
  • Credit costs money.

Types of Credit

  • Closed-End Credit:
    • One-time loans for a specific purpose, repaid in a specified period with equal payments.
    • Examples: Mortgage, automobile, and installment loans for furniture, appliances, and electronics.
  • Open-End Credit:
    • Use as needed until reaching line of credit max.
    • Examples: Credit cards, department store cards, bank credit cards, incidental credit.
    • Interest and finance charges apply if the bill is not paid in full when due.

Credit Cards

  • Eight out of ten U.S. households carry one or more credit cards.
  • One-third are convenience users (pay balances in full each month).
  • Two-thirds are borrowers (carry a balance over, paying finance charges).
  • Some use cards for cash advances (expensive).
  • Co-branding: Linking a credit card with a business offering rebates on products and services.
  • Smart cards have an embedded computer chip.
  • Debit cards: Similar impact as writing a check.

Protecting Yourself Against Debit/Credit Card Fraud

  • Sign new cards when they arrive.
  • Treat cards like money - keep them secure.
  • Shred anything with your account number on it.
  • Don’t give your number over the phone unless you initiate the call, and don’t put it on postcards.
  • Get card & receipt after every transaction: compare receipts to bills when they arrive, checking for errors.
  • Notify the card issuer if you don’t get your billing statement, or if your card is lost or stolen.
  • Check credit report.

Making Purchases Online

  • Use a secure browser.
  • Keep records of online transactions.
  • Review monthly statements-can do so online.
  • Read policies of the websites you visit concerning refunds, site security, and privacy.
  • Keep personal information private unless you know who is gathering it and why.
  • Shop at businesses you know and trust.
  • Never give out your password to anyone online.
  • Don’t download files sent by strangers.

Travel and Entertainment Cards

  • These cards are not really credit cards.
  • Monthly balance is due in full.
  • American Express recently started issuing credit cards.

Home Equity Loans

  • Based on the difference between current market value of your home and the amount owed on the mortgage.
  • Borrow up to 85% of the value of the home.
  • It is set up like a revolving line of credit.

Measuring Your Credit Capacity

  • Before taking out a loan, ask yourself:
    • Can you afford the loan?
    • What do you plan to give up in order to make the payment? Are you prepared to make this trade-off?

General Rules of Credit Capacity

Debt Payments-to-Income Ratio: This does not include house payment as it's a long-term liability.

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Consumer credit payments should not exceed a maximum of 20% of your net income.

Debt To Equity Ratio:

Total liabilitiesnet worth\frac{Total\ liabilities}{net\ worth}

Should be < 1, excluding home value.

Co-signing a Loan

  • The creditor will give you a notice that tells you:
    • You are being asked to guarantee the debt, so consider if you can afford it if the borrower defaults.
    • If the borrower does not pay, you may have to pay up to the full amount and also any late or collection fees.
    • If a payment is missed the creditor can collect the debt from you without first trying to get it from the borrower.
  • If you do co-sign, consider…
    • Can you afford to pay the loan? If not, your credit rating could be damaged.
    • Liability for this debt may prevent you from getting other credit that you want.
    • If you put up collateral, you could lose it if the loan goes into default.
    • Check your state’s law to learn about cosigner’s rights.
    • Request that a copy of overdue payment notices be sent to you.

Building and Maintaining Your Credit Rating

  • Limit your borrowing to your capacity to repay.
  • Live up to the terms of contracts.
  • Check to see what is in your credit report.

Credit Bureaus

  • Credit bureaus collect information.
  • Bureaus get information from banks, finance companies, credit card companies, merchants, other creditors.

Fair Credit Reporting Act

  • This act regulates the use of credit reports.
  • Credit card companies must correct inaccurate or incomplete information.
  • Only authorized persons have access to your report.
  • Adverse data can be reported for seven years; bankruptcy for ten years.

What If You are Denied Credit?

  • Check your credit file at the credit bureau.
  • If you believe reasons for denial are invalid: file suit and/or notify federal enforcement agency.
  • Ask the creditor to clarify reason for denial; if you believe the denial is valid…
    • Apply to another creditor with different standards.
    • Take steps to improve your creditworthiness.
    • You have the right to provide a 100-word explanation in your file.

Applying for Credit

What Creditors Look For: 5 Cs

  • Character - Do you pay bills on time?
  • Capacity - Can you repay the loan?
  • Capital - What are your assets and net worth?
  • Collateral - What property do you have to pledge that the lender can repossess if you default on the loan?
  • Conditions - What economic conditions could affect your ability to repay the loan?

Avoiding and Correcting Credit Mistakes

Fair Credit Billing Act

  • Notify creditor of error in writing within 60 days.
  • Include your explanation of the error and your account number to the billing inquiries address.
  • They must respond within 30 days.
  • Credit card company has two billing periods but no longer than 90 days to correct your account or tell you why they think the bill is correct.
  • Your credit rating is not affected while item is in dispute.
  • You can withhold payment on damaged or shoddy goods or poor services if you have paid for them with a credit card, if you make a sincere attempt to resolve the problem with your creditor.

What if Your Identity is Stolen?

  • Contact the fraud department of each of the three major credit bureaus; tell them to flag your file with a fraud alert, including a statement that creditors should call you for permission before opening any new accounts in your name.
  • Contact creditors to check for accounts that have been tampered with or opened fraudulently.

Complaining About Consumer Credit

  • First try to solve the problem directly with the creditor.
  • If that does not work there are more formal complaint procedures.
  • There are a variety of consumer credit protection laws and federal agencies who administer and assist with complaint procedures.

Central Credit Reference Information System (CCRIS)

  • The Credit Bureau in Malaysia is established under the Central Bank of Malaysia Act 1958. It has been in operation since 1982.
  • Like all other credit bureaus in the world, the Credit Bureau essentially collects credit information on borrowers from lending institutions and furnishes the credit information collected back to the institutions in the form of credit report via an on-line system known as Central Credit Reference Information System (CCRIS).
  • The financial institutions extend credit facilities to borrowers either for business or personal purposes.
  • To facilitate these institutions to make assessments and decisions on credit applications, the financial institutions would require up-to-date and accurate information on their prospective borrowers.
  • Therefore, the information in the credit report could assist the financial institutions to make informed decisions on credit applications.
  • The information reported to the Credit Bureau is housed in a computerized database system known as the Central Credit Reference Information System (CCRIS).
  • At present, the database system contains credit information on about 9 million borrowers in Malaysia.
  • CCRIS automatically processes the credit data received from the financial institutions and synthesizes the information into credit reports, which can be made available to the financial institutions upon request.

Credit Tip-Off Service (CTOS)

  • CTOS stands for Credit Tip-Off Service, the company itself (CTOS Sdn Bhd) is categorized as Credit Agency.
  • CTOS is essentially an electronic ‘archive’ of information collated from gazettes, newspapers, court notices, and searches at the relevant statutory bodies. A 'credit lead' information system.
  • In general, CTOS reports provide information on bankruptcy, summons of any individual in Malaysia.
  • Due to this, it is important for anyone to ensure their CTOS report is clear. This is typically the first piece of advice given to anyone because it is so important to understand how you appear to creditors, while also ensuring that your report is actually accurate.