Credit • Credit: receiving funds, directly or indirectly, to buy goods and services today with the promise of paying for them in the future. (basically – taking goods and services and promising to pay for them later) • Debt (amount owed from credit) = Principal + Interest • Principal: amount originally borrowed • Interest: cost for borrowing money (credit) • Most common type of debt: • Installment debt: loan paid back in equal payments over a specific amount of time • Used for purchasing durable goods: items that have longer life span, usually over three years (cars, appliances) • Longer payback times have lower payments, but more interest • Mortgage: installment debt on houses, buildings, or property
Credit • Why use Credit? • To satisfy an immediate feeling of need (avoid waiting) or an actual need • To spread payments over the life of the product (car or truck) • As a necessity when making large purchases (house) • Deciding to Use Credit • Question comparing costs to benefits – interest payments vs. enjoyment times • Be aware of costs of using credit • Do you require the purchase now? • What’s the opportunity cost of using cash? • Will satisfaction be greater than interest amount? • Is this the best credit available? • Can I afford to use credit? • You do not have to accept credit (offered a lot)
Sources of Credit • Two main sources of credit: using credit cards and borrowing money directly from financial institutions • Types of Financial Institutions: • Commercial Banks: control largest amount of money and have widest range of services, checking, savings, individual loans, and transferring funds • Savings and Loan Associations:accept deposits and lend money; make single family and multi-family dwelling mortgage loans, commercial mortgages, and car loans (usually at lower interest rate than commercial banks) • Savings Banks:lend for home mortgages, personal and auto loans • Credit Unions:Union member owned to offer savings accounts and low interest loans only to its members (primarily personal, auto and home improvement loans); offer higher interest rates on savings and charge lower interest rates on loans
Sources of Credit • Finance companies: take over contracts from stores and add fee for collecting debts (in form of higher interest rates than before) • Consumer finance companies: lend directly to consumer at high interest rate, usually because borrower cannot borrow elsewhere (bad credit) • Charge Accounts:credit from a particular company for a consumer to buy goods or services there and to pay later • Three types: • Regular charge account: 30-day charge with credit limit (maximum amount of credit), must be paid in full to not accumulate interest • Revolving charge account: allows consumer to make additional purchases without paying previous bill in full, but with interest added • Installment charge account: equal payments over a period of time (part to interest, part to principal), at end of term, consumer owns product
Sources of Credit • Credit Cards: allows consumer to buy something and pay for it later • Can be used in variety of places • High interest rates due to large number of delinquent loans • Some offer lower rates with special terms to attract consumers • Finance charge: cost of credit monthly in dollar amount (principal + interest + other charges • Four methods of determining charges: (Figure 4.9 p. 93) • Previous Balance • Adjusted Balance • Average Daily Balance • Past Due Balance • Annual Percentage Rate (APR):cost of credit as a yearly percentage • Allows for easier credit comparisons (Figure 4.10 p. 94) • Debit Cards: cashless purchases electronically transferring funds, not a loan
Applying for Credit • Fill out a credit application • Lending agency that hires a credit bureau to do a credit check. • Credit bureau: private business that investigates a person to determine the risk in lending them money • Credit check:investigation of a person’s income, debts, personal life, and history of borrowing and paying debts
Credit Rating • Credit rating: rating of the risk in lending money to a specific person • what credit bureau reports to creditor • Factors to help checked for creditworthiness • History • Capacity to pay: income and debt • Good character: reputation, trustworthiness, legal issues • Collateral: size of personal capital (something of worth) • Secured loans: backed up by collateral • Unsecured loans: promise to repay money (sometimes require cosigner, who is responsible in non-payment) • Responsibilities as a Borrower: • pay on time • repay all debts or suffer bad credit • Keep records to not go over credit limit • Concentrate on high-interest debts first, and pay more that minimum if debt is unmanageable
Government Regulations of Credit • Truth in Lending Act • first law to expand government’s role of protecting consumer credit • ensures that consumer are fully informed of conditions of borrowing • Equal Credit Opportunity Act • Creditors cannot discriminate on basis of race, religion, nationality, gender, marital status or age • Lender must give reasons for denying loan application • State Usury Laws • Restrict amount of interest that can be charged, setting maximum interest rates • Interest ceilings can lead to shortage of credit if general rates rise, hurting lender and consumer
Personal Bankruptcy • Bankruptcy: inability to pay debts based on income • For people who absolutely cannot repay debts • Debtors give up most of what they own to be distributed among creditors • Creditors are forced to forgive entire debt • Remains on a person’s credit history for 10 years (difficult to reestablish credit and borrow funds)
Buying Necessities • Comparison Shopping: • Making comparisons to decide what and where to shop • Must consider time costs and transportation costs • Advertisements and coupons can save time and money • Trade-offs in Food Stores: • Club warehouse stores: carries limited number of brands and items in large quantities and is less expensive • Convenience stores: open most of the time, higher prices, but open more hours • Brand-names are well known nationally or regionally. • Private-labeled products are lower priced store-brand products carried by some supermarkets and warehouse stores (save almost 40%) • Generic products have no brand name and are lower priced. • Coupons are available to attract consumers to brand names.
Clothing Choices • Comparing Clothing Value: • Three factors that influence clothing value: • Style: tend to be more expensive and change each year • Durability: ability of an item to last a long time • Service flow: amount of time you get to use the product and the value you place on that use. • Cost of Care: require dry cleaning vs. machine washed • More for Less: • Clothing costs have decreased significantly over time. • Clothing sales generally happen at the end of a season. • Bargain fanatics buy items because they are on sale; if it is unnecessary, you may not be saving at all.
Housing Options • Rent or Buy • How much to spend? • Avoid spending more than you can afford • Need cash for down payments and closing costs: fees involved in arranging a mortgage or in transferring ownership of property • Be aware of points: fees paid to lenders and computed as a % of the loan (included in closing costs) each point = 1% of borrowed amount • Buying a House • Many different types of mortgages and finance options (Figure 5.9 p 124) • Mortgages include down payments, interest, paid in monthly installments, and often property taxes, homeowners insurance, and mortgage insurance
Housing Options • Renter Rights and Responsibilities: • Most renters sign a lease: long-term contract describing terms of rented property (read carefully) • Tenants have right to property under agreements in the lease, and a right to privacy, but must pay rent on time, take care of property, notify landlord for major repairs • Some must place a security deposit (money held by landlord in case rent is not paid or to cover damages) down • Tenants must give written notice if leaving before end of lease (may result in fees and fines for breaking lease) • Landlords must supply minimum services (ex. Heat) and obey safety laws • Rent-control laws limit the amount a landlord can charge in rent
Buying and Operating a Vehicle • Trade-offs of deciding which vehicle: • Smaller engines give better gas mileage, but less acceleration • Newer vehicles cost more, but need les repairs • Smaller vehicles are more energy efficient, but often less protection • Registration fees are state fees paid each year • Normal maintenance and repairs (oil and filter changes, tune-ups) • Extended warranties covers future problems, but costs more • Depreciation (decrease in value of the vehicle) as it ages • States require liability insurance: to cover bodily injury and property damages (varies based on age, sex, and driving history)