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Going Into Debt Americans and Credit
What is Credit? l Credit is the receiving of funds either directly (Cash) or indirectly (Approval) to buy goods and services today with the promise to pay for them in the future.
What is Debt? l l Debt is the amount you owe when using credit to buy goods and services. Any time you receive credit, you are borrowing funds and going into debt. • Debt = Principal + Interest • Principal—the amount originally borrowed • Interest—the amount of money the borrower must pay for the use of someone else’s money.
Consumer Debt on the Rise l http: //www. glencoe. com/sec/socialstudie s/economics/econtoday 2001/pdfs/C 0401 C-820489. pdf
Installment Debt l Installment Debt is a loan repaid with equal payments, or installments, over a specific time period. • • • Often used to purchase durable goods (last more than 3 years). The largest form of an installment debt is a mortgage —debt owed on property: houses, buildings, land. http: //www. bankrate. com/brm/mortgage-calculator. asp
Sources of Loans and Credit l l Types of financial institutions • • • Commercial Banks Savings and Loan Associations Savings Banks Credit Unions Finance Companies • • • Regular Charge Accounts Revolving Charge Accounts Installment Charge Accounts Credit Cards Debit Cards
Charge Accounts l l l A charge account allows a customer to buy goods or services from a particular company and pay for them later. For example, many department stores offer their own charge cards, which consumers may use to purchase goods in their stores. There are 3 different types of charge accounts • • • Regular Revolving Installment
Regular Charge Account l l l Also known as a 30 day charge At the end of every 30 day period, the store sends out a bill, no interest is charged, but the entire bill must be paid or interest is charged on the unpaid amount. Has a credit limit—A credit limit is the maximum amount of goods or services a person or business can buy on the promise to pay in the future.
Revolving Charge Account l l Allows you to make additional purchases from the same store even if you have not paid the previous month’s bill in full. Usually you must pay a certain portion of your balance each month but not all of it. Interest is charged on the amount you do not pay. There is a credit limit.
Installment Charge Accounts l l l Items are purchased and paid for through equal payments spread over a period of time. Part of the amount paid each month is applied to the interest, and part is applied to the principal. Usually used when buying expensive major items such as TVs, appliances, furniture, etc…
Credit Cards l Allow a person to make purchases without paying cash. • • • Can be used at many kinds of stores, restaurants, hotels, and other businesses. Used for: • • Purchasing things in stores Borrowing funds up to a certain limit Credit Card Tradeoff—Although using credit cards may be convenient, stores must pay a certain percentage of credit purchases to the company that issued the card. The stores include this cost in the prices they charge customer, making the prices higher for everyone. • Well known types of credit cards • Visa • Master. Card • American Express • Discover Card
Finance Charges l l Finance Charges—The cost of credit expressed in dollars and cents, along with account interest costs plus any other charges. (Example-membership fees) This type of charge has 4 methods to determine how much people will pay for credit. • • Previous Balance Adjusted Balance Average Daily Balance Past Due Balance
Previous Balance l How finance charge is computed: • Charge is computed on the months opening balance. There is no benefit in paying off debt early with this method.
Adjusted Balance l How finance charge is computed: • Payments made during this month are deducted from the opening balance. You save the most money with this method if you pay the bill right away.
Average Daily Balance l How finance charge is computed: • Charge is applied to the sum of the actual amounts owed each day during the billing period, divided by the number of days in the at period.
Past Due Balance l How finance charge is computed: • No finance charge is applied if full payment is received within a certain period. If the full payment is not received, then a finance charge for the unpaid amount is added to the next month’s bill.
Annual Percentage Rate (APR) l l The cost of credit expressed as a yearly percentage. APR provides a guide for consumers determining which creditor is charging the most for credit without knowing what the actual dollar amount is. • Example: Creditor A is charging 12%, creditor B is charging 14%, and creditor C is charging 19%. Creditor C will be charging the largest amount for credit while creditor A will be charging the least amount for credit.
An Example Relating Finance Charge and APR l l l Borrow $1000 for a year. Your interest rate is 10% $25 membership fee. The finance charge would be $125 • 10% of 1000=$100 + $25 = $125. The annual percentage rate (APR) is 125/1000 which is 12. 5% Pay back $1125 at the end of the year for borrowing $1000.
Debit Cards l A debit card is not a loan. They make cashless purchases easier by enabling customers to transfer funds electronically from their bank accounts directly to the store or restaurant where they purchased goods.
How Does a Person Get Credit? l l l Fill out a credit application. Application is sent to a credit bureau who performs a credit check—an investigation of a person’s income, current debts, personal life, and past history of borrowing and repaying debts. The credit check then determines a credit rating—usually good, average, poor
How Does a Person Get Credit? l l Creditworthiness is centered in on 3 factors: • • • Capacity to Pay—related to income and debt. An employment income is crossed with size of debts. Good Character—Are you reliable or trustworthy? May look at education or history with the law. Collateral—Size of personal wealth and value. (your belongings or “toys”) These two side items may get thrown in at times. • • Secured Loans—Loans that are backed up by collateral. Unsecured Loans—Loans guaranteed only by a promise. Some of these unsecured loans ask for a cosigner—a person who signs a loan contract along with the borrower and agrees to pay a loan off if the borrower can not.
Government Involvement in Credit l There are many major federal laws regulating consumer credit. • Truth in Lending Act (1968)—the consumers • • are ensured they are fully informed about the costs and conditions of borrowing. Equal Credit Opportunity Act (1974)— prohibits discrimination in giving credit. State Usury Laws—laws restricting the amount of interest that can be charged for credit.
Government Involvement in Credit l The Constitution authorizes Congress to establish bankruptcy laws. • Bankruptcy is the inability to pay debts based on the income received. If you file: • You must still pay personal taxes • Your record is blemished for 10 years • You are telling creditors that they will never be paid back ever. • How do you feel about that?
Credit Relevance l How does credit play a role in the economy? • Positively? • Negatively?
Your Role as a Creditor l What responsibilities do you have?