Keown PF5 CH06

Using Credit Cards: The Role of Open Credit
Learning Objectives
1. Know how credit cards work. 2. Understand the costs of credit. 3. Describe the different types of credit cards. 4. Know what determines your credit card worthiness and how to secure a credit card. 5. Manage your credit cards and open credit.
Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall
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Introduction
Convenient, but if youre not careful, credit cards will cost you. Some charge over 20% interest on unpaid balances. Most people dont consider interest charges on purchases they have to have. Manage credit wisely to avoid high interest.
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A First Look at Credit Cards and Open Credit

Credit involves receiving cash, goods, or services with an obligation to pay later. Open credit (revolving credit) is a line of
credit extended before the purchase.
Unpaid balance plus interest carries over to next month. Higher balances on credit lines, higher costs.
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Interest Rates
Annual Percentage Rate (APR)the true simple interest rate paid over the life of the
loan.
APR for all consumer loans must be disclosed. Fixed APR vs. variable APR
Teaser Rates
Compound interest
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Calculating the Balance Owed

The method of determining the balance
(balance calculation method)
Average daily balance method Previous balance method Adjusted balance method Variationsinclude new purchases or exclude
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Figure 6.1
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Buying Money: The Cash Advance

Cash advances at ATMs are just like taking out
a loan.
Higher interest rate charged immediately on
cash advances
Up-front fee of 2-4% of the amount advanced. Pay down the balances for purchases before paying down the higher interest rate cash balance.
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Grace Period
Grace periodthe length of time given to make a payment before interest is charged against the outstanding balance on a credit card.
20-25 days from date of bill. Some credit cards have no grace period
No grace period with cash advances. On most cards, the grace period is canceled if there is unpaid balance from previous month.
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Annual Fee
A fixed annual charge imposed by a credit card. Over 70% of biggest credit card issuers do not charge an annual fee. Many dont charge the fee if the card is used at least once a year.
Merchants discount feethe percentage of the sale that the merchant pays to the credit card issuer.
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Additional Fees
Cash Advance Fee Late Fee
Over-the-Limit Fee
Penalty Rate
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Pros and Cons of Credit Cards

Advantages: Convenience Used as identification Phone and internet purchases Temporary funds Use product before paying for it Bill consolidation Pay less today and earn interest elsewhere Extended warranties, travel insurance, and rewards.
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Pros and Cons of Credit Cards

Disadvantages: Too easy to spend money Too easy to lose track of spending High interest rate Obligating future income Heavy budgetary problems with uncontrolled spending
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Figure 6.2
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Choosing a Source of Open Credit

Bank Credit Cardsa credit card issued by a bank or large corporation, generally a Visa or Mastercard.
Bank Card Variationsdifferent classes (credit levels) of bank credit cards.
Premium or Prestige card Affinity card Secured credit card
6-15

Travel and entertainment cards (T&E)
do not offer revolving credit and require full payment of balance each month.
Interest-free grace period. Issuers receive annual fee and merchants discount fee. American Express, Diners Club, and Carte Blanche are the primary issuers.
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Single-Purpose Cardscan be used only at a specific company. Companies issue their own cards to avoid merchants discount fees. Terms vary, some offer revolving credit. Typically, no annual fee.
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Traditional charge accountcan be used to make purchases or get services only at the issuing company such as utility companies and doctors who provide services and bill later.
Convenient for both issuer and payee. Pay monthly bill in full or pay interest/fee.
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The Choice: Whats Best for You

Credit usercarries an unpaid balance from month to month. Convenience userpays off the credit card balance each month (avoids interest). Convenience and credit usergenerally pays off all the balance
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Figure 6.3
6-20
Getting a Credit Card

Excellent idea for students. Emergency funds. Build solid credit history if used prudently.
First step is to apply.
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Figure 6.4
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Credit Evaluation: The Five Cs of Credit

Character Capacity Capital Collateral Conditions
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The Key to Getting Credit: Your Credit Score

A credit bureaugathers information on
consumers financial history, including payment history and sells to customers.
Credit bureaus compile credit report and
assign a credit score.

and dealings.
Credit reportinformation on financial situation
Credit information impacts whether you get a
loan, it affects your interest rate.
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Determining Creditworthiness
Credit scoringnumerical evaluation of
scoring of applicants based on their credit history.
Reduces the lenders uncertainty

Lender able to make credit available to
good risk customers at lower interest rates.
6-25
Your Credit Score

Affects rates you pay on credit cards Affects size of credit line Affects insurance rates Affects mortgage rate Strong credit scorelower interest trate
6-26
How Your Credit Score is Computed

Based on models developed by Fair Isaac
Corporation.
FICO Score but name and your score
varies with bureau.
Scores range from 300-850. Visit www.myfico.com/ScoreEstimator.html to get an estimate of your score.
6-27
Figure 6.5
6-28
How Your Credit Score is Computed

What is a good score? A good credit score doesnt just mean that youll get a loan, it also means youll pay less for it through lower rates. Creditworthiness also based on employment history, job history, and amount of debt you currently have.
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Table 6.1
6-30
Whats in Your Credit Report?

Identifying Information Trade Lines or Credit Accounts
Inquiries
Public Record and Collection Items
6-31
Factors That Determine Your Score

Your Payment History (35%) Amount You Owe and Your Available Credit (30%) Length of Credit History (15%)
Types of Credit Used (10%)

New Credit (10%)
6-32
Figure 6.6
6-33
Monitoring Your Credit Score

Check for errors in credit report. Get free copy of your credit report each year from the three major credit bureaus
at www.annualcreditreport.com
Check all information correct, all accounts
on report are yours.
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Table 6.2
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Consumer Credit Rights

Take credit complaints directly to the
creditor.
Federal laws protect consumers with
complains about credit
6-36
The Credit Bureau and Your Rights

FACTAyou can request one free copy for
your credit report from national bureaus and contact them for inaccuracies.
Bureau must investigate and correct. File a statement to explain negative information that is accurate, not corrected. FCRAnegative information remains on report for 7 to 10 years.
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Table 6.3
6-38
If Your Credit Card Application is Rejected

Apply for a card with another financial institution. Find out why you have been rejected.
Set up an appointment with credit card manager. Address the problem.
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Resolving Billing Errors

FCBAprocedures for correcting billing errors.
Withhold payment for item in question.

Notify card issuer within 60 days of statement
date. Use billing inquiry or billing error address on credit card bill.
Should receive notification within 30 days. Card issuer investigates within 90 days account is credited or not with explanation.
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Table 6.4
6-41
Identity Theft
Use of your name, address, Social Security number, bank or credit card account number, or other identifying information by someone other than you without your knowledge to commit fraud and other crimes.
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How Do You Know if Youre a Victim of Identity Theft?

Receive a credit card you didnt apply for.
Denied credit or offered less favorable terms. Calls or letters from debt collectors.
Fail to receive bills or other mail.
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Identity has been stolen

Put fraud alert on credit file.
Close accounts that have been tampered
with or you didnt open.
File police report. File report with the FTC.

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Controlling and Managing Your Credit Cards and Open Credit

Reducing your balance
Protecting against fraud Trouble signs in credit card spending
If you cant pay your credit card bills
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Table 6.5
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Table 6.6
6-47
Checklist 6.1
6-48
Summary
Main form of open credit is the credit card which you can use to make charges up to a
certain point as long as you pay off the minimum amount of your debt each month.
Costs of open credit include interest rate, cost of cash advances, annual fee, penalty fees.
Choices of open credit lines include different types of credit cards and charge accounts.
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Summary
Lenders determine creditworthiness using the five Cs of creditcharacter, capacity, collateral, and condition.
Different credit cards charge different APR and calculate finance charges differently. Focus on controlling credit card spending and look for signs of trouble.
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All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.
6-51

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Using Credit Cards: The Role of Open Credit

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

A First Look at Credit Cards and Open Credit

credit extended before the purchase.

Calculating the Balance Owed

(balance calculation method)

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Buying Money: The Cash Advance

Higher interest rate charged immediately on

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Pros and Cons of Credit Cards

Pros and Cons of Credit Cards

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Choosing a Source of Open Credit

Choosing a Source of Open Credit

Choosing a Source of Open Credit

Choosing a Source of Open Credit

The Choice: Whats Best for You

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Getting a Credit Card

First step is to apply.

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Credit Evaluation: The Five Cs of Credit

The Key to Getting Credit: Your Credit Score

consumers financial history, including payment history and sells to customers.

Credit bureaus compile credit report and

assign a credit score.

Credit reportinformation on financial situation

Credit information impacts whether you get a

loan, it affects your interest rate.

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

scoring of applicants based on their credit history.

Reduces the lenders uncertainty

good risk customers at lower interest rates.

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Your Credit Score

How Your Credit Score is Computed

FICO Score but name and your score

varies with bureau.

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

How Your Credit Score is Computed

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Whats in Your Credit Report?

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Factors That Determine Your Score

Types of Credit Used (10%)

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Monitoring Your Credit Score

Check all information correct, all accounts

on report are yours.

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

Consumer Credit Rights

Federal laws protect consumers with

complains about credit

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

The Credit Bureau and Your Rights

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall

If Your Credit Card Application is Rejected