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Consumer Credit: The Good,

The Bad, and the Ugly

1
Consumer Credit
• Personal, non-mortgage, credit and debts

2
Sources of Consumer Credit
WHAT KIND OF LOAN SHOULD YOU SEEK?
• Inexpensive loans
– Parents or family members
– Loans based on assets- using CD as collateral
• Medium-priced loans
– Commercial banks, savings and loan
associations, and credit unions
• Expensive loans
– Finance and check cashing companies
– Retailers such as car or appliance dealers
– Bank credit cards and cash advances 3
4
Debt is a liability meaning you owe it back!

You are buying something today with


tomorrows income for a cost

You are mortgaging (lowering) future income


for a current expense or opportunity
• Remember the principle of opportunity costs

5
Is debt ever okay? (some
guiding questions)
Financial Questions
• Does the use of credit/debt have a real
likelihood of providing an economic advantage
– Does the debt increase overall earning ability now or
in the near future?
• Can I manage the payments until that advantage is
realized?
• Is the debt filling one of the basic needs for
survival? (LAST RESORT)
– Is there no other “less costly” alternative? (Do all of
these first…)
6
The Cost of Credit

• Finance charge is the total dollar amount you pay to use


credit. It includes interest costs, service charges, credit-
related insurance premiums, lender’s profits, risk factor,
and/or appraisal fees

• The annual percentage rate (APR) is the percentage cost


of credit on a yearly basis, includes interest and mandatory
fees.
– APR: True rate of interest so you can compare rates with other
sources of credit. It is important to shop for credit.

7
Types of Credit
• Closed-End Credit
– One-time loans for a specific purpose that you pay
back in a specified period of time, and (typically) in
payments of equal amounts
• Mortgage, automobile, student loans, and
installment loans for furniture, appliances and
electronics

• Open-End Credit
– Use as needed until reaching line of credit max
• Credit cards, departments store cards, bank credit
cards, incidental credit, lines of credit
– You pay interest and finance charges if you do not
pay the bill in full when due 8
Credit Cards: Open-Ended
Credit

9
CREDIT CARDS
• Using credit (borrowed money)
– in contrast to Debit cards: similar impact as writing a check

• Eight out of ten U.S. households carry one or more credit


cards
– One-third are convenience users- pay balances in full each month (this
is when the money is due).
– Two-thirds are borrowers, carrying a balance over, paying finance
charges

• Some consumers use cards for cash advances – very


expensive

• Co-branding - linking a credit card with a business


offering rebates on products and services
• Smart cards have an imbedded computer chip 10
11
12
13
7-14
7-15
The Data on Plastic (credit) vs.
Cash
• 10-20% More (on average) with credit
• On some items people have been willing
to pay double.

16
7-17
7-18
7-19
• http://www.bankrate.com/calculators/index
-of-credit-card-calculators.aspx
• http://www.bankrate.com/calculators/mana
ging-debt/minimum-payment-
calculator.aspx
http://www.interest.com/credit-
cards/calculators/credit-card-minimum-
payment-calculator/

20
Drowning in Credit Card Debt
• Lasting debt: Pay off $1,000 using minimum
payment of 5% of balance ($50/month)

Percent Interest paid Time


7.9% $ 128.85 48 month
13.9% $ 254.30 53 months
18.9% $ 385.03 58 months
23.9% $ 549.86 65 months
29.9% $ 815.74 75 months
Select the answer that best
completes Dr. Pope’s comments
from class. “You should
____________ the minimum
balance on your credit card.”
1. never, never, never pay
2. make a punctual payment of
3. pay triple
4. revolve payments of the
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
• They may change your rates/fees… must notify you in
writing 45 days in advance.

23
Fair Credit Billing Act
If there is an error on my credit card
• 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 / 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

24
Lost or Stolen Credit Card

25
Liability for Lost or Stolen Cards
• Credit Card Liability
– Unless reported, the amount owed if lost or stolen
card is used by others
– limited to $50 per card if used before issuer is
notified (law)
• Many cards have a $0 liability for fraud if you report it.
– Not liable for charges after you report it lost or
stolen
– may covered by homeowner’s or renter’s insurance

For more info: https://www.consumer.ftc.gov/articles/0213-lost-or-stolen-credit-


atm-and-debit-cards
While out on Lake Travis with some buddies, Tim
lost his wallet. He didn’t do anything about it since
he decided the wallet was at the bottom of Lake
Travis. Then, 3 weeks later he received a statement
from his VISA credit card company showing $3,500
in charges that he didn’t make. Additionally, his
ATM had $650 in unauthorized transactions. Upon
discovering this, he reported the stolen cards to his
banks. Given this information, what is Tim’s
maximum liability for these fraudulent charges?

1. $ 0
2. $ 100
3. $ 550
4. $1,000
5. $4,150
While out on Lake Travis with some buddies, Tim
lost his wallet. He didn’t do anything about it since
he decided the wallet was at the bottom of Lake
Travis. Then, 3 weeks later he received a statement
from his VISA credit card company showing $3,500
in charges that he didn’t make. Additionally, his
ATM had $650 in unauthorized transactions. Upon
discovering this, he reported the stolen cards to his
banks. Given this information, what is Tim’s
maximum liability for these fraudulent charges?

1. $ 0
2. $ 100
3. $ 550
4. $1,000
5. $4,150
The day after 2016 Elections

29
Student Loans

30
https://clevelandfed.org/newsroom-and-
events/publications/forefront/ff-v7n02/ff-
20160516-v7n0204-is-there-a-student-
loan-crisis.aspx

https://ticas.org/sites/default/
files/pub_files/Debt_Facts_a
nd_Sources.pdf

32
In 2010-11, about 57% of public four-year college
students graduated with debt. They had borrowed an
average of $23,800 (in 2011 dollars). About two-thirds
of those earning bachelor’s degrees from private
nonprofit institutions had debt averaging
$29,900.(Source: College Board)
http://trends.collegeboard.org/sites/default/f
iles/student-aid-2012-full-report-130201.pdf

Textbook states “In 2015, nearly 70% of


students graduated with student debt.” (p.
118, no source given)

https://clevelandfed.org/newsroom-and-
events/publications/forefront/ff-v7n02/ff-
20160516-v7n0204-is-there-a-student-
loan-crisis.aspx 33
Consider the
following
Excerpt from
Richard
Settersten, Jr.
A scholar who
studies young
adulthood
(2012, p. 5-6)

34
Demands for higher education
• 36.1% of young adults between 25 to 34
have a bachelor's degree. (Census,
2016)
• 10.9% have a graduate degrees.
(Census, 2016)
• Only 40% enter 4 year institution earn
degrees in 6 years
https://www.census.gov/content/dam/Census/library/publications/2016/d
emo/p20-578.pdf
Education Trends

• Tends
– More are enrolling in
college
– Women are getting
the message more
than men
– Hispanics and blacks
are catching up
Education Trends: Loans…

• Trend
– % with loans increased
– Average indebtedness for
those with loans increases
• Reasons
– College Costs have
increases (not shown)
– Economic downturns brings
more people to college
– Increase in lower SES
students pushing their way
into college

Source: http://www.childstats.gov/americaschildren/edu3.asp
7-38
http://www.bls.gov/emp/ep_chart_001.htm

39
Student Loan “Rule of Thumb”
“A simple rule of thumb for someone who
does not have other unusually high
expenses is that total borrowing should not
exceed expected first-year salary after
graduation.” (Bajtelsmit, chapter 5, p. 118)

40
Take Home
• Have a plan, including a good picture of what your financial
prospects will be after graduating
• Don’t borrow if you don’t need to borrow
• Only borrow what you need
• If you have borrowed, think of every purchase as if it is part
of that loan
– If you are “living on borrowed money” track your spending and
constantly be evaluating it using tools this class gave you.
• Think of your education as a down payment on your future
lifestyle.
– Make sure you are choosing that lifestyle for the right reasons and
that the numbers work.
41
Student Loan Action
 If you have a student loan (or plan on getting one)
 Get real with your numbers
 What is loan balance?
 What is the interest rate?
 https://studentaid.ed.gov/sa/types/loans/interest-rates
 How long are you going to take to pay it off? (also, consider
estimating break-even)
 Estimate total pay-off
 https://www.bankrate.com/calculators/college-planning/loan-
calculator.aspx
 Enter your student loan on your balance sheet
 Print out a budget sheet for “after graduation” enter
student loan payment amount. 42
Get Real with your Numbers

43
Measuring Your Credit Capacity

• Before you take out a loan, ask yourself….

– Can you afford the loan?


• Overall, can I assume this much total debt?
(balance sheet)
• Can I afford to service the loan (payments)? (cash
flow)
– What do you plan to give up in order to make
the payment?
– Are you prepared to make this trade-off?
44
Debt Ratio

Debt Ratio

Total Debts

Total Assets

*Which financial document do you use to calculate this ratio?


45
Debt Safety Ratio
(Non-Mortgage) Debt Payments-to-Income
Ratio

monthly payments*

net monthly income**


Rule of thumb: over 15% in risk zone
Over 20% in danger zone

*Not including house payment which is a long-term liability


**net income is after-tax income 46
Debt Safety Ratio
Total Debt Payments Ratio

Total debt payment*

net monthly income**


Rule of thumb: over 35% in risk zone
Over 45% in danger zone

* includes all debts, even mortgage


**net income is after-tax income 47
Snowball + Accelerated
Payment Amount (two sorting
methods)
Sorted by interest Sorted by balance
3000 3000

2500 2500

2000 2000

1500 1500

1000 1000

500 500

0 0
Debt Size Debt Size
Card 3 (16.5%)2 Card 2 (12.2%)2 Card 1 (7.9%) Card 2 (12.2%)
Card 1 (7.9%)2 Card 4 (5%) Card 3 (16.5%) Card 4 (5%)

Make payment to all balances + accelerated amount on the first one.


Once the one is paid off, use the accelerated amount + previous account
payment to accelerate the next payoff.
What Lenders Consider

49
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? 50
What If You are Denied Credit?

• Ask the creditor to clarify reason for denial


• Check your credit file at the credit bureau
– If report was used as part of the denial, you can obtain the report
for free
– You have the right to provide a 100 word explanation in your file

• If you believe the denial is valid . . .


– Apply to another creditor with different standards
– Take steps to improve your creditworthiness
• If you believe reasons for denial are invalid (i.e.,
discrimination) you may consider filing suit and/or notify
federal enforcement agency 51
Credit Reports and Credit
Scores

52
CREDIT BUREAUS

– Credit bureaus collect and share information. Bureaus


get information from banks, finance companies, credit
card companies, merchants, other creditors
– Three main credit bureaus
• Experian: https://www.experian.com
• Trans Union: https://www.transunion.com/
• Equifax: https://www.equifax.com/personal/
– FTC gets about 12,000 complaints about credit bureaus
each year
• https://www.consumerfinance.gov/about-
us/newsroom/consumer-financial-protection-bureau-now-taking-
complaints-on-credit-reporting/

53
Free Credit Reports (not credit scores)
• Check credit reports at no-cost annually
from the 3 major credit bureaus via web,
toll-free number, and mailing address
• Centralized source
• www.ftc.gov regulates credit reports
Free Credit Reports
(not credit scores)
URL for getting free annual credit reports
• https://www.annualcreditreport.com

BEWARE OF OTHER SITES OFFERING TO


GIVE YOU FREE REPORTS/SCORES. BE
SURE THEY ARE TRUSTWORTHY &
UNDERSTAND THE TERMS YOU ARE
AGREEING TO WHEN YOU ENROLL IN
THEIR PROGRAM.
http://www.consumerfinance.gov/askcfpb/313/what-should-i-look-for-in-my-credit-report-what-are-a-few-of-
the-common-credit-report-errors.html

56
Two Main Scores
• FICO (350-850)
• VantageScore (501-990)
– https://your.vantagescore.com/
– https://www.vantagescore.com/pdf/VantageSc
ore%20Infographic%2005.pdf
• The scores measure “credit worthiness” as they
call it. It is an number that estimates the
agencies level of confidence that you will be
able to make full, on-time, payments for the
duration of the loan. 57
DO YOU KNOW?
WHAT'S IN YOUR
FICO® SCORE?

This is actually your %


of available credit 58
used
https://www.vantagescore.com/pdf/Vantage
Score%20Infographic%2005.pdf

https://www.experian.com/blogs/ask-
experian/how-long-past-due-remains/ 59
Where Can I get my Credit
Score?
Unless you are qualifying for a loan, you often don’t “need”
to know the exact score.
• Can buy it from each Agency separately
• When you apply for a loan the potential lender will let
you know your score
• Many banks and credit cards now give you access to the
score they use for free
• There are 3rd party groups that for a cost or for free +
your email and advertisements will give it to you (e.g.,
www.creditkarma.com, https://my.bankrate.com/, watch
out for promos & upsales… nothing is truly free)
60
Ways to Improve Your Credit
• Have a steady job and residence
• Keep your expenses under control & save
• Pay bills on time
• Check your credit report (NOT SCORE)
frequently
• Do not request credit from many sources in
a short period of time for different types of
loans (hard pulls)
• Reduce outstanding credit
No Credit?
• Some common options to building credit history.
– https://www.consumerfinance.gov/about-us/blog/who-are-credit-
invisible/
Credit history means you have accessed credit.
Some ways students do this: (REVIEW PREVIOUS SLIDE
1st!)
• Be on a joint credit account with a parent
• Open a secured credit card
• Credit building loans (offered by some smaller banks and some
credit unions)
• Have a credit card (pay off the balance in full)
• It is a myth that you keep a balance to build credit history. Other
factors they consider is: duration of account, % of credit used, and
on-time payment history.

62
Slow and
Steady…

• https://s3.amazonaws.com/files.consu
merfinance.gov/f/documents/201612_c
fpb_credit_invisible_checklist.PDF
• 63
https://www.consumerfinance.gov/abou
t-us/blog/who-are-credit-invisible/
WARNING!
• Using Credit unwisely will hurt your credit
score.
– Missed payments or failing to pay minimum
balance
– Too many hard pulls (request for new credit or
lines of credit)
– High % of available credit utilization (Over
30% utilization starts adversely impacting
your credit score)
64
Tips on Shopping for a Credit
Card
• What is the annual fee?
• What is the grace period?
• What is the APR?
• What is the method for determining the
interest rate?
• What is the method for determining how
interest is calculated (e.g., daily average
balance)
65
How much is due on 7/24/10?

66
Protecting Your Credit

67
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
– If stolen call 1-888-EXPERIAN
• Check credit report
68
When You Make Purchases Online
• Use a secure browser
• Have your anti-virus/maleware softwares running and up to date
• 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 use the
same passwords for different, esp. linked accounts)
• Don’t download files sent by strangers

69
Freeze Your Credit Reports
• You can freeze inquiries into your credit (may
involve a fee)
– https://help.equifax.com/app/answers/detail/a_id/159/~
/placing-a-security-freeze
– https://www.transunion.com/credit-freeze/place-credit-
freeze
– http://www.experian.com/consumer/security_freeze.ht
ml
• Can be temporarily lifted (may involve a fee)
• Can be removed
Two Government Links
• https://www.consumer.ftc.gov/articles/049
7-credit-freeze-faqs
• https://www.identitytheft.gov/Info-Lost-or-
Stolen

71
Credit Monitoring (Identity
Protection) Plans

72
Identity Protection Plans
• New“ish” in the game.
• Probably still an optional insurance, but likely to increase
in importance over time.
• Be wary of the “posers” who are trying to steal your
identity.
– You seek them out. Don’t just click on a link that pops up or you
are emailed.
• Go with legitimate companies
– Many employers now offer it as a benefit (trust, but verify)
– Many companies now sell it (e.g., Costco, again, trust, but verify)
– Consumer agencies sell protection packages that cover all the
other agencies (e.g., Experian)
• https://www.experian.com/lp/identity-int-2.html 73
What if I don’t want to
pay the fee?
• Recommend you pull your credit report (not
score) regularly, get from each agency once a
year…
– Every 4 months can pull another one.
– https://www.annualcreditreport.com
– Report any errors
• Keep an eye on your “free credit scores”
• Consider freezing unused accounts (esp. if free)
– If it costs, total up costs and see what is better in your
situation to freeze/unfreeze accounts or pay to
monitor them. 74
• Level 1: Keep your sensitive documents secure (social
security #, account numbers). (cost = free)
• Level 2: check your free annual credit reports. (cost =
free)
• Level 3: Self-monitor your credit score (cost = can do for
free, or can pay)
• Level 4: Freeze credit account access at agencies (cost
= $5-10 each time freeze and unfreeze, and can take up
to 3 days. https://www.consumer.ftc.gov/articles/0497-
credit-freeze-faqs
• Level 5: Pay for Credit Monitoring Protection (Insurance).
(Cost = monthly fee, typically around $20).
75
You Can Learn More about
Identity Theft Here:
• https://www.consumer.ftc.gov/topics/identit
y-theft

76
Victim of Identity Theft?

77
https://www.identitytheft.gov/
Fraud Alerts

https://www.consumer.ftc.gov/articles/0497-
credit-freeze-faqs 78
Debts becoming
Unmanageable?

79
Managing Your Debts
• Notify creditors if you can’t make a payment.
• The Fair Debt Collection Practices Act regulates
debt collection agencies
– If a debt collector calls you, within five days they
must send you a written notice of amount owed, the
creditors name, and your right to dispute the debt
– You can dispute the debt or pay it
• You request verification of the debt within 30 days; If
not sent, you can insist that communication about the
debt cease
• If verification sent, you may pay the debt or give notice
that you will not pay
80
Non-Financial Reasons for Debt

• Life/Health/Emotional problems
• The need for instant gratification
• The use of money to punish or get even
• The expectation of instant comfort among young
individuals/couples who overuse the installment
plan
• Keeping up with the Joneses
• Overindulgence of children
• Misunderstanding or lack of communication among
family members
• Amount of finance charges makes it difficult to
repay
81
Warning Signs of Debt Problems
• Paying only the minimum balance each month
• Increasing the total balance due each month
• Missing or alternating payments or paying late
• Intentionally using overdraft protection or taking
frequent cash advances
• Using savings to pay routine bills and living expenses
such as food
• Getting second or third payment notices
• Not talking to your partner about money or talking only
about money
• Depending on overtime to meet routine expenses 82
Warning Signs of Debt Problems
(continued)

• Borrowing money to pay old debts


• Not knowing how much you owe
• Going over your credit limit on credit cards
• Having little or no savings for the unexpected
• Being denied credit due to a credit report
• Getting a credit card revoked by the issuer
• Putting off medical or dental visits, or car or home
maintenance/repairs because you can’t afford them
now

83
Credit Counseling Services
** If you can’t pay your bills, postpone further credit
purchases, talk with your creditors, or seek help from
a non-profit credit counseling service
– Not all credit counseling services are equal. Do
your homework.
• Look at services provided and fees
• Look at profit/non-profit status
• See how long they have been in business and
accreditations
• Look at the BBB and other sources for information on
consumer complaints

84
Some sources for financial
counseling
• Universities, local county extension agents, credit
unions, military bases, and state and federal housing
authorities often provide nonprofit financial counseling
services.
• You can check with your financial institution (bank) or
consumer protection office (state or federal) to see if it
has a listing of reputable, low-cost financial counseling
services.
• Bankruptcy is a last resort

85
Credit Counseling Services
Not all credit counseling services are equal. Do your
homework.
• Look at services provided and fees
• Look at profit/non-profit status
• See how long they have been in business and
accreditations
• Look at the BBB and other sources for information on
consumer complaints

First get educated about financial counseling…


– https://www.texasattorneygeneral.gov/cpd/debt-management
– https://www.consumer.ftc.gov/articles/0153-choosing-credit-
counselor
86
Bankruptcy

87
Bankruptcy Profiles
• Average age: 38
• 44% of filers are couples
• 30% are women filing alone
• 26% are men filing alone
• Slightly better educated than general pop.
• Two out of three have lost a job
• Half have had a serious health problem;
• Fewer than 9% have not suffered a job loss, medical
event or divorce;
• Highest bankruptcy rates: Tennessee, Utah, Georgia,
Alabama.

Source: The Fragile Middle Class: Americans in Debt;


Elizabeth Warren, Harvard Law School; Smith Business Solutions
The Bankruptcy Abuse Prevention &
Consumer Protection Act ’05
• Restrict consumer abuse of bankruptcy filings
• Implements a “means test” to determine if
consumer can file a Chapter 7 or Chapter 13
– Income: Average past 6 months income used. If
it falls below the state’s median – Chapter 7
eligible
– Expenses: If able to repay $100/month for 5
years then not eligible for Chapter 7
• More complex & costly process
• Enroll in & pay for approved credit counseling
program 6 months before filing date
Chapter 7 . . .
– Submit a petition to the court that lists assets
and liabilities, and pay a filing fee
– Many, but not all, debts are forgiven
– Assets are sold to pay creditors
– Can keep some assets
– Fresh start
– Most filed are this type

90
After Chapter 7 You May After Bankruptcy You Still
No Longer Owe… May Owe...

• Retail store charges • Certain taxes and fines

• Bank credit card charges


• Child support and
alimony

• Unsecured loans • Educational loans

• Unpaid hospital or • Debts from willful or


physician bills malicious acts

91
Chapter 13 Bankruptcy…
• A voluntary plan proposed to the bankruptcy court for
those to want to pay a portion of debt up to five years
– Must have a regular income

– Can’t have more than $250,000 unsecured debt or


$750,000 in secured debt
– Payments are made to a trustee

– Trustee distributes money to your creditors

– Court may allow you to keep property & pay less than full
amount of debts

• Costs to the debtor include court costs, attorney’s fees


and trustee’s fees and costs 92
Bankruptcy Outcomes
• Findings are mixed

93
Co-signing a Loan

94
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 borrow 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

95
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
96
If someone co-signs a loan for
you
• Do all in your power to honor your
agreement
• If things become complicated,
communicate without delay…
– Don’t just try to solve it on your own, you owe
it to them to clearly communicate difficulties in
making payments.

97
Credit Invisible
• https://www.consumerfinance.gov/about-
us/blog/who-are-credit-invisible/

98