CHAPTER 3

Introduction to Consumer
Credit

UEH - School of Banking - Nguyễn Thị Hồng Nhung – April 2017

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 Learning Objectives

1. Define consumer credit and analyze its

advantages and disadvantages.
2. Differentiate among various types of
credit.
3. Assess your credit capacity and build your
credit rating.
4. Describe the information creditors look for
when you apply for credit.

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 What is Consumer Credit?
Objective 1: Define consumer credit and
analyze its advantages and disadvantages.

• 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 (except a home mortgage)

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What is Consumer Credit?

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 What is Consumer Credit?
• THREE WAYS CONSUMERS CAN FINANCE
PURCHASES

– Draw on their savings

– Use present earnings

– Borrow against expected future income

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 What is Consumer Credit?
• TRADE-OFFS WITH EACH ALTERNATIVE

– Deleting savings reduces emergency funds

– Spending current income will eventually
reduce future well-being
– Spending future income now reduces funds
available for future expenses

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 What is Consumer Credit?
• ADVANTAGES OF CREDIT
– Immediate access to goods and services
– Permits purchase even when funds are low
– A cushion for financial emergencies
– Advance notice of sales
– Convenient when shopping

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 What is Consumer Credit?
ADVANTAGES OF CREDIT (cont)

– One monthly payment

– Safer than cash
– Needed for hotel reservations, car rentals,
and shopping online
– May get rebates, airline miles, extended
manufacturer’s warranties, or other bonuses
– Indicates financial stability

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 What is Consumer Credit?
• DISADVANTAGES OF CREDIT
– Temptation to overspend
– Failure to repay loan may lead to loss of
income
– Misuse of credit can create serious long-term
financial problems, damage to family
relationships, and a slowing of progress
toward financial goals
– It does not increase total purchasing power
– Credit costs money

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 Types of Credit
Objective 2:Differentiate among various types
of credit.
• CLOSED-END CREDIT
– One-time loans for a specific purpose that
you pay back in a specified period of time
and in payments of equal amounts
– Installment sales credit, Installment cash
credit, and Single lump-sum credit
– Mortgage, automobile, and installment loans
for furniture, appliances, and electronics

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 Types of Credit
• OPEN-END CREDIT
– Use as needed until reaching line of credit
max
– You pay interest and finance charges if you
do not pay the bill in full when due
– Types: Credit cards issued by departments
stores, Bank credit cards, Overdraft
protection and Revolving check credit (bank
line of credit)

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Types of Credit

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 Types of Card
CREDIT CARDS

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 Types of Card
– CREDIT CARDS
o Eight out of ten U.S. households carry one or
more credit cards
o One-third are convenience users and pay
balances in full each month
o Two-thirds are borrowers, carrying a balance
over and paying finance charges
o Some use cards for cash advances, paying a
transaction fee and interest
o Co-branding - linking a credit card with a
business offering points or rebates on products
and services

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 Types of Card
– SMART CARDS
o Have an embedded computer chip
o Combine credit cards, a driver’s license,
a health care ID with your medical history
and insurance information, etc.

– DEBIT CARDS
o Often called bank cards, ATM cards, cash
cards, and check cards
o Electronically subtracts from your
account at the moment you make a
purchase (no delay in payment)
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 Types of Card

– STORED VALUE (OR GIFT) CARDS

o A debit card.
o Used as paper gift certificates.
o Used for business purposes (travel
expenses).
o Bankruptcy can make the cards worthless.

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 Types of Card
– TRAVEL AND ENTERTAINMENT CARDS
o These cards are not really credit cards
o Monthly balance is due in full
o Diners Club or American Express cards

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 Types of Card
– SMART PHONE

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PROTECTING YOURSELF AGAINST
DEBIT/CREDIT CARD FRAUD

o Sign new cards as soon as they arrive

o Treat cards like money and keep them secure
o Shred anything with your account number on it
o Don’t give your card number over the phone
unless you initiate the call and don’t write it on
postcards
o Get card & receipt after every transaction and
check for errors by comparing receipts to bills
o Notify the card issuer if you don’t get your billing
statement or if your card is lost or stolen
o Check your credit report regularly

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WHEN YOU MAKE PURCHASES
ONLINE
o Use a secure browser
o Keep records of online transactions
o Review monthly statements-can do so online
o Read policies of the websites you visit
concerning refunds, site security, and privacy
o Keep personal information private unless you
know who is gathering it and why
o Shop at businesses you know and trust
o Never give out your password to anyone
online
o Do not download files sent by strangers
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Objective 3: Assess your credit capacity
and build your credit rating.

• CAN YOU AFFORD A LOAN?

– Ask yourself if you can still meet all essential
expenses and still afford the monthly loan
payments
– Ask yourself what do you plan to give up in
order to make the monthly payment?
– Are you prepared to make this trade-off?

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Measuring Your Credit Capacity
• GENERAL RULES OF CREDIT CAPACITY

Debt Payments your monthly debt payments*

-to-Income Ratio =
net monthly income

Consumer credit payments should not

exceed a max of 20% of your net (after-tax) income

*Exlcuding your house payment which is a long-term liability

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Measuring Your Credit Capacity

Debt To Equity Ratio

Total Liabilities
= Should be < 1
Net Worth*

*Excluding the value of your home and the amount

of its mortgage

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 Measuring Your Credit Capacity
• 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

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Measuring Your Credit Capacity

• BUILDING AND MAINTAINING YOUR

CREDIT RATING

– A good credit rating is a valuable asset

that should be nurtured and protected
– Limit your borrowing to your capacity in
order to repay
– Live up to the terms of contracts
– Check to see what is in your credit report

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Measuring Your Credit Capacity
– CREDIT BUREAUS
o Consumer Reporting Agencies
collect information
o Experian, TransUnion, and Equifax
o Federal Trade Commission gets about
12,000 complaints about credit bureaus
each year

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Measuring Your Credit Capacity
– WHAT IF YOU ARE DENIED CREDIT?
o Check your credit file at the credit bureau
o If you believe reasons for denial are invalid: file
suit and/or notify federal enforcement agency
o 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

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 Objective 4: Describe the information
creditors look for when you apply 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?

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Applying for Credit

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Part 3
Choosing a Source of Credit:
The Costs of Credit
Alternatives

UEH - School of Banking - Nguyễn Thị Hồng Nhung – April 2017

5-30
UEH - School of Banking - Nguyễn Thị Hồng Nhung – April 2017

5-31
 Learning Objectives
1. Analyze the major sources of consumer
credit.

2. Determine the cost of credit by calculating

interest using various interest formulas.

3. Develop a plan to manage your debts.

4. Evaluate various private and governmental

sources that assist consumers with debt
problems.

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 Objective 1: Analyze the major sources
of consumer credit.

• WHAT KIND OF LOAN SHOULD YOU SEEK?

– Inexpensive loans
o Parents or family members
o Loans that use your assets (CDs or value
of whole life insurance) as collateral.

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 Sources of Consumer Credit

– Medium-priced loans
o Commercial banks, savings and loan
associations, and credit unions

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 Sources of Consumer Credit
– Expensive loans
o Finance and check cashing companies
o Retailers such as car or appliance dealers
o Bank credit cards and cash advances

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 The Cost of Credit
Objective 2: Determine the cost of credit by
calculating interest using various interest
formulas.
• TRUTH IN LENDING LAW is the federal law that
requires creditors to disclose the annual percentage
rate (APR) and the finance charge as a dollar
amount
• FINANCE CHARGE is the total dollar amount you
pay to use credit. It includes interest costs, service
charges, credit-related insurance premiums, or
appraisal fees

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 The Cost of Credit

• The ANNUAL PERCENTAGE RATE (APR) is the

percentage cost of credit on a yearly basis
– Your key to comparing costs, regardless of the
amount of credit or how much time you have to
repay it
– APR is the true rate of interest so you can
compare rates with other sources of credit.
It is important to shop for credit.

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The Cost of Credit

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 The Cost of Credit

• Ví dụ bạn vay $100 trong 1 năm, sử dụng $100

tiền vay trong cả năm và trả phí $10 vào cuối kỳ,
APR là 10%.
• Nhưng nếu bạn trả $100 thành 12 kỳ trong năm
với số tiền bằng nhau mỗi tháng, bạn không sử
dụng $100 cho cả năm, mà số tiền đó bị trừ dần
hàng tháng $8.33 ($100: 12), trả phí $10 vào cuối
kỳ. APR trong trường hợp này là 18.5%

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 The Cost of Credit
• TACKLING THE TRADE-OFFS
– Term versus interest costs
o Longer loans with lower payments results in
more total interest
– Lender risk versus interest rate
Some ways to reduce the lender’s risk and the
interest rate:
o Accept a variable interest rate
o Provide collateral to secure the loan
o Make a large cash down payment up front
o Have a shorter loan term

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 The Cost of Credit

• CALCULATING THE COST OF CREDIT

– Simple interest
o Computed on principal only and without
compounding
o The dollar cost of borrowing
o I=PxrxT

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The Cost of Credit
– Simple interest on
the declining
balance
o Interest is paid only
on the amount of
original principal not
yet repaid
o The more frequent
your payments, the
lower the interest
you will pay

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 The Cost of Credit

– Add-on interest
o Interest is calculated on the full amount of the
original principal. It is then added to the
principal, and the total of both is divided by the
number of payments to be made to arrive at the
payment amount

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 The Cost of Credit
– Cost Of Open-End Credit
o Credit cards, department store charge
cards, and check overdraft accounts

o Adjusted Balance Method

▪ Method of computing finance charges
where they are calculated after payments
made in the billing period have been
subtracted

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 The Cost of Credit
o Average Daily Balance Method
▪ The fairest method of computing finance
charges
▪ Creditors add your balances for each day
in the billing period
▪ Then they divide this total by the number
of days in the billing period
▪ Then they multiply this average by the
monthly interest rate

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 The Cost of Credit
o Previous Balance Method
▪ Method of computing finance charges that
gives no credit for payments made during
the billing period

▪ For example...
APR 18%; Monthly rate 11/2%
Previous balance $400; Payments $300
= Finance charge
= 11/2% x $400
= $6.00
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 The Cost of Credit
– COST OF CREDIT AND INFLATION
o Borrowers and Lenders are concerned about
the goods and services that dollars “can” buy
(purchasing power of dollars) rather than the
actual credit used
o Inflation erodes the purchasing power of money
o Each percentage point increase in inflation
means a decrease of approximately 1% in the
quantity of goods and services you can
purchase with a dollar

– COST OF CREDIT AND TAXES

o Interest paid on consumer credit is not tax
deductible
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 The Cost of Credit

– AVOID THE MINIMUM PAYMENT TRAP

o If you make only the minimum payment each
period, you will pay more in interest and it will
take you longer to pay off your balance

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 The Cost of Credit
• EARLY REPAYMENT
– The Rule of 78s favors lenders
– Formula requires that you pay more interest at
the beginning of the loan, when you have the
use of more of the money, and pay less and
less interest as the debt is reduced

• CREDIT INSURANCE
– Ensures Loan is paid off in the event of death,
disability, or loss of property
– Three types include credit life, credit accident
and health, and credit property
– Premiums are quite high

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 Managing Your Debts

Objective 3: Develop a plan to manage your

debts.

• NOTIFY CREDITORS IF YOU CAN’T MAKE

A PAYMENT

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 Managing Your Debts
• FAIR DEBT COLLECTION PRACTICES ACT
– 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 may request verification of the debt within 30
days
– If verification sent, you may pay the debt or give
notice that you will not pay

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 Managing Your Debts
• REASONS FOR DEBT
– Emotional problems such as the need for
instant gratification
– The use of money to punish or get even
– The expectation of instant comfort among
young 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
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 Managing Your Debts
• 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 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

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 Managing Your Debts
WARNING SIGNS OF DEBT PROBLEMS

– Using up your savings

– 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 because
you can’t afford them now
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 Managing Your Debts
• THE SERIOUS CONSEQUENCES OF DEBT
– Robbing Peter to pay Paul can affect family
health
– May result in neglecting the educational needs
of children
– May result in heavy drinking
– May result in neglect of children
– May result in marital difficulties
– May result in drug abuse
– May result in bankruptcy

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Consumer Credit Counseling Services
Learning Objective 7-4:
Evaluate various private and governmental
sources that assist consumers with debt
problems.

** If you cannot pay your bills, then postpone

further credit purchases, talk with your
creditors, or seek help from a non-profit credit
counseling service

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Consumer Credit Counseling Services

• CONSUMER CREDIT COUNSELING

SERVICE (CCCS)
– a non-profit which is supported by
contributions from banks, merchants, etc.
– Provides education about credit and budgeting
– Provides help with spending plan
– Provides debt counseling services for
those with serious financial problems
– Can develop a debt repayment plan and
negotiate reduced interest rates

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Consumer Credit Counseling Services

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Declaring Personal Bankruptcy
Learning Objective 7-5:
Assess the choices in declaring personal
bankruptcy.

• BANKRUPTCY
– is a legal process in which some or all of
the assets of a debtor are distributed
among the creditors because the debtor is
unable to pay his or her debts

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Declaring Personal Bankruptcy
– Women account for 36 percent bankruptcies

– A record 2.0 million people declared bankrupt in

2005

– Bankruptcy was designed as a last resort but has

become an “acceptable” tool of credit
management

– Declaring bankruptcy is a last resort because it

severely damages your credit rating

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Declaring Personal Bankruptcy

– Chapter 7 Bankruptcy
o Submit a petition to the court that lists
assets and liabilities, and pay a filing fee
o Known as a Straight Bankruptcy
o Many, but not all, debts are forgiven
o Most assets are sold to pay creditors
o Can keep some assets
o Fresh start
o Most filings used to be this type

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Declaring Personal Bankruptcy

o After Chapter 7 Bankruptcy,

You May No Longer Owe...

▪ Retail store charges

▪ Bank credit card charges
▪ Unsecured loans
▪ Unpaid hospital or physician bills

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Declaring Personal Bankruptcy

o After Chapter 7 Bankruptcy,

You May Still Owe...

▪ Certain taxes and fines

▪ Child support and alimony
▪ Educational loans
▪ Debts from willful or malicious acts

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Declaring Personal Bankruptcy
– Chapter 13 Bankruptcy
o A voluntary plan proposed to the bankruptcy
court for those to want to pay a portion of their
debt over a period up to five years
o Known as a Wage-Earner’s Plan
o Must have a regular income
o Payments are made to a trustee
o Trustee distributes money to your creditors
o Court may allow you to keep property & pay
less than full amount of debts
o Costs to the debtor include court costs,
attorney’s fees and trustees’ fees and costs

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Declaring Personal Bankruptcy

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