Garman/Forgue

Personal FinanceNinth Edition

Chapter 6Building

andMaintaining

Good Credit

6 | 2

Learning Objectives

1. Explain reasons for and against using credit

2. Establish your own debt limit

3. Achieve a good credit reputation

4. Describe common sources of consumer credit

5. Identify signs of overindebtedness and describe options available for debt relief

6 | 3

1. Reasons For and Against Using Credit

Credit represents a form of TRUST established between a lender and borrower

Good uses (advantages) of credit: A cushion for financial emergencies Convenient when shopping One monthly payment Making reservations Rewards, sometimes

To obtain an education

Helps establish good credit history (if used wisely)

6 | 4

The downside (disadvantages) of credit:

It is tempting to overspend

Interest (the price of credit) can be costly

Becoming financially “overstretched”

Interest is costly

6 | 5

2. You Should Set Your Own Debt Limits

YOU, rather than the lender, should set your own debt limit

• Typically, your debt limit should be lower than what lenders are willing to lend

Debt payments-to-disposable income:

6 | 6

Debt payments-to-disposable income:

6 | 7

Loan Affordability

Before you apply for a loan,

determine if you can afford it…

– Will the payments fit into your budget? (what might you have to give up in order to afford the new payment each month?)

– Are you prepared to make this trade-off?

6 | 8

• Increasing debts: the effects on your budget (PG 164)

• Dual-earner households: consider a lower debt limit

– Our spending GROWS in tandem with our rising income

– “How can we be so broke when we make so much money?”

6 | 9

Credit agreement orPromissory note

3. Obtaining Credit and Building a Good Credit Reputation

Who gets approved and who doesn’t?

1. Apply for credit: Credit Application• 15% applicants are DENIED (due to no established credit history or

negative information)

2. Lender conducts credit investigation

• Evaluates applicant’s creditworthiness: ability AND willingness to repay

• All 3 major credit bureaus calculate and report scores to lenders. Ex: FICO score (most popular scoring system)

3. Approval or rejection

4. If approved, a contract is created =>

5. Tiered pricing

6 | 10

Your Credit ReputationThe information in your credit files is one of the most

important aspects of your financial life!Ex: jobs, insurance, rental housing, auto loans

• Must confirm that information is accurate

• 3 major credit bureaus collect information to create a credit file: Experian, Trans Union, Equifax

• The information is used to create a credit score• FICO score is most well-known, reflects your creditworthiness

• Building a credit history / increasing your score:– Establish both a checking account and savings account– Have telephone / utilities billed in your name– Apply for a gas credit card– Apply for a secured credit card– Pay off student loans

6 | 11

• What’s in MY report? Be curious…!

• One free each year from all 3 major bureaus:

– www.annualcreditreport.com

– http://www.myfico.com/CreditEducation/CreditScores.aspx

• Instant Message! Closing accounts does not help your credit score!

• Accuracy is important• Agencies must correct inaccurate information• Negative data can remain for up to 7 years

(bankruptcy for 10 years!)

6 | 12

Making Sense of Your FICO Credit Score

Your FICO score is extremely important because it dictates whether you will be granted credit and at what interest rate.

WHAT FACTORS DETERMINE MY SCORE?

PG 177

6 | 13

4. Sources of Loans and the Cost of Borrowing Money, pg 182-183

6 | 14

10 Signs of Overindebtedness

1. Exceeding debt limits and credit limits

2. Not knowing how much you owe

3. Running out of money

4. Paying only the minimum amount due

5. Requesting new credit cards and increases in credit limits

6. Paying late or skipping payments

7. Using debt-consolidation loans

8. Getting late payment notices

9. Experiencing garnishment

10. Experiencing repossession or foreclosure

Humorous College Student:http://www.debtsmart.com/pages/article_college_credit_video_070905747.html

6 | 15

5. How to Get Out from Under Excessive Debt

• Get organized: determine your account balances

• Prioritize: focus on debt reduction

• Contact your creditors if necessary

• Don’t take on new credit

• Refinance

• Find good help

6 | 16

Consumer Credit Counseling Services

A CCCAS is a non-profit credit counseling service

Its activities are twofold:

1. Help

• Debt counseling services

• Debt consolidation plans

• Negotiated reduction in interest rates

• Spending plan / budget

2. Prevention

• Education about credit

BEWARE of other agencies that offer to consolidate debt!

6 | 17

Sometimes… the answer is Personal Bankruptcy

• Designed as a last resort, it has become an

“acceptable” tool of credit management

• Bankruptcy stays on your credit report for

10 years

• Who should file?

• Who CAN file?

• How will it affect your life?

6 | 18

Chapter 7Liquidation (straight) Bankruptcy: A fresh start

• Submit a petition to the court

• If you are eligible, most of your debts will be discharged

• All non-exempt property can be sold off to pay your creditors

• Most debts are forgiven, except for:– Certain taxes and fines

– Child support and alimony

– Educational loans

– Debts from willful or malicious acts

• Some assets are EXEMPT and can be kept (protected)

• There are state and federal exemptions

• Are you eligible to file? Compare your income to median income

• New York: $46,320 $57,902 $69,174 $82,164• http://www.totalbankruptcy.com/chapter_7_more_information.htm

• http://www.bankruptcyaction.com/questions.htm

6 | 19

Chapter 13A Wage Earner Plan Bankruptcy

• A 3-5 year repayment plan is established

• Person keeps most possessions and makes regular payments to a bankruptcy trustee

• Person pays less than the full amount owed

• For much more information: http://www.bankruptcyaction.com/questions.htm

6 | 20

You have little property except for the basic necessities like furniture and clothing

You have significant equity in a home or other property and you want to keep it

You have little or no money left after paying basic expenses each month—or you’re not even meeting basic expenses

You have regular income and can pay your living expenses, but you can’t keep up the scheduled payments on your debts

Most unsecured debts can be discharged (completely eliminated)

You can keep most of your property while spreading out time to pay past due accounts

The process moves quickly—you may receive your discharge in just a few months

You’ll have 3-5 years to catch up delinquent accounts—according to a schedule that you and the bankruptcy trustee have agreed is workable for you.

Creditors can’t contact you while the automatic stay is in effect—or after debts are discharged.

You’ll make one monthly payment to the bankruptcy trustee for distribution—you’ll have no direct contact with creditors during the protection period of 3-5 years.

Co-signers may be protected

Debtors who have qualified under the “ means test” and completed a required pre-filing session with a credit counselor may file for Chapter 7 bankruptcy protection.

Any individual debtor whose unsecured debts are below $307,675 and whose secured debts are less than $922,975.

CHAPTER  7(Liquidation)

CHAPTER  13 (Adjustment of debts for an individual with regular income)

You may want to consider Chapter 7 if : You may want to consider Chapter 13 if :

Advantages of Chapter 7 : Advantages of Chapter 13 :

Who can file under Chapter 7 ? Who can file under Chapter 13 ?