Going Into Debt

Americans and Credit

What is Credit?

• Credit: is the receiving of funds either directly or indirectly to buy goods and services now with the promise to pay for them later

• The amount owed is called debt

What is debt

• Debt is equal to the principal (money borrowed) + the interest which is the money you must pay for using someone else's money like a bank, store or credit card company

Installment Debt

• Consumers repay this type of debt with equal payments, or installments, over a period of time Ex. 36 equal payments over 36 months

• Durable Goods: these are often bought on installment loans because they will last much longer than it will take to pay off the debt

• The longer it takes to pay off the debt/loan the more expensive it is to purchase the item

Installment Debt Cont.

• A mortgage is the most common type of installment debt. It is owed on real property,-houses, buildings, or land

• Look at figure 4.2 to see how interest is applied to the principal of a loan over time

Why People Use Credit

• People buy goods on credit because the believe they require these items immediately

• Of course most things people buy on credit can wait until they have enough money to pay cash for them

Deciding to Use Credit

• The decision to borrow or use credit involves weather the borrower gets from the purchases is greater than the interest payments

• The benefit of borrowing is being able to buy and enjoy the good or service now rather than later

• The cost is whatever the borrower must pay in interest of lost opportunities to buy other items

Types of Financial Institutions

• Different Institutions offer different interest rates so before to shop around before you apply for a loan

• Commercial Banks: these institutions control the largest amounts of money and offer the widest range of services

Types of Financial Institutions

• Savings and Loan Associations: these institutions accept deposits and lend funds. They also finance commercial mortgages and auto loans

• They also offer savings and checking accounts as well

• The also provide interest rates that are often lower than banks

Types of Financial Institutions Cont.

• Savings Banks: First set up to serve small investors that were overlooked by commercial banks

• Credit Unions: A credit union is owned and operated by its members to provide savings accounts and low interest loans only to its members

Types of Financial Institutions Cont.

• Credit unions primarily make personal, auto, and home improvement loans, although larger credit unions offer home mortgages as well.

• Finance Companies: A finance company takes over contracts for installment debts from stores and adds a fee for collecting the debt. The consumer pays slightly higher interest than he/she would have paid the retailer

Finance Companies

• The borrower usually pays interest rates of 20% or higher

• People usually use these loan sharks because their credit is poor due to unpaid debts in the past

• Charge Accounts: allows a customer to buy goods or services from a particular company and pay for them later

Regular Charge Accounts

• Use have credit limits of 500.00 to 1000.00. This is the maximum amount you can borrow.

• No interest is charged but the entire bill most be paid on time or interest is charged on the unpaid amount and sometimes on the entire amount

Revolving Charge Accounts

• Revolving Charge Accounts: these allow you to make additional purchases from the same store even if the previous month’s bill is unpaid

• Installment Charge Accounts: Major items such as sofas, TVs, and refrigerators. Like mortgages the payments are spread in equal parts over time.

Credit Cards

• A credit card like charge account, allows a person to make a purchase without paying cash.

• The difference is that credit cards can be used at many kinds of stores, restaurants, hotels, and other businesses throughout the US and other countries

Credit Cards Cont.

• In order to make online purchases you have to have a credit card

• Visa, MasterCard, and others issue cards through banks

• This gives consumers access to loans at all times without having to apply for them

• The better your credit score the lower the interest rate and vise versa

Finance Charges and Annual Percentage Rates

• The terms finance charge and annual percentage rate tell the consumer the same thing-the cost of credit

• The finance charge is the cost of credit expressed in dollars and cents

• It must take into account interest costs plus any other charges connected with credit. i.e. membership fees and finance charges

Annual Percentage Rates

• The annual percentage rates (APR) is the cost of credit expressed as a yearly percentage

• The APR must take into account any noninterest cost of the credit such as membership fees

• Remember to go with the credit card company with the lowest interest rate

Debit Cards

• There is another method of payment, known as a debit card.

• This is not a loan and come directly out of your checking account

Applying for Credit

• Creditworthiness: Credit bureaus check your credit scores to investigate your credit history

• The investigation will reveal your income, any current debts, details about your personal life, and how well you have repaid debts in the past

The Credit Rating

• The information supplied by the credit bureau provides the creditor with a credit rating for you

• This is a rating of the risk good, average, or poor-involved in lending funds to a specific person or business

Capacity to Pay

• This is related to income and debt. It’s referred to as the debt to income ratio

• The amount of debt you’re already paying is a factor

• If your debt is large creditors will be reluctant to loan you more