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Copyright ©2004 Pearson Education, Inc. All rights reserved.

Chapter 7

Managing Your Credit

Copyright ©2004 Pearson Education, Inc. All rights reserved. 7-2

Chapter Objectives

• Provide a background on credit

• Explain the key characteristics of credit cards

• Offer tips on using credit cards


Background on Credit

• Credit: funds provided by a creditor to a borrower that will be repaid by the borrower in the future with interest

• Advantages of using credit– Ability to purchase when price exceeds

available cash• Purchase home, car, pay tuition

– Convenience



• Disadvantages of using credit– Difficulty making payments

– Temptation for impulse purchases

– Hinders ability to save

– Expensive


Financial Planning Online:Personal Credit Counseling

• Go to http://www.phil.frb.org/consumers/establish.html

• This Web site provides information on how to establish, use, and protect credit.

http://www.phil.frb.org/consumers/establish.html







Exhibit 7.1: Impact of Credit Payments on Saving



• Establish a credit history– Often begins with timely payment

of utility bills

• Impact of the interest rate on credit payments– Simple interest rate: the percentage of

credit that must be paid as interest on an annual basis



Exhibit 7.2: How Interest Payments Are Influenced by Interest Rates



Exhibit 7.2: How Interest Payments Are Influenced by Interest Rates



– Annual percentage rate (APR): the simple interest rate including any fees charged by the creditor

• Allows comparison among potential lenders


Credit Cards

• Applying for a credit card — potential creditors obtain information from you, about you, and about the economy– Personal information

• Cash inflows

• Cash outflows

• Credit history

• Capital

• Collateral


Credit Cards

• Credit check– Credit report: a statement of

creditworthiness based on information such as whether you have made late payments, and any unpaid current bills

– Credit scoring often determines whether or not you are approved for credit


Credit Cards

– Interpreting credit ratings• High ratings usually provide easy credit

approval

• How ratings make obtaining credit difficult


Financial Planning Online:Your Credit Card Report

• Go to: http://loan.yahoo.com/c/index.html

• This Web site provides a credit report that assesses your creditworthiness. The report is available to you online for a small fee.

http://loan.yahoo.com/c/index.html


Credit Cards

• Focus on Ethics: Guarding your financial information– Financial institutions must provide privacy

policies telling what information they collect and what information they intend to share

– Evaluate your credit report regularly

– Creditors may also consider debt level and economic situation


Credit Cards

– The credit decision• You should receive a reply within 30 days

• If you are rejected, the creditor must give an explanation

• Laws prohibit discrimination in credit based on race or gender

• Creditors may not consider criminal records, political preferences, or religion


Credit Cards

• Types of credit cards– Visa, MasterCard and American Express

most popular

– Visa and MasterCard allow partial payments

– American Express requires full payments


Credit Cards

– Retail (or proprietary) credit card: a credit card that is honored by a specific retail establishment

• Retail stores and gas stations

• Limits purchases to a single merchant

• Credit limit — maximum amount of credit allowed

• Annual fee

• Incentives to use the card


Financial Planning Online: Estimating Your Future Credit Card Payments

• Go to: http://www.financenter.com/products/sellingtools/calculators

• Click on: “Credit Card” then “How Important is the Interest Rate?”

• This Web site provides estimates of your future credit card payments.

http://www.financenter.com/products/sellingtools/calculators






Credit Cards

• Prestige cards: credit cards, such as gold or platinum cards, issued by a financial institution to individuals who have an exceptional credit standing

• Grace period — period between time of purchase and when payment is due

• Cash advances– Usually charge high interest plus a fee


Credit Cards

• Interest rate — usually between 15 and 20 percent– Finance charge: the interest that you must

pay as a result of using credit

• Credit card statement details differences in new balance and previous balance


Credit Cards

• Comparing credit cards– Acceptance by merchants

– Annual fee

– Interest rate• Watch for “teaser rates”

– Maximum limit


Financial Planning Online:Your Rights When Using Credit• Go to: http://www.chicagofed.org

• Click on: “Project Money $mart,” then “Your Credit Rights: How the Law Protects You” under the heading “Using Credit Wisely.”

• This Web site provides information about various laws that protect your rights when using credit.

http://www.chicagofed.org/




Tips on Using Credit Cards

• Use a credit card only if you can cover the bill

• Impose a tight credit limit

• Pay credit card bills before investing money

• Use savings if necessary to pay the credit card bill on time

• If you cannot avoid credit card debt, pay it off before other debt



• Avoid credit repair services

• Avoid credit card fraud

• Deter identity theft


Financial Planning Online:The Best Credit Card for You

• Go to: http://www.bankrate.com/brm/rate/cc_home.asp

• This Web site provides links to help you get the best overall credit card rate, the lowest introductory rate, frequent flier credit cards, and other special features.

http://www.bankrate.com/brm/rate/cc_home.asp







Exhibit 7.3: Self-Imposed Credit Limit Based on Monthly Cash Inflows



Exhibit 7.4: Self-Imposed Credit Limit Based on Monthly Cash Inflows and a Monthly Savings Goal


Dealing With Credit Debt

• If you find yourself with excessive credit card debt– Spend as little as possible

– Consider ways to increase income

– Borrow from a family member

– Get a debt consolidation loan

– Sell assets for cash

– Reduce everyday expenses


Dealing With Credit Debt

– If all else fails you may need to file for personal bankruptcy

• Chapter 7 allows the discharge of almost all debts, but also have to surrender assets to pay debt

• Chapter 13 allows you to keep your assets, but the court takes control of your finances and devised a 3 – 5 year repayment plan


Financial Planning Online: Establishing and Protecting Credit

• Go to: http://www.chicagofed.org

• Click on: Project Money $mart, then Spend Wisely on the right hand side of the page

• This Web site provides information about establishing, using, and protecting your credit.





Financial Planning Online: Estimating the Time Necessary to Pay Off Your Balance

• Go to: http://www.financenter.com/products/sellingtools/calculators

• Click on: “Budget,” then “What will it take to pay off my balance?”

• This Web site provides an estimate of the number of payments you need to make to pay off your credit card balance.







Financial Planning Online:Identity Theft

• Go to: http://www.consumer.gov/idtheft/

• This Web site provides information on how thieves can steal your identity and how you can prevent identity theft.

http://www.consumer.gov/idtheft/






How Credit Management Fits Within Your Financial Plan

• Key credit management decisions for your financial plan are:– What limit should you impose on your

credit card?

– When should you use credit?


Integrating Key Concepts


Integrating Key Concepts

• Part 1: Financial Planning Tools

• Part 2: Liquidity Management– In Chapter 5 we learned about banking and interest rates

– In Chapter 6 we learned about managing your money

– In Chapter 7 we learned about managing your credit

• Part 3: Financing

• Part 4: Protecting Your Wealth

• Part 5: Investing

• Part 6: Retirement and Estate Planning


Finance Payment Methods

• Previous Balance Method– Interest charged on the balance at the beginning

of the new billing period

• Average Daily Balance Method– Interest charged on average daily balance at the

end of every day in the billing period

• Adjusted Balance Method– Interest is charged based on the balance at the

end of the new billing period

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