Slide - Chapter 5 - Managing Liquidity - Open Credit PDF

Learning Objectives
1. Know how credit cards work.
2. Understand the costs of credit.

Chapter 5
3. Describe the different types of credit cards.
Using Credit
Cards: The Role 4. Know what determines your credit card
of Open Credit worthiness and how to secure a credit card.
5. Manage your credit cards and open credit.
6-2 © 2016 Pearson Education, Inc. All rights reserved.
A First Look at Credit Cards

Introduction
and Open Credit
• Convenient, but if you’re not careful, credit • Credit involves receiving cash, goods, or
cards will cost you. services with an obligation to pay later.
• Some charge over 20% interest on unpaid • Open credit (revolving credit) is a line of
balances. credit extended before the purchase.
• Unpaid balance plus interest carries over to

• Most people don’t consider interest charges next month.
on purchases they have to have.
• Higher balances on credit lines, higher
• Manage credit wisely to avoid high interest. costs.
6-3 © 2016 Pearson Education, Inc. All rights reserved. 6-4 © 2016 Pearson Education, Inc. All rights reserved.
Interest Rates Calculating the Balance Owed
• Annual Percentage Rate (APR)—the true simple • The method of determining the balance
interest rate paid over the life of the loan. (balance calculation method)
• APR for all consumer loans must be disclosed. – Average daily balance method
– Previous balance method

• Fixed APR vs. variable APR
– Adjusted balance method
• Teaser Rates
• Variations—include new purchases or
• Compound interest exclude
• The Levy’s credit card statement shows a
balancedue of $1578.25 on March 23, the billing
date. For the period ending Aprial 23, they had
the following transactions:
• March 26 Charge: Party Supplies $79.98
• March 30 Charge: Restaurant meal $52.76
• April 3 Payment $250
• April 15 Charge: Clothing $190.52
• April 22 Charge: Car repairs $190.85
• A) Find the average daily balance of the billing
period
• B) Find the finance charge to be paid on April 23.
Assume interest rate of 1.3% per month
Buying Money: The Cash Advance Grace Period
• Cash advances at ATMs are just like taking out • Grace period—the length of time given to make
a loan a payment before interest is charged against
the outstanding balance on a credit card.
• Higher interest rate charged immediately on
cash advances
• 21-25 days from date of bill. Some credit
cards have no grace period
• Up-front fee of 2 to 4 percent of the amount
advanced
• No grace period with cash advances.
• Pay down the balances for purchases before
paying down the higher interest rate cash • On most cards, the grace period is canceled if
balance there is unpaid balance from previous month.
Annual Fee Additional Fees
• A fixed annual charge imposed by a credit card. • Cash Advance Fee
• Over 70% of biggest credit card issuers do not

charge an annual fee. • Late Fee
• Many don’t charge the fee if the card is used at • Over-the-Limit Fee
least once a year.
• Penalty Rate
• Merchant’s discount fee—the percentage of the
sale that the merchant pays to the credit card
issuer.
Pros and Cons of Credit Cards Pros and Cons of Credit Cards
Advantages: Disadvantages:
• Convenience • Too easy to spend money
• Used as identification • Too easy to lose track of spending
• Phone and internet purchases • High interest rate
• Temporary funds
• Obligating future income
• Use product before paying for it
• Heavy budgetary problems with
• Bill consolidation
uncontrolled spending
• Pay less today and earn interest elsewhere
• Extended warranties, travel insurance, and
rewards.
What the CARD Act Means for

You
1. Your credit card company has to tell you
when they plan to increase your rate or
other fees.
2. Your credit card company has to tell you
how long it will take to pay off your
balance.
3. No interest rate increases for the first year.
4. Increased rates apply only to new charges.
What the CARD Act Means for

Choosing a Source of Open Credit
You
• Bank Credit Cards—a credit card issued by
5. Restrictions on over-the-limit transactions.
a bank or large corporation, generally a Visa
6. Caps on high-fee cards. or Mastercard.
7. Protections for underage consumers.
8. Standard payment dates and times. • Bank Card Variations—different classes
9. Payments directed to highest interest (credit levels) of bank credit cards.
balances first. – Premium or Prestige card
10.Your credit card company cannot charge – Affinity card
you a fee of more than $25 in most cases. – Secured credit card
11.No inactivity fees.
Choosing a Source of Open Credit Choosing a Source of Open Credit
• Travel and entertainment (T&E) cards—do • Single-Purpose Cards—can be used only

not offer revolving credit and require full at a specific company.
payment of balance each month.
• Interest-free grace period. • Companies issue their own cards to avoid

merchant’s discount fees.
• Issuers receive annual fee and merchant’s
discount fee. • Terms vary, some offer revolving credit.
• American Express, Diners Club, and Carte

Blanche are the primary issuers. • Typically, no annual fee.
Choosing a Source of Open Credit The Choice: What’s Best for You
• Traditional charge account—can be used • Credit user—carries an unpaid balance from

to make purchases or get services only at month to month.
the issuing company such as utility
companies and doctors who provide services • Convenience user—pays off the credit card
and bill later. balance each month (avoids interest).
• Convenient for both issuer and payee.

• Convenience and credit user—generally
pays off all the balance
• Pay monthly bill in full or pay interest/fee.
Getting a Credit Card
• Excellent idea for students.
• Emergency funds.
• Build solid credit history if used prudently.
• First step is to apply.
Credit Evaluation: The Key to Getting Credit:
The Five C’s of Credit Your Credit Score
1. Character • A credit bureau—gathers information on
consumers’ financial history, including payment
history and sells to customers.
2. Capacity
• Credit bureaus compile credit report and assign
a credit score.
3. Capital
• Credit report—information on financial situation
and dealings.
4. Collateral
• Credit information impacts whether you get a
loan, it affects your interest rate.
5. Conditions
Determining Creditworthiness Your Credit Score
• Credit scoring—numerical evaluation of • Affects rates you pay on credit cards

‘scoring’ of applicants based on their credit
history. • Affects size of credit line
• Reduces the lender’s uncertainty

• Affects insurance rates
• Lender able to make credit available to good • Affects mortgage rate

risk customers at lower interest rates.
• Strong credit score—lower interest rate
How Your Credit Score is

Computed
• Based on models developed by Fair Isaac
Corporation.
• FICO Score but name and your score varies

with bureau.
• Scores range from 300-850.
• Visit www.myfico.com/ficocreditscoreestimator
to get an estimate of your score.
What is a good score?
• A good credit score doesn’t just mean that

you’ll get a loan, it also means you’ll pay
less for it through lower rates.
• Creditworthiness also based on employment

history, job history, and amount of debt you
currently have.
What’s in Your Credit Report?
• Identifying Information
• Trade Lines or Credit Accounts
• Inquiries
• Public Record and Collection Items
Monitoring Your Credit Score
• Check for errors in credit report.
• Get free copy of your credit report each year

from the three major credit bureaus at
www.annualcreditreport.com
• Check all information correct, all accounts

on report are yours.
The Credit Bureau and Your
Consumer Credit Rights
Rights
• Take credit complaints directly to the • Fair and Accurate Credit Transactions (FACT)
creditor. Act—you can request one free copy for your
credit report from national bureaus and contact
them for inaccuracies.
• Federal laws protect consumers with
complains about credit – Bureau must investigate and correct.
– File a statement to explain negative information that

is accurate, not corrected.
• Fair Credit Reporting Act (FCRA)—negative

information remains on report for 7 to 10 years.
If Your Credit Card Application

is Rejected
1. Apply for a card with another financial
institution.
2. Find out why you have been rejected.

• Set up an appointment with credit card manager.
• Address the problem.
Resolving Billing Errors
• Fair Credit Billing Act (FCBA)—procedures for

correcting billing errors.
• Withhold payment for item in question.
• Notify card issuer within 60 days of statement date.

Use “billing inquiry” or “billing error” address on
credit card bill.
• Should receive notification within 30 days.
• Card issuer investigates within 90 days—account is

credited or not with explanation.
Consumer Financial Protection
Identity Theft
Bureau
• Provides single location for financial • Use of your name, address, Social Security
protection and oversight number, bank or credit card account
number, or other identifying information by
• Ensures that financial markets are easier to someone other than you without your
understand knowledge to commit fraud and other
crimes.
– Makes prices clear and easy to see
– Makes comparison shopping easier
How Do You Know if You’re a

Victim of Identity Theft?
• Receive a credit card you didn’t apply for.
• Denied credit or offered less favorable

terms.
• Receive calls or letters from debt collectors.
• Fail to receive bills or other mail.
What To Do If Your Identity Has

Ways to avoid credit card fraud.
Been Stolen
1. Put fraud alert on credit file. • Save all credit card charge receipts, compare
them to the monthly statement, and then
destroy them to avoid someone getting your
2. Close accounts that have been tampered card number from a receipt.
with or you didn’t open.
• Don’t disclose your account number over the
phone unless you initiated the purchase.
3. File police report. • Never disclose your account number over a
public phone.
4. File report with the FTC. • Never leave a store without your card.
http://www.consumer.gov
Summary Summary
• Main form of open credit is the credit card • Lenders determine creditworthiness using
which you can use to make charges up to a the “five C’s” of credit—character, capacity,
certain point as long as you pay off the capital, collateral, and condition.
minimum amount of your debt each month.
• Different credit cards charge different APR

• Costs of open credit include interest rate,
cost of cash advances, annual fee, penalty and calculate finance charges differently.
fees.
• Focus on controlling credit card spending
• Choices of open credit lines include different and look for signs of trouble.
types of credit cards and charge accounts.
Assignment (Group-based or
individually)
• 1. Ted and Tiffany are meeting Mitch and Amber
• Working in a small group, collect credit card at the Green Turtle Club Later in the evening.
marketing information or the summary of Wanting to set some limits on what could be an
account information sent to cardholders for expensive evening, Ted stops at the ATM and uses
his credit card to get a cash advance. When the
three to five different cards.
two couples meet for dinner, Tiffany tells Amber
• à Summarize the card information into a that she is going to splurge and get lobster
chart showing the purchase balance because Ted is rolling in cash. Mitch overhears
calculation method, annual percentage rate this and begins to laugh at Ted for making such a
(APR) of interest for purchases, grace financial blunder. Ted argues that Mitch is blind to
period, annual fee, and minimum finance the convenience and control offered by cash
charge, transaction fee for cash advance, advances, as research shows that people tend to
penalty fees... Compare the results. spend more when using credit cards. Tiffany and
6-53 © 2016 Pearson Education, Inc. All rights reserved. Amber ask you to determine who is right.
Ex 2 Ex 2 (cont.)
• Melita carried an average daily balance of • Since the average daily balance is the most
$550 on her credit card this month. Her commonly used balance calculation method,
previous balance last month was $1,000, is shopping for a lower interest rate really
com- pared to a balance of $100 this that important?
month. There are 30 days in this billing
cycle & Melita always makes a payment on
the fifteenth of the month. Based on this
information, calculate the monthly interest
charges for credit card accounts charging
14%, 16%, and 18% interest. Complete the
following chart.
Mini case
• Garth was amazed to hear that his friend • He reasoned that his credit card was a safe
Lindsey always pays off her credit card balance and convenient way to shop and it allowed
each month. Garth just assumed that everyone him to buy expensive items by paying
used credit cards the same way- buy now, pay minimum monthly payments. Overall, Garth
later-only in his case, months later. He buys thought of himself as a responsible credit
almost everything he needs or wants, including user, despite the fact he had been late
clothes, food, and entertainment with his card. making a few monthly payments and, once or
When Lindsey asked him about the balance twice, had gone over his credit limit. He also
caculation method, APR, grace period, or other uses his card regularly to obtain cash
fees and features of his card, Garth was advances. After hearing all of this, Lindsey is
clueless. worried about her friend. She has come to
you for help in answering the following
6-57 © 2016 Pearson Education, Inc. All rights reserved. questions.
• 1. What type of credit user is Garth? Based • 4. Based on what you know about Garth, what
on your answer, what is the number one kind of additional fees and penalties is he most
factor that should influence Garth's choice of likely to encounter? What is the impact ofthese
a credit card? fees and penalties on Garth?
• 2. Lindsey insisted that Garth request a free • 5. Explain the differences in credit card interest
credit report. List and briefly explain the rates when described as a fixed, variable,
information that Lindsey will need to help teaser, or penalty rate. How do these different
Garth decipher his report. rates affect the cost of using a credit card?
• 3. Nathaniel, another friend, suggested that • 6.What factors should Garth consider if he
Garth should obtain a secured credit card, or decides to transfer his current card balance to
better yet a Titanium card. Do you agree? another card?
Why or why not?
• 7. Much to his surprise, Garth was rejected on
his last credit card application. What actions, if • 9. After Lindsey's crash course on credit
any, should he take? Why should he be education, Garth decided to discipline
concerned about this rejection if he still has his himself by closing a couple of his older
other cards? accounts. Is this a good strategy?
• 8. Use Table 6.5 to determine how many months • 10. What advice would you give Garth if he
Garth will need to pay off a $3,000 outstanding has trouble paying his credit card bill in the
balance if he pays $150 per month with an APR future?
of 15 percent and he does not make any
additional purchases. Tell Garth how much his
monthly payment needs to be in order to
eliminate his debt in 12 months, assuming no
additional purchases.

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Learning Objectives

1. Know how credit cards work.

2. Understand the costs of credit.

5. Manage your credit cards and open credit.

6-2 © 2016 Pearson Education, Inc. All rights reserved.

A First Look at Credit Cards

• Unpaid balance plus interest carries over to

Interest Rates Calculating the Balance Owed

– Previous balance method

Buying Money: The Cash Advance Grace Period

Annual Fee Additional Fees

• A fixed annual charge imposed by a credit card. • Cash Advance Fee

• Over 70% of biggest credit card issuers do not

What the CARD Act Means for

What the CARD Act Means for

• Travel and entertainment (T&E) cards—do • Single-Purpose Cards—can be used only

• Interest-free grace period. • Companies issue their own cards to avoid

• American Express, Diners Club, and Carte

• Traditional charge account—can be used • Credit user—carries an unpaid balance from

• Convenient for both issuer and payee.

Getting a Credit Card

• Excellent idea for students.

• Build solid credit history if used prudently.

• First step is to apply.

Determining Creditworthiness Your Credit Score

• Credit scoring—numerical evaluation of • Affects rates you pay on credit cards

• Reduces the lender’s uncertainty

• Lender able to make credit available to good • Affects mortgage rate

• Strong credit score—lower interest rate

How Your Credit Score is

• FICO Score but name and your score varies

• Scores range from 300-850.

• A good credit score doesn’t just mean that

• Creditworthiness also based on employment

What’s in Your Credit Report?

• Trade Lines or Credit Accounts

• Public Record and Collection Items

Monitoring Your Credit Score

• Check for errors in credit report.

• Get free copy of your credit report each year

• Check all information correct, all accounts

– File a statement to explain negative information that

• Fair Credit Reporting Act (FCRA)—negative

If Your Credit Card Application

2. Find out why you have been rejected.

Resolving Billing Errors

• Fair Credit Billing Act (FCBA)—procedures for

• Withhold payment for item in question.

• Notify card issuer within 60 days of statement date.

• Should receive notification within 30 days.

• Card issuer investigates within 90 days—account is

How Do You Know if You’re a

• Denied credit or offered less favorable

• Receive calls or letters from debt collectors.

• Fail to receive bills or other mail.

What To Do If Your Identity Has

• Different credit cards charge different APR

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