Chapter 7: Planned Borrowing

Objectives

• Discuss the elements of the planned use of credit.

• Establish your own debt limit.

• Understand the language of consumer loans.

• Describe the sources of consumer loans.

Objectives

• Calculate the APR and finance charges on both single-payment and installment loans.

• Recognize signs of over-indebtedness, know what to do when it occurs, and explain your rights regarding credit collection and bankruptcy.

Planned Borrowing

•Most people use installment credit 12+ times during their life.

•Yet, only 1:3 shop for credit terms!

DID YOU KNOW!

Planned Borrowing

•A knowing decision to borrow to finance a purchase or simply to

borrow cash.

Planning Your Credit Usage

• When

• How often

• How much

THE TASK OF DETERMINING:

•The debt limit most people establish for themselves

is lower than what lenders would be willing to lend.

Establishing a Debt Limit

• Debt-payments-to-disposable-income method

• Ratio of debt-to-equity method

• Continuous-debt method

Establishing a Debt Limit

The Cost of Credit (continued)

TACKLING THE TRADE-OFFS

• Term versus interest costs. Longer loans-lower payments, but more total interest

• Lender risk versus interest rate. Some ways to reduce the

lender’s risk and the interest rate:• Accept a variable interest rate• Provide collateral to secure the loan• Make a large down payment up front• Have a shorter loan term

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The Cost of Credit (continued)

CALCULATING THE COST OF CREDIT

• Simple interest• Computed on principal only

and without compounding. • The dollar cost of borrowing• I = P x r x T

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The Cost of Credit (continued)

CALCULATING THE COST OF CREDIT (continued)

• Simple interest on the declining balance

• Interest is paid only on the amount of original principal not yet repaid

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The Cost of Credit (continued)

CALCULATING THE COST OF CREDIT (continued)

• Add-on interest• Interest is calculated on the full amount of the

original principal, added to the principal, and the total of both is divided by the number of payments to be made

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The Cost of Credit (continued)

COST OF OPEN-END CREDIT

• Adjusted balance method• Finance charges are

calculated after payments made in the billing period have been subtracted

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The Cost of Credit (continued)

COST OF OPEN-END CREDIT (continued)

• Average daily balance method• Creditors

1) add your balances for each day in the billing period2) divide this total by the number of days in the billing period 3) multiply this average by the monthly interest rate.

• New purchases may be excluded from the average daily balance calculation, but generally are included if you carry over a balance.

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Truth In Lending RightsThe Truth In Lending Act requires

creditors to provide you with accurate and complete credit costs and terms. APR

Creditors must disclosecredit terms and information... In a clear and conspicuous manner In a form you can keep

Sources of Consumer Credit

Parents and family members

Commercial bank

Credit union

Life insurance company

Savings and loan association

Finance company

Retailers

Cash advances

• Installment loans

• Secured/unsecured loans

• Purchase loan installment contracts

The Language of Consumer Loans

Monthly Installment Payments (Principal and Interest)

Terms of Installment 4% 6% 8% 10% 12% 14% 16% 18% 20%

1 year (12 months) 85.15 86.07 86.99 87.92 88.85 89.79 90.73 91.68 92.63

2 years (24 months) 43.42 44.32 45.23 46.14 47.07 48.01 48.96 49.92 50.90

3 years (36 months) 29.52 30.42 31.34 32.27 33.21 34.18 35.16 36.15 37.16

4 years (48 months) 22.58 23.49 24.41 25.36 26.33 27.33 28.34 29.37 30.43

5 years (60 months) 18.42 19.33 20.28 21.25 22.24 23.27 24.32 25.39 26.49

Monthly Installment Payment (Principal and Interest) Required to Repay $1,000*

*To illustrate, assume you want to know how much the monthly payment would be to finance a $9,000 loan at 10% for 3 years. To repay $1,000, the figure is $32.27, multiply by 9 (for $9,000) to determine that $290.43 is required for 36 months of payments. When using amounts greater or less than $1,000, convert using decimals. For example, a loan of $950 at 10 percent for 3 years would be calculated as follows: $32.27 x 0.95 = $30.66.

The Cost of Credit (continued)

• Minimum Payment: Avoid the minimum monthly payment trap.

• Early repayment: The Rule of 78s-favors lenders.

• Credit insurance: Loan paid off if insured dies or becomes disabled--Expensive.

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The Cost of Credit (continued)• Credit Card Accountability, Responsibility, and

Disclosure Act of 2009 (The Credit Card Act)• Limits increases in the APR in the first year• Restricts issuers from charging higher interest rates on

existing balances• Teaser rates must be for at least 6 months• Issuers must mail statements at least 21 days before

payment is due• Disclosure statement must be clear and timely• Card issuers must post card agreements on the internet

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The Cost of Credit (continued)• Credit Card Accountability, Responsibility, and

Disclosure Act of 2009 (The Credit Card Act) (continued)

• Requires statements to report the due dates, potential late fees, and total costs of making only the minimum payments

• Sets a consistent due date for card payments each month• Restricts the penalties for over the limit fees• Prohibits card issuers from issuing card to consumers

under 21 with out a cosigner or independent means to repay debt.

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Declaring Personal Bankruptcy

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 (continued)

Chapter 7 bankruptcy (most debts are forgiven)

• Submit a petition to the court that lists assets and liabilities, and pay a filing fee

• Many, but not all, debts are forgiven

• Assets are sold to pay creditors

• Can keep some assets

• Fresh start

• Most filed used to be this type

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Declaring Personal Bankruptcy (continued)

After Chapter 7 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 (continued)

After Chapter 7 Bankruptcy You Still May Owe...

• Certain taxes and fines

• Child support and alimony

• Educational loans

• Debts from willful or malicious acts

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Declaring Personal Bankruptcy (continued)

Chapter 13 Bankruptcy…

• 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

• Must have a regular income• Can’t have more than $250,000 unsecured debt or $750,000 in

secured debt• Payments are made to a trustee• Trustee distributes money to your creditors• Court may allow you to keep property & pay less than full

amount of debts

• Costs to the debtor include court costs, attorney’s fees and trustee’s fees and costs

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