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

Credit Capacity Indicators

*Not including housing

Debt Payments-to-Income Ratio

monthly payments*

monthly after tax income

6-9

Credit Capacity Indicators

Debt To Equity Ratio

total liabilities

net worth*= Should be < 1

*Excluding home value6-10

Debt-Payment Limits as a Percentage of Disposable Income

PercentFor Current

Debt*Take on

Additional Debt?10 or less Safe limit; borrower feels little

debt pressure.Could be undertaken cautiously.

11 to 15 Possibly safe limit; borrower feels some pressure.

Should not be undertaken.

16 to 20 Fully extended; borrower hopes that no emergency arises.

Only the fearless or foolhardy ask for more.

21 to 25 Overextended; borrower worries about debt

No, borrower should see a credit counselor.

* Excluding home mortgage loans and convenience credit to be repaid in full when the bill arrives.

If one of the earners reduces/eliminates

earnings, debts that had been manageable with

two incomes may become overwhelming.

Setting Debt Limits for Dual-Earner Households

BEWARE!

• 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.

Sources of Consumer Credit

Parents and family members

Commercial bank

Credit union

Life insurance company

Savings and loan association

Finance company

Retailers

Cash advances

Truth In Lending Rights

The 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

Calculating Finance Charges and APR

•Simple-interest method

•Discount method

APR CALCULATIONS FOR SINGLE-PAYMENT LOANS:

Calculating Finance Charges and APR

•Simple-interest method

•Add-on method

•Discount method

APR CALCULATIONS FOR INSTALLMENT LOANS:

Formula 7.3

Dealing With Over-indebtedness

TEN SIGNS OF OVER-INDEBTNESS:1. Exceeding debt/credit limit.

2. Running out of money.

3. Paying only the minimum due.

4. Requesting new cards and increases in credit limits.

5. Paying late or skipping payments.

6. Not knowing how much you owe.

7. Taking add-on loans.

8. Using debt consolidation.

9. Receiving notice of repossession or foreclosure.

10. Experiencing garnishment.

Dealing With Over-indebtedness

• Federal law regulates debt collection

• Bankruptcy as last resort

• Chapter 13• Chapter 7

History of Bankruptcies Since 1961

Fair Debt Collection Practices Act

Can’t be abusive or threatenCan’t call you at work if you say noCan’t tell boss and friendsCan’t call you at odd hoursMust follow set proceduresThe act does not apply to creditors that

try and collect the debt themselves

Collection agencies...

Impact ofDivorce on Credit

• Pay attention to accounts held jointly

• Ask creditors to close joint accounts

• Remember, creditors can legally collect from either party

• Get updated copy of credit report

Alternative Lenders

• Pawnshop

• Rent-to-own program

• Check cashers

• Rapid refund services

ManageOver-indebtedness

1. Determine what is owed.2. Focus budget on debt reduction.3. Contact creditors.4. Take on no new credit.5. Refinance.6. Find good help.7. Avoid bad help.

Manage StudentLoan Debt

1. Choose most advantageous repayment pattern allowed.

2. Consolidate student loans.

3. Pay electronically.

4. Be punctual with repayments.

5. Refinance with second mortgage loan.