how are credit scores determined?

© Family Economics & Financial Education –Updated April 2009– Credit Unit – Understanding a Credit CardFunded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences Take Charge America Institute at The University

of Arizona

How are Credit Scores determined?• Credit cards may influence each

component of how an individual’s credit score is calculated

10%10%

15%

30%

35%

Credit Mix

Pursuit of New Credit

Credit History & Length

Outstanding Debt

Payment History


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What is a good FICO credit score?• FICO scores range from 300

– 850. The higher score is better.

• 750-850 (excellent)• 660-749 (good)• 620-659 (fair)• 350-619 (poor)


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The higher your credit score, the lower your payments for a car• Purchasing a $20,000 car with a 3 yr.

loan:• Cr. Score APR Mo. Paym.• 720-850 6.790% $616• 690-719 7.672% $624• 660-689 9.171% $638• 620-659 10.771% $653• 590-619 14.120% $685• 500-589 15.127% $695• www.myfico.com (if you have a low credit score, you probably cannot

get a loan)

http://www.myfico.com/


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The higher your score, the less you pay on a home loan• For example, on a $216,000 30-year, fixed-rate

mortgage:• credit score interest rate monthly payment • 760 – 850 5.26% $1,194• 700 – 759 5.48% $1,223• 680 – 699 5.66% $1,248• 660 – 679 5.87% $1,277• 640 – 659 6.3% $1,337• 620 – 639 6.85% $1,415

As you can see in this example, a person with a credit score of 760 or better will pay $221 less per month for a $216,000 30-year, fixed-rate mortgage than a person with a FICO® score of 620 – that’s a savings of $2,652 per year.


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Example of how a credit score can move up and down:

March 2009


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February 2010


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Types of CreditCharacteristics Close-end

Credit(Installment loans)

Open-end credit (revolving credit)

Definition A one-time loan Credit is extended in advance

Purpose of the loan

Specified in application

May be used for a variety of purposes

Payments Specified number of equal payments

Vary depending upon amount charged

Loan amount Agreed upon during the application process

May be increased for responsible consumers

Examples Mortgage, Automobile Loan

Credit Card (VISA)

Layaway • Before the widespread use of credit

cards, most stores had layaway plans. The store kept the merchandise until you paid it off.

• Some stores have started allowing layaway again, and it is becoming more popular.

New federal laws for students (2/10):Credit card companies cannot solicit on campus or

near campus.Cannot offer students “tangible” items like t-shirts

to apply for a card.You cannot have a credit card if you are under age

21 unless you can prove you have a steady income or you have a co-signer.

Example: If you are 18 and in the Navy, you may be able to get a credit card after you get a paycheck for a year.

Example of a co-signer: a parent signs the card application. If you do not pay, the parent is responsible.


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Credit card Interest examplesAmount charged to credit card

APR Minimum Payment

Time to pay off the credit card

Total amount of interest paid

Total paid for credit card balance

$2,000 18% $50.00 62 months

$1,077.25

$3,077.25

$2,000 10% $50.00 49 months

$443.00 $2,443.00

$2,000 18% $75.00 35 months

$573.00 $2,573.00


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The Cost of Using Credit

APR = 24%

Minimum Payment of 4% or $12

$300 for an IPod/accessories

Finance Charge $149.99Your IPod REALLY cost $449.99

After you’ve made the last payment, will your iPod still be around???

And it will take 3 years

and 8 months to pay off

1


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How Long Will It Take?

APR = 18%

Minimum Payment of 4% or $120

You charge $3,000 for furniture.

Finance Charge $1,715.67

Total cost of original $3,000 loan = $4,715.67

After you’ve made the last payment, will you still be using that furniture in 11 years?

And it will take

nearly 11 YEARS to pay off

1


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Prime Rate• Credit card interest rates are based

on the Prime Rate


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What is a Prime Rate?• The Prime Interest Rate is the

interest rate charged by banks to their most creditworthy customers.

• The current Prime Rate is 3.25%• Providers of consumer and

commercial loan products often use the U.S. Prime Rate as their base lending rate, then add a margin (profit) based primarily on the amount of risk associated with a loan.


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How is the prime rate calculated?• The U.S. Prime Rate is determined by

adding 3.00 percentage points to the “federal funds target rate.” For example, if the fed funds target rate is 0.25%, then the U.S. Prime Rate will be 3.25%.


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What is the Fed Funds Target Rate?• It is the interest rate banks charge each

other for loans.• The federal funds target rate is

controlled by a group within the U.S. Federal Reserve system called the Federal Open Market Committee (FOMC). The FOMC holds a monetary policy meeting eight times every year to decide whether to raise, lower or make no changes to the fed funds target rate.


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Federal Funds Target Rate recent history


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understanding the information on a credit card application• The Federal Truth in Lending Act of

1968 required card issuers to display the costs of a credit card in an easy to read format. (among other rules)

• The Credit Cardholder’s Bill of Rights Act of 2008 refined this law even further by requiring the wording to be more understandable, the print large, and certain information must be in bold and/or larger font.


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Information you need to knowAnnual

Percentage

Rate for Purchases

How to Avoid Paying

Interest on Purchases

Minimum Finance Charges

Balance

Calculation Method

for Purchases

Annual

FeesTransaction Fees for

Cash Advances

Late

Payment Fees

_______%

Due date will be a

minimum of 21 days after the close of

each billing cycle. Pay everything during that 21 days and you pay no interest.

$______ if the balance is not paid each month. (Typically $.50-1.50)

Average daily

balance method

(including new

transactions)

$__ per year or none

____% with

a minimum fee of $_____(Typically 3-5% with a minimum fee of $5-

10)

$_____ depending

on your balance

• Above is some of the types of information you need to know when applying for a credit card. These are explained further in the next slides.


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Annual percentage rateAnnual

Percentage

Rate for Purchases

How to Avoid Paying



Balance

Calculation Method

for Purchases

Annual


Cash Advances

Late

Payment Fees

_______%

• Annual percentage rate (APR) – Interest rate charged for amount borrowed in terms of per dollar per year.

• All APR’s for credit cards are based on the Prime Rate. The credit card application will tell you how much is added to the prime rate. Your APR is based on your credit rating (score).

• The lower the interest rate, the better


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How to Avoid Paying Interest

on PurchasesAnnual

Percentage

Rate for Purchases

How to Avoid Paying



Balance

Calculation Method

for Purchases

Annual


Cash Advances

Late

Payment Fees

Due date will be a

minimum of 21 days after the close of

each billing cycle. Pay everything during that 21 days and you pay no interest.

• As long as you pay your entire balance by

5:00 on the day it is due, you will not pay interest on the balance. If the due date is a weekend or holiday, it is due at 5:00 on the next business day.


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Minimum finance chargeAnnual

Percentage

Rate for Purchases

How to Avoid Paying



Balance

Calculation Method

for Purchases

Annual


Cash Advances

Late

Payment Fees

$______ if the balance is not paid each month. (Typically $.50-1.50)

• If you don’t pay off the balance, you pay a finance charge, which is based on the APR and the balance you owe.

• Minimum finance charge – Minimum amount charged for card use if you don’t pay the entire balance.

• Card companies make you pay a finance charge even if you have a very low balance.


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Balance calculation methodAnnual

Percentage

Rate for Purchases

How to Avoid Paying



Balance

Calculation Method

for Purchases

Annual


Cash Advances

Late

Payment Fees

Average daily

balance method

(including new

transactions)

• Balance calculation method for purchases- Method used to determine balance for finance charges.

• You will learn how banks calculate Average Daily Balance when we start the assignments.


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Annual feesAnnual

Percentage

Rate for Purchases

How to Avoid Paying



Balance

Calculation Method

for Purchases

Annual


Cash Advances

Late

Payment Fees

$__ per year or none

• Annual fees- Yearly charge for credit card ownership

• These used to be virtually unheard of, but with the law changes in 2010 many companies are starting to charge annual fees again.


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Cash advancesAnnual

Percentage

Rate for Purchases

How to Avoid Paying



Balance

Calculation Method

for Purchases

Annual

FeesInterest

Rates and Transaction Fees for

Cash Advances

Late

Payment Fees

____% with

a minimum fee of $_____(Typically 3-5% with a minimum fee of $5-

10)

• What is a Cash Advance?• The APR for Cash Advances is higher than

the card APR• Transaction fees for cash advances – If you

choose to withdraw cash using your credit card, there are always extra fees. Typically 3-5% of how much you withdraw.


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Late payment feesAnnual

Percentage

Rate for Purchases

How to Avoid Paying



Balance

Calculation Method

for Purchases

Annual


Cash Advances

Late

Payment Fees

$_____ depending

on your balance

• Late payment fees – Penalty fee for payments not made by the due date (even one day late, or paid after 5:00 on the due date)

• Usually based on your balance, but can be a flat fee. $39 is typical

• Late payments can affect your credit score.


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Penalty APR’s

• Your APR can jump to a “penalty rate” if you:

• Pay less than the minimum payments

• Don’t pay the minimum by the due date

• Make a payment that is returned (bounced check)

• Penalty rates are typically 27% and up.


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Credit limits

• Every card has a credit limit, and it is based on your credit score.

• For example, someone with very little credit history or a poor credit score may have a credit limit of $250-$500.

• A person with a good credit score may have a limit of $10,000 or more.


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Over the limit fees

• The new credit card law requires the bank to decline your charge if your purchase will put you over your credit limit.

• You can opt to change that if you choose, but if you go over the limit you pay a fee, usually of $39.


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Balance Transfers• Moving the amount you owe on a

credit card to a different credit card is called a balance transfer.– Companies will advertise a lower interest

rate for balance transfers. – These are usually introductory rates and

will only last for a short time.– Why do credit card companies try to

tempt you to transfer balances?


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Safety tips• Sign card with a signature and “Please

See ID” • Do not leave cards lying around • Close unused accounts in writing and by

phone, then cut up the card • Do not give out account numbers over

the phone unless making purchases with a secure company.

• Keep a list of all cards, account numbers, and phone lists separate from cards (copy the f/b of cards)

• Report lost or stolen cards immediately.


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Fair Credit Billing Act • Helps to protect consumers while using a credit

card to make purchases • It allows the consumer to not pay for a product

or service for which the consumer has a complaint

• Billing disputes are covered within the Fair Credit Billing Act for credit cards

• If products are not delivered or if it is not what they consumer requested, any amount of money that was credited to the card above the $50.00 fee that consumers are responsible for will be issued back

• Debit cards do not have the same protection– Making credit cards a safer form of payment for

online purchases


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7.1 Account Statements

Formula used to calculate the new balance on your credit card :

New Balance = Previous Balance + Finance Charge + New Purchases –

Payments – Credits

Turn to p. 286, #1 for practice (answers next slide)


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p. 286, #1You owed $600 on your last bill

(previous bal.)You did not pay it all, so you had a

finance charge (interest) of $7.50 (+)

You bought $90 at the store and used your card. (+)

You sent $100 as a payment (-)Your new balance is $597.50Try #2 on p. 286


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p. 286, #2• $270.78

Assignment:• pp. 286-287 (3, 5, 9-14)• #10, the $40 is not deducted yet


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P. 286

3. $6495. $337.659.$1,809.3010.$299.9711.$182.09


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p. 286

12.$679.5813.a. $109.90 b.

$188.73c. $369.0414.$2494.20


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Complete the Credit card application assignment

Any Questions?

Next section: 7.3

Lesson 7.3—how the bank calculates finance charges on a credit card• Average Daily Balance Method (New

Purchases Included)

• Average Daily Balance—The average daily balance is the average of the account balance at the end of each day of the billing period.

• The company adds purchases and subtracts any payments or credits posted during that day from the beginning balance.

• The ending balances for every day are then totaled and divided by the number of days in the billing period to get the average daily balance.

• This number is used to calculate finance charges.

• Average Daily Balance = Sum of Daily Balances

• Number of Days in Billing Period

• Number of Days in the Billing Period: how many days does the bank use to calculate your A.D.B.?

• Usually it is the total number of days in that month, but it can be days from a previous month also. Use a calendar if necessary.

• Post Date—shows dates when the bank recorded your purchases or payments. Anything that would make the balance change.

• **the post date will not always be the same date you bought the merchandise—there is usually a difference.

• Transactions—either a payment or credit (returned something) that is deducted from the Balance or a purchase or fee that is added to the Balance.

• End of Day Balance—Previous Balance - Payments +

Purchases

• Number of Days—the number of days that the balance remained the same.

• Sum of Daily Balances—Balance at End of Day x Number of

Days

Look at the chart below to visualize how the Average Daily Balance is calculated. The billing period is the entire month of October.

Post Date Transactions (payment or purchase)

End of Day Balance

NumberOf Days

Sum of DailyBalances

10/1-10/3 0.00 225.60 3 (3 days counting from 10/1 to 10/3)

676.80 (225.6 x 3)

10/4 -28.99 (return) 196.61 (225.60-28.99)

1 (1 day) 196.61 (196.61 x 1)

10/5-10/8 0.00 (during this period nothing was charged or returned)

196.61(nothing has changed in these 4 days)

4 786.44 (196.61 x 4)

10/9 +21.89 (boughtsomething)

218.50 (196.61 + 21.89)

1 218.50 (218.50 x 1)

10/10-10/17 0.00

10/18 -35.99

10/19 +42.75

10/20-10/23 0.00

10/24 -75.00

10/25 +129.32

10/26-10/31 0.00

*(does this equal the number of days in October?) _____________add add _______________

• YOU HAVE ENOUGH INFORMATION TO FIND the Average Daily Balance:

• Sum of Daily Balances ÷ Number of Days in Billing Period = _____________________

• Complete Practice Problem #1 in your notes.

Lesson 7.3, Part II: CALCULATING THE NEW BALANCE• Use Practice Problem I

(December) at the TOP of the previous page in your notes to find the new balance below. The APR is 24%.

Finding the New Balance

• Step 1: Find the Average Daily Balance (already found in Practice Problem I--$119.31)

Lesson 7.3, Part II: CALCULATING THE NEW BALANCE

Periodic Rate (if not given) = APR ÷ 12 (24% ÷ 12) = 2%

• Step 2: Find the Finance Charge: Average Daily Balance x Periodic Rate

$119.31 x .02 = $2.39

• Step 3: Find the Unpaid Balance =

Previous Balance – (Payments + Credits)$_______-$_______ = $________

• Step 4: Find the Total New Purchases

$_________• Step 5: Find the New Balance = Unpaid Balance + Finance Charge + New

Purchases$_______ +$_______+ $_____=

$______

Assignment:

Use Practice Problem #2Calculate the finance charge, unpaid

balance, and new balance. Show the equation for each.

a. Finance chargeb. Unpaid balancec. New balanceGet initials, and then continue your

assignment as written in your notes.

how are credit scores determined?

Documents

credit unit

credit cardfunded

individuals credit score

credit cards

fico credit scores

good fico credit score

charge america institute

higher score