Using Credit Cards: The Role of Open

Credit

6-2Copyright © 2010 Pearson Education, Inc.  Publishing as Prentice Hall

Learning Objectives

1. Know how credit cards work.

2. Understand the costs of credit.

3. Describe the different types of credit cards.

4. Know what determines your credit card worthiness and how to secure a credit card.

5. Manage your credit cards and open credit.

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Introduction Convenient, but if you’re not careful, credit

cards will cost you.

Some charge over 20% interest on unpaid balances.

Most people don’t consider interest charges on purchases they have to have.

Manage credit wisely to avoid high interest.

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A First Look at Credit Cardsand Open Credit

Credit involves receiving cash, goods, or services with an obligation to pay later.

Open credit (revolving credit) is a line of credit extended before the purchase.

Unpaid balance plus interest carries over to next month.

Higher balances on credit lines, higher costs.

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Interest Rates Annual Percentage Rate (APR)—the true

simple interest rate paid over the life of the loan.

APR for all consumer loans must be disclosed.

Fixed APR vs. variable APR

Teaser Rates

Compound interest

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Calculating the Balance Owed

The method of determining the balance (balance calculation method)

Average daily balance method

Previous balance method

Adjusted balance method

Variations—include new purchases or exclude

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Buying Money: The Cash Advance

Cash advances at ATMs are just like taking out a loan.

Higher interest rate charged immediately on cash advances

Up-front fee of 2-4% of the amount advanced.

Pay down the balances for purchases before paying down the higher interest rate cash balance.

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Grace PeriodGrace period—the length of time given to

make a payment before interest is charged against the outstanding balance on a credit card.

20-25 days from date of bill. Some credit cards have no grace period

No grace period with cash advances.

On most cards, the grace period is canceled if there is unpaid balance from previous month.

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Annual FeeA fixed annual charge imposed by a credit

card.

Over 70% of biggest credit card issuers do not charge an annual fee.

Many don’t charge the fee if the card is used at least once a year.

Merchant’s discount fee—the percentage of the sale that the merchant pays to the credit card issuer.

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Additional Fees

Cash Advance Fee

Late Fee

Over-the-Limit Fee

Penalty Rate

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Pros and Cons of Credit Cards

Advantages:ConvenienceUsed as identificationPhone and internet purchasesTemporary fundsUse product before paying for itBill consolidationPay less today and earn interest elsewhereExtended warranties, travel insurance, and

rewards.

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Pros and Cons of Credit Cards

Disadvantages:Too easy to spend moneyToo easy to lose track of spendingHigh interest rateObligating future incomeHeavy budgetary problems with

uncontrolled spending

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Choosing a Source of Open Credit

Bank Credit Cards—a credit card issued by a bank or large corporation, generally a Visa or Mastercard.

Bank Card Variations—different classes (credit levels) of bank credit cards.Premium or Prestige cardAffinity cardSecured credit card

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Choosing a Source of Open Credit

Travel and entertainment cards (T&E)—do not offer revolving credit and require full payment of balance each month.

Interest-free grace period.

Issuers receive annual fee and merchant’s discount fee.

American Express, Diners Club, and Carte Blanche are the primary issuers.

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Choosing a Source of Open Credit

Single-Purpose Cards—can be used only at a specific company.

Companies issue their own cards to avoid merchant’s discount fees.

Terms vary, some offer revolving credit.

Typically, no annual fee.

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Choosing a Source of Open Credit

Traditional charge account—can be used to make purchases or get services only at the issuing company such as utility companies and doctors who provide services and bill later.

Convenient for both issuer and payee.

Pay monthly bill in full or pay interest/fee.

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The Choice: What’s Best for You

Credit user—carries an unpaid balance from month to month.

Convenience user—pays off the credit card balance each month (avoids interest).

Convenience and credit user—generally pays off all the balance

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Getting a Credit Card

Excellent idea for students.

Emergency funds.

Build solid credit history if used prudently.

First step is to apply.

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Credit Evaluation: TheFive C’s of Credit

Character

Capacity

Capital

Collateral

Conditions

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The Key to Getting Credit: Your Credit Score

A credit bureau—gathers information on consumers’ financial history, including payment history and sells to customers.

Credit bureaus compile credit report and assign a credit score.

Credit report—information on financial situation and dealings.

Credit information impacts whether you get a loan, it affects your interest rate.

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Determining Creditworthiness

Credit scoring—numerical evaluation of ‘scoring’ of applicants based on their credit history.

Reduces the lender’s uncertainty

Lender able to make credit available to good risk customers at lower interest rates.

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Your Credit Score

Affects rates you pay on credit cards

Affects size of credit line

Affects insurance rates

Affects mortgage rate

Strong credit score—lower interest trate

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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/ScoreEstimator.html to get an estimate of your score.

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How Your Credit Score is Computed

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.

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What’s in Your Credit Report?

Identifying Information

Trade Lines or Credit Accounts

Inquiries

Public Record and Collection Items

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Factors That Determine Your Score

Your Payment History (35%)

Amount You Owe and Your Available Credit (30%)

Length of Credit History (15%)

Types of Credit Used (10%)

New Credit (10%)

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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.

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Consumer Credit Rights

Take credit complaints directly to the creditor.

Federal laws protect consumers with complains about credit

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The Credit Bureau andYour Rights

FACTA—you can request one free copy for your credit report from national bureaus and contact them for inaccuracies.

Bureau must investigate and correct.

File a statement to explain negative information that is accurate, not corrected.

FCRA—negative information remains on report for 7 to 10 years.

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If Your Credit Card Applicationis Rejected

Apply for a card with another financial institution.

Find out why you have been rejected.Set up an appointment with credit card

manager.Address the problem.

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Resolving Billing ErrorsFCBA—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.

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Identity Theft

Use of your name, address, Social Security number, bank or credit card account number, or other identifying information by someone other than you without your knowledge to commit fraud and other crimes.

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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.

Calls or letters from debt collectors.

Fail to receive bills or other mail.

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Identity has been stolen

Put fraud alert on credit file.

Close accounts that have been tampered with or you didn’t open.

File police report.

File report with the FTC.

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Controlling and Managing Your Credit Cards and Open Credit

Reducing your balance

Protecting against fraud

Trouble signs in credit card spending

If you can’t pay your credit card bills

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SummaryMain form of open credit is the credit card

which you can use to make charges up to a certain point as long as you pay off the minimum amount of your debt each month.

Costs of open credit include interest rate, cost of cash advances, annual fee, penalty fees.

Choices of open credit lines include different types of credit cards and charge accounts.

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Summary

Lenders determine creditworthiness using the “five C’s” of credit—character, capacity, collateral, and condition.

Different credit cards charge different APR and calculate finance charges differently.

Focus on controlling credit card spending and look for signs of trouble.

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