MCS*2100 Chapter Summaries 5-9 Inclusive Personal Finance

29 Pages
Unlock Document

University of Guelph
Marketing and Consumer Studies
MCS 2100
Rosemary Vanderhoeven

Chapter 5: Introduction to Consumer Credit A Rising House of Cards? Poorer Borrowers Use More Plastic  Mid-2000 marked the beginning of a downturn, which is primarily driven by the technology slump and a reduction in corporate profits, whereas the consumer has remained very resilient.  The growing use and convenience of credit cards has facilitated the process of borrowing, and even those who can’t really afford to borrow still do.  Poorer, riskier borrowers joined the credit card ranks in the 1990’s. Many of whose members have low-level blue-collar jobs, are highly vulnerable to even a modest cyclical slowdown. What is Consumer Credit?  Credit is an arrangement to receive cash, goods, or services now and pay for them in the future.  Consumer credit refers to the use of credit for personal needs (except a home mortgage) by individuals and families, in contrast to credit used for business purposes.  Most consumers have three alternatives in financing current purchases: They can draw on their savings, use their present earnings, or borrow against their expected future income.  Trade offs to these alternatives: If you continually deplete your savings, little will be left for emergencies or retirement income. If you spend your current income on luxuries instead of necessities, your well-being will eventually suffer. And if you pledge your future income to make current credit purchases, you will have little or no spendable income in the future. Consumer Credit in Our Economy  Instalment credit is where the debt is repaid in equal instalments over a specified period of time.  The aging of the baby boom generation has added to the growth of consumer credit. This represents 30% of the population but holds nearly 60% of the outstanding debt. Uses and Misuses of Credit  Reasons for using credit: a medical emergency may leave someone strapped for funds, a homemaker returning to the workforce may need a car, it may be possible to buy an item for less now than it will cost later, and borrowing for a higher education.  “Shopaholics” and young adults are most vulnerable to misusing credit.  Using credit increases the amount of money a person can spend to purchase goods and services now. But the trade-off is that it decreases the amount of money that will be available to spend in the future.  If you decide to use credit, make sure the benefits of making the purchase now (increased efficiency or productivity, a more satisfying life, and so on) outweigh the costs (financial and psychological) of using credit. Credit, when effectively used, can help y9ou have more and enjoy more. When misused, credit can result in default, bankruptcy, and loss of creditworthiness. Advantages of Credit  Consumer credit enables people to enjoy goods and services now- a car, a home, an education, help in emergencies- and pay for them through payment plans based on future income.  Credit cards also provide shopping convenience and the efficiency of paying for several purchases with one monthly payment.  It’s safer to use credit, since charge accounts and credit cards let you shop and travel without carrying a large amount of cash.  Some large corporations, issue either co-branded (a.k.a. affinity or value-added) cards or their own Visa and MasterCard and offer rebates on purchases. Disadvantages of Credit  The temptation to overspend, especially during periods of inflation.  Failure to repay may result in loss of income, value property, and your good reputation, can even lead to court action and bankruptcy.  It does not increase total purchasing power. Credit purchases must be paid for out of future income, therefore, credit ties up the use of future income.  Credit costs money. Paying for purchases over a period of time is more costly than paying for them with cash. Involves one very obvious trade-off when using credit instead of cash: it will cost more due to monthly finance charges and the compounding effect of interest on interest. Types of Credit  Consumer loans (a.k.a. instalment loans), you pay back one-time loans in a specified period of time with a pre-determined payment schedule.  Revolving credit is where loans are made on a continuous basis and you are billed periodically for at least partial payment. Consumer Loans  Demand loans, where the lender can demand full repayment of the loan at any time, are also classified as consumer or instalment loans.  Demand loans may be interest-only for a set period of time. If the loan is secured, the lender will have a legal claim against the security pledged until the loan has been completely paid off. Revolving Credit  You can use revolving credit to make any purchases you wish if you do not exceed you credit limit, the maximum dollar amount of credit the lender has made available to you.  Incidental credit is a credit arrangement that has no extra costs and no specific repayment plan  A personal line of credit is a pre-arranged loan for a specified amount that you can use by writing a special cheque. Repayment is made in instalments over a set period. The finance charges are based on the amount of credit used during the month and on the outstanding balance. Credit Cards  83% of Canadian households carry one or more credit cards.  Convenience users are the people who pay off their balances in full each month.  Cash advances may look attractive but interest usually accrues from the moment you accept the cash, and you must also pay a transaction fee.  Smart cards, the ultimate plastic, embedded with a computer chip that can store 500 times the data of a credit card, have been introduced into the market. A smart card is a plastic card embedded with a computer chip that stores and transacts data between users. The card data is transacted via a reader that is part of a computing system. Smart cards have failed to make an impact on the Canadian consumer market. Protecting Yourself against Debit/Credit Card Fraud  Terrible for victims of fraud, they are forced to endure major inconvenience  All of us pay the costs of credit card fraud through higher prices, higher interest rates, and increased inconvenience Advice from a Pro- Jonathan Hoenig, Radio Show Host and Columnist  A good rule to live by: Don’t but things you can’t afford  A credit card bill, and other types of “unsecured” debt should be paid as soon as possible  Most college/university students recognize the importance of establishing and maintaining a good credit history Financial Planning for Life’s Situations- Payment via PayPal  By visiting the PayPal website, buyers and sellers can open a password-protected account that registers information concerning their personal payment options (credit card and bank account numbers, etc.)  Following an online purchase, the buyer then logs on to the PayPal site and requests that funds be transferred to the seller, who also has a PayPal account, and indicates the mode of payment (credit card, bank account), the timing of the transfer, and the desired currency.  This process permits buyers and sellers to send and receive money online in a secure fashion, without having to reveal their credit card number or other financial information to the other party. Travel and Entertainment Cards  T&E cards are really not credit cards but charge cards because the monthly balance is due in full. Most people think of them as credit cards because they don’t pay the moment they purchase goods or services. Personal Line of Credit  A personal line of credit is usually set up as a revolving line of credit, typically with a variable interest rate linked to the lender’s prime rate. A specified credit limit is established and funds can be withdrawn at the borrower’s convenience by using a debit card or by writing a cheque.  If the line of credit is secured by a pledge of assets the interest rate charged on funds borrowed will be reduced. In the event of borrower defaults, the lender can sell the collateral and recover the outstanding loan balance.  In a home equity line of credit, the limit on the line of credit is based on the difference between the current market value of your home and the amount you still owe on your mortgage.  Compared to an unsecured personal line of credit, most borrowers can obtain a higher credit limit at a lower interest rate with a home equity line of credit because of the pledge of the equity in their home as collateral. Interest paid on a home equity line of credit will be tax deductible, unlike the interest paid on a home mortgage, if the loan proceeds are used to generate taxable investment income. Some lenders permit interest-only payments. The cost of the appraisal, along with other application and legal fees that must be paid at the outset, are a major disadvantage of using a home equity line of credit.  You should use the home equity line of credit only for major items, such as education, home improvements, or medical bills, and not for daily expenses. If you miss payments, you can lose your home. When you sell your home, you probably will be required to pay off your home equity line of credit in full. Consumer Loans- Mortgage Loans  A home mortgage is probably the biggest single debt most individual Canadians will incur. Consumer Loans- Car Loans  Buying a vehicle is the second largest investment you will probably make after buying a house. Financing at a Bank  Most financial institutions offer consumer instalment loans to purchase an automobile. The purchaser may be required to make a minimum down payment against the cost of the vehicle, with the remaining cost financed by an instalment loan, at a fixed or variable interest rate, for terms ranging from one to five years.  The loan has an opening prepayment clause, unlike a home mortgage, and the borrower suffers no penalty for early repayment. Financing at the Dealer  Most car dealers offer financing in affiliation with car manufacturers or financial institutions. Factory financing enables you to get a loan directly from the car manufacturer, and you can expect to pay significantly lower interest rates and no down payment on the models they are trying to move. Leasing - There are two types of leases: closed-ended leases and open ended leases. - Closed-end lease: - The leasing company is responsible for the residual value of the vehicle at lease end. - Can choose to buy the vehicle for that price and any other charges or fees stipulated in the contract or return it to the leasing company. - Open-end lease: - You are responsible for the residual value of the vehicle and must pay that amount and any other charges or fees stipulated in the lease at lease-end. - One must remember however that leasing a car is a contractual arrangement that cannot be easily broken and that while you lease a car, you are still responsible for all maintenance and repairs and mileage restrictions and charges for excess wear and use may result in additional charges due at the end of the lease. - The following are some words of advice in negotiating a lease: 1. Ensure that the price of the car is identical under the lease and purchase option and that any discounts, trade-ins, and credits are identical. 2. Ensure that the financing rate is identical under both options. 3. Lease cars that maintain their value so that the residual value used in the lease calculation is high. This will result in a lower monthly lease payment. 4. Assess any mileage restrictions and additional front-end or back-end charges under a lease. 5. New cars offer a three to five-year warranty. Keep the lease term within this time frame. Paying Cash - This is the least expensive method to pay for your new or used vehicle because you avoid the cost of borrowed money (interest charges). - If you are able to place the amount in an investment that earns a higher rate of return than the cost of borrowing the money, it is better to invest it. For example, if you were faced with the choice of financing a car at 1.7 interest or investing your available funds to earn 6 percent interest, the better solution would be to invest, even considering that your investment returns will be taxed and the interest on the car loan is not deductible unless the car is used for business purposes. The after-tax interest earned on the investment would permit you to pay the interest cost of the car loan and pocket the difference. Measuring Your Credit Capacity Can You Afford a Loan? - Before you take out a loan, you must ask yourself whether you can meet all of your essential expenses and still afford monthly loan payments. You can calculate this in two ways. One is to add up all your basic monthly expenses and then subtract this total from your take-home pay. If the difference will not cover the monthly payments and still leave funds for other expenses, you cannot afford the loan. A second more reliable method is to ask yourself what you plan to give up to make the monthly loan payment. If you currently save a portion of your income that is greater than the monthly payment, you can use these savings to pay off the loan. If you do not save a portion of your income, you will have to forgo spending on entertainment, new appliances, or perhaps even necessities and you must determine if you are prepared to make this trade-off. General Rules of Credit Capacity Debt-Payments-To-Income Ratio - The debt-payments-to-income is calculated by dividing your monthly debt payments (not including house payment, which is a long-term liability) by your net monthly income. Experts suggest that you spend no more than 20 percent of your net (after-tax) income on consumer credit payments. - The 20 percent estimate is the maximum; however, 15 percent is much better. The 20 percent estimate is based on the average family with average expenses and does not account for major emergencies. - Some financial institutions do not take the actual monthly credit card or personal line of credit payment into account when calculating the debt-payments-to-income ratio and instead, they factor in the minimum payment on the card or line assuming that the balance had reached the maximum. This implies that even if a card or personal line of credit is not used, the credit potential that it provides is factored into the ratio and for this reason, some financial planners will recommend that an individual carry, at most, two credit cards. GDS and TDS Ratios - When it comes to mortgage loans, most lenders use the gross debt service (GDS) ratio or the total debt service (TDS) ratio to determine whether you can afford the loan. - The GDS is your monthly mortgage payment, including principal, interest, heating, and taxes, as a percentage of your gross monthly income. The lender will not allow you to spend more than 30 to 32 percent of your gross income on shelter costs. - The TDS ratio is your monthly mortgage payment, including payments on any outstanding debt as a percentage of your gross monthly income. The amount the lender will allow you to spend on shelter and non-shelter financial obligations combined should not exceed 40 percent of gross monthly income. The combined incomes of both spouses are usually considered, but excluding rental income. Co-Signing a Loan - Co-signing a loan entails being asked to guarantee a debt. One must think carefully before co-signing as if the borrower doesn’t pay the debt, you will have to. You must be sure you can afford to pay if you have to and that you want to accept this responsibility. - You may have to pay up to the full amount of the debt if the borrower does not pay and you may also have to pay late fees or collection costs, which increase this amount. If You Do Co-Sign - Despite the risks, at times you may decide to co-sign, such as if your child needs a first loan or a close friend needs help. Below are a few things to consider before you co-sign: 1. Be sure you can afford to pay the loan. If you are asked to pay and cannot, you could be sued or your credit rating could be damaged. 2. Consider that even if you are not asked to repay the debt, your liability for this loan may keep you from getting other credit you want. 3. Before you pledge property, such as your automobile or furniture, to secure a loan, make sure you understand the consequences. If the borrower defaults, you could lose the property you pledge. 4. Check your provincial law. Some provinces have laws giving you additional rights as a co-signer. 5. Request that a copy of overdue-payment notices be sent to you so that you can take action to protect your credit history. Building and Maintaining Your Credit Rating - If you apply for a charge account, credit card, car loan, personal loan, or mortgage, your credit experience, or lack of it, will be a major consideration for the creditor. Your credit experience may even affect your ability to get a job or buy life insurance. A good credit rating is a valuable asset that should be nurtured and protected. If you want a good rating, you must use credit with discretion, including limiting your borrowing to your capacity to repay and living up to the terms of your contracts. - In reviewing your creditworthiness, a creditor seeks information from a credit bureau and most creditors heavily rely on credit reports in considering loan applications. Credit Bureaus - Credit bureaus are reporting agencies that collect and assemble credit and other information about consumers. - There are two main bureaus in Canada: Equifax Canada and TransUnion Canada. In addition, several thousand regional credit bureaus collect credit information about consumers. These firms sell the data to creditors that evaluate credit applications. Who Provides Data to Credit Bureaus? - Credit bureaus obtain their data from banks, finance companies, merchants, credit card companies, and other creditors. These sources regularly send reports to credit bureaus containing information about the kinds of credit they extend to customers, the amounts and terms of that credit, and customers’ paying habits. Credit bureaus also collect some information from other sources, such as court records. What is in Your Credit Files? - Credit bureau files contain your name, address, social insurance number, and birthdate. It may also include the following information: - Your employer and position - Your former address - Your former employer - Your spouse’s name, social insurance number, and employer - Public records and information - Cheques returned for insufficient funds - Your credit file may also contain detailed credit information. Each time you buy from a reporting store on credit or take out a loan at a bank, a finance company, or some other reporting creditor, a credit bureau is informed of your account number and the date, amount, terms, and type of credit. As you make payments, your file is updated to show the outstanding balance, the number and amounts payments past due, and the frequency of 30-, 60-, or 90-day delinquencies. Any suits, judgements, or tax liens against you may appear as well. However, provincial laws protect your rights if the information in your credit file is erroneous. Credit Bureau Regulations in Canada - Besides Alberta, News Brunswick, and the territories, each province has legislation regarding consumer reporting agencies, such as credit bureaus. The principal concerns of these regulations are the protection of consumer privacy with respect to credit information and the consumer’s right not to suffer from false credit and personal information. - In addition, credit reporting legislation stipulates the nature of the information that can be used in a credit report; a distinction is made between consumer information and personal data. While the former might include such details as your name, address, occupation, income, paying habits, and a number of other pertinent issues, personal information, such as character, reputation, and other characteristics, may not be included in a credit report. Access to Credit Reports - While you have a right to know the contents of your credit bureau file at any time, others may view your file only if you have given written consent or if you have been sent a written notice that your report has been obtained. Generally, you will find that a request for permission to access your report is included in a credit application. - In the event that you do not apply for credit but request for information is made, the credit bureau must inform you of the request and provide you with the name and address of the requestor. - Though access to information is well legislated and despite the claims to the contrary by credit bureaus, many consumer organizations have expressed concerns that credit bureau files are less than secure. The relatively recent shift to electronic files has created a whole new level of vulnerability in terms of privacy and consumer groups are worried that anyone with a computer and a modem will be able to access confidential files. The Limits on Adverse Data - There are limitations to the inclusion of detrimental information in a credit report, such as in Ontario, a first bankruptcy can be reported only within seven years of its occurrence and in the event of a second bankruptcy, both bankruptcies will remain on the file for a total of 14 years after the second bankruptcy is discharged. In Saskatchewan, the limit is 14 years for bankruptcy and seven years for any other adverse data. The actual limits may vary slightly from province to province, but the common goal is to limit the credit-damaging effect of past events. - There are also rules in place to protect the consumer’s privacy, including restrictions on the situations in which a credit report agency may make a report. Your data can be divulged only in the event of a court order or a legitimate request from a person or organization concerned with extending credit, employment, or insurance to you. Incorrect Information in Your Credit File - Credit bureaus are required to follow reasonable procedures to ensure that subscribing creditors report information accurately; however, mistakes may occur. Your file may contain erroneous data or records of someone with a similar name to yours. When you notify the credit bureau that you dispute the accuracy of its information it must reinvestigate and modify or remove inaccurate data. You should give the credit bureau any pertinent data you have concerning an error. If you contest an item on your credit report, the reporting agency must remove the item unless the creditor verifies that the information is accurate. - You should review your credit files annually even if you are not planning to apply for a big loan. Married women and young adults should make sure that all accounts for which they are individually and jointly liable are listed in their credit files. Credit Scoring - Credit scoring is a system used by lenders and others to assess the credit risk of prospective borrowers, most often when they apply for credit cards, automobile loans, and, more recently, home mortgages. Information about the applicant and his or her credit history is collected from the credit application and the individual’s credit bureau report. Data contained in the credit report is summarized in a credit score, such as a FICO score (derived from statistical models developed by Fair Isaac Corporation), which awards points for each factor that helps predict the applicant’s creditworthiness. The higher the score, the more likely the individual is to pay his or her bills on time. FICO scores range between 300 and 900 and scores above 600 are considered very good. - FICO scores assign different weightings, or importance, to five categories of data contained in a credit report: payment history, length of credit history, amounts owed, types of credit used, and number of recent applications for credit; however, they do not consider such factors as age, race, colour, religion, nationality, sex, marital status, or employment data. - A strong credit score will enable you to obtain credit faster and at more advantageous rates. You can improve your credit score by managing your debt responsibly. Establish a credit history as soon as possible, pay your bills on time, limit the amount of credit you have access to, and avoid certain types of credit, such as loans from finance companies. Don’t apply for too much new credit at one time, as frequent applications will have a negative impact on your credit score. Obtaining Your Credit Report - To obtain a copy of your credit report, credit score, and score analysis online in Canada, you can visit the Equifax Canada website or the TransUnion Canada website. - Equifax charges $15.50 for an online credit report and $23.95 for an online credit report, credit score, and analysis. TransUnion Canada charges $14.95 for an online credit report and you can add your credit score for $7.95 and your score analysis for another $7.95. You can also receive your credit report by mail, free of charge, by downloading a credit report request form from either website, completing the form, and sending it by mail to the relevant company. Applying For Credit What Creditors Look For: The Five C’s of Credit Management - When a lender extends credit to its customers, it recognizes that some customers will unable to unwilling to pay for their purchases. Therefore, lenders must establish policies for determining who will receive credit. Most lenders build their credit policies around the 5 C’s of credit: character, capacity, capital, collateral, and conditions, but this can vary from institution to another. - Character is the borrower’s attitude toward credit obligations. Most credit managers consider character the most important factor in predicting whether you will make timely payments and ultimately repay your loan. Character is assessed by your credit score, credit report, and credit rating. - Capacity is the borrower’s financial ability to meet credit obligations, that is, to make regular payments as scheduled in the credit agreement. Therefore, the lender checks your salary statements and other sources of income, such as dividends and interest. Your other financial obligations and monthly expenses are also considered before credit is approved. Typically, the gross debt service (GDS) ratio is approximately 30 percent and the total debt service (TDS) ratio 40 percent. - Capital is the borrower’s assets or net worth. Generally, the greater the capital, the greater your ability to repay a loan. The lender determines your net worth by requiring you to complete a credit application. You must authorize your employer and financial institutions to release information to confirm the claims made in the credit application. - Collateral is a valuable asset that you pledge to a financial institution to obtain a loan and to ensure loan payments. If you fail to honour the terms of the credit agreement, the lender can repossess the collateral and then sell it to satisfy debt. - Conditions refer to general economic conditions that can affect a borrower’s ability to repay a loan. The basic question focuses on security, of both your job and the firm that employs you. Age - Many older and retired individuals complain that they have been denied credit because they were over a certain age or that when they retired, their credit was suddenly cut off or reduced. - The law is very specific about how a person’s age may be used in credit decisions. A creditor may ask about your age, but if you’re old enough to sing a binding contract, a creditor may not: - Turn you down or decrease your credit because of your age. - Ignore your retirement income in rating your application. - Close your credit account or require you to reapply for it because you have reached a certain age or retired. - Deny you credit or close your account because credit life insurance or other credit-related insurance is not available to people of your age. Public Assistance and Housing Loans - You may not be denied credit because you receive Old Age Security or public assistance. But, as with age, certain information related to this source of income could have a bearing on your creditworthiness. - Federal laws ban discrimination due to such characteristics as your race, colour, or gender or to the race or national origin of the people in the neighbourhood where you live or want to buy a home. Creditors may not use any appraisal of the value of your property that considers the race of the people in your neighbourhood. What If Your Application Is Denied? Ask Questions If Your Application Is Denied - If you receive notice that your application has been denied, you should ask to know the specific reasons for denial. If the denial is based on a credit report, you should enquire about the specific information in the credit report that led to it. After you receive this information from the creditor, you should contact the local credit bureau to find out what information is reported. You may ask the bureau to investigate any inaccurate or incomplete information and correct its records. In Case of a Billing Error - First, notify the creditor. Give the creditor your name and account number, say that you believe the bill contains an error and explain what you believe the error to be. State the suspected amount of the error or the item you want explained. - Lending institutions in general will review all contested material within a stated time frame and will specify the grace period they allow for any complaints or requests for changes. They will usually ask that you pay all amounts in full pending the results of their investigation of your complaint, with the agreement that they will refund any erroneous billing amounts. Identity Crisis: What to Do If Your Identity Is Stolen - There may be occurrences in which you don’t remember charging certain items or even being in a particular store. Maybe you never charged those goods and services, but someone else did – someone who used your name and personal information to commit fraud. When imposters take your name, social insurance number, credit card number, or some other piece of your personal information for their use, they are committing a crime. - The biggest problem is that you may not know your identity has been stolen until you notice that something is amiss, such as getting bills for a credit card account you never opened, your credit report may include debts you never knew you had, a billing cycle may pass without you receiving a statement, or you may see charges on your bills that you didn’t sign for, didn’t authorize, and know nothing about. - If someone has stolen your identity, you should: 1. Contact the fraud department of each of the major credit bureaus. Tell them to flag your file with a fraud alert, including a statement that creditors should call you for permission before they open any new accounts in your name. 2. Contact the creditors for any accounts that have been tampered with or opened fraudulently. Ask to speak with someone in the security or fraud department and follow up in writing. 3. File a police report. Keep a copy in case your creditors need proof of the crime. Chapter 6: Choosing a Source of Credit: The Costs of Credit Alternatives Objective 1: Analyze the major sources of consumer credit Sources of consumer Credit  You must always weight the benefits of buying an item on credit versus waiting until you have saved enough money to pay cash  Before deciding to borrow money, ask yourself three questions: o Do I need a loan? o Can I afford a loan? o Can I qualify for a loan?  You should avoid credit in two situations: 1. You do not need or really want a product that will require financing. The solution to this is, after you have selected a product, resist any sales pressure to buy immediately and take a day to think it over 2. You can afford to pay cash. Paying cash is almost always cheaper than paying credit. What Kind of Loan Should You Seek? Inexpensive loans: Parents or family members are often the source of the least expensive loans. All family loans should be in writing and state the interest rate, repayment schedule, and the final payment due. Another form of inexpensive loans is money borrowed on financial assets held by a lending institution, such as a bank guaranteed investment certificate or the cash value of a whole life insurance policy. Medium- Priced Loans: Often you can obtain medium-priced loans from banks, trust companies, and credit unions. Ex. New-car loans. Borrowing from credit unions has several advantages; these institutions provide credit life insurance, are generally sympathetic to borrowers with legitimate payment problems, and provide personalized service. Expensive Loans: Thought convenient to obtain, the most expensive loans available are from finance companies, retailers, and banks through credit cards. Typically, the interest ranges from 12- 25 percent, although some retailers cost up to 29 percent; by law in Canada they cannot charge a rate higher than 60 percent Objective 2: Determine the effective cost of borrowing by considering the quoted rate the number of compounding periods, the timing of the interest payments, and any other service charges. The Cost of Credit The Effective Cost of Borrowing The effective annual interest rate charged on a loan will depend upon the quoted annual percentage rate, how frequently interest is compounded, whether interest is charged on a discount basis and whether any other charges are incurred. Annual Percentage Rate (APR): The yearly interest rate quoted by a financial institution on a loan. The APR may be compounded more frequently than once a year, in which case the effective annual rate on the loan will be higher than the APR. The higher the compounding frequency, the higher is the effective annual rate (EAR) of the loan. m EAR= (1+APR/m) -1 *See EAR Chart for compounding frequency Tackling the Trade-Offs When you choose you financing, there are trade-offs between the features you prefer and the cost of your loan. Some major trade-offs to consider: Term versus Interest Costs: Many people choose longer-term financing because they want smaller monthly payments. But the longer the term for a loan at a given interest rate, the greater the amount you must pay in interest charges. Lender Risk versus Interest Rate: If you want to minimize your borrowing costs, you may need to accept conditions that reduce your lender’s risk, such as;  Variable Interest Rate- based on fluctuating rates, such as the prime rate  A Secured Loan- pledge property or other assets as collateral  Upfront Cash-paying a large portion in cash upfront  A Shorter Term- the shorter the period of time you borrow, the smaller chance something will prevent you from repaying the loan. Calculating Your Loan Payments Fixed-Rate Installment Loan: Detailed example in textbook- pg. 166. Installment loans impose financial responsibility as they are designed to pay off the loan over a pre-determined period of time. Each payment represents a blend of interest and principal. n PMT= PV/ {1-[1/ (1+i) ]} i Floating Rate Personal Line of Credit: Detailed example in textbook- pg.167. The principal disadvantage of using an interest only line of credit, or one with a very low minimum principal repayment, is the considerably longer time it takes to repay the loan compared to a traditional consumer installment loan. Interest= B x APR x (n/365) Financial Planning Calculations Cost of Carrying Credit Card Balances: Open- end credit includes not only personal lines of credit, but also credit cards, store cards, and overdraft protection. Creditors use various methods to calculate the balance on which they will apply interest charges. Adjusted Balance Method: The assessment of financial charges after payments made during the billing period have been subtracted Previous balance method: a method of compounding finance charges that gives you no credit for payments made during the billing period. Average Daily Balance Method: A method of computing finance charges that uses a weighted average of the account balance throughout the current billing period. Cost of Credit and Expected Inflation: Borrowers and lenders are less concerned about dollars, present or future, than about the goods and services those dollars can buy, that is, their purchasing power. Inflation erodes the purchasing power of money. Each percentage point increase in inflation means a decrease of approximately 1 percent in the quantity of goods and services you can purchase with a given quantity of dollars. As a result, lenders, seeking to protect their purchasing power, add the expected rate of inflation to the interest rate they charge. You are willing to pay a higher rate because you expect inflation to enable you to repay the loan with cheaper dollars. Avoid the Minimum Monthly Payment Trap: The “minimum monthly payment” is the smallest amount you can pay and still be a cardholder in good standing. Credit Insurance Credit Insurance: any type of insurance that ensures repayment of a loan in the event the borrower is unable to repay it. There are three types of credit insurance: 1. Credit life: provides repayment of the loan if the borrower dies. 2. Credit accident and health: provided repayment in the event of a loss of income due to illness or injury. 3. Credit property: provides coverage for personal property purchased with a loan. Objective 3: Develop a plan to manage you debts. Managing Your Debts Warning Signs of Debt Problems Frequent reasons for indebtedness: 1. Emotional Problems: such as the need for gratification. 2. The use of money to punish: a husband buys a new car without consulting his wife; she in turn buys a new diamond ring. 3. The expectation of instant comfort: people assume that by using an installment plan they can immediately have the possessions their parents acquired after years of work. 4. Keeping up with the Joneses: appearing to everyone else you have it all 5. Overindulgence of children: buying their children things to compete with one another, or make up for their own emotional problems. 6. Misunderstanding or lack of communication among family members. 7. The amount of the finance charges. Objective 4: Evaluate various private and governmental sources that assist consumers with debt problems. Consumer Credit Counselling Services Credit counselling activities are divided into two parts: 1. Aiding families with serious debt problems by helping them manage their money better and setting up a realistic budget and plan for expenditures 2. Helping people prevent debt problems by teaching them the necessity of family budget planning, providing education to people of all ages regarding the pitfalls of unwise credit buying, suggesting techniques for family budgeting, and encouraging credit institutions to provide full information about the costs and terms of credit and to withhold credit from those who cannot afford to repay it. Objective 5: Assess the choices in declaring personal bankruptcy. Declaring Personal Bankruptcy Fending off bankruptcy: Consolidation Loans It is sometimes possible to avoid declaring bankruptcy. If you are under an excessive debt load and would like to regularize and control your payments, you may be able to obtain a consolidation loan. This is a new loan that is used to discharge a collection of existing debts and it may have different advantages and disadvantages. Advantages: single interest rate Disadvantages: you will be asked to pay a higher interest rate; as well you are extending your term of the loan. Bankruptcy and Insolvency Act A federal law initiated in 1992 and amended in 1997, regulates
More Less

Related notes for MCS 2100

Log In


Don't have an account?

Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.