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LO5.1
Analyze advantages and disadvantages of using consumer credit.
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. Many people use credit to live beyond their means, largely because of a change in perception about credit. Past generations viewed credit as a negative and used it very sparingly. Society today has popularized credit with phrases such as “Life takes Visa,” “Priceless” campaigns, and even references to a “Plunk factor” when using a sought-after credit card. That said, when used appropriately, credit can be a very useful tool.
Consumer credit is based on trust in people’s ability and willingness to pay bills when due. It works because people by and large are honest and responsible. But how does consumer credit affect our economy, and how is it affected by our economy?
The Importance of Consumer Credit in Our Economy
Consumer credit dates back to colonial times. Although credit was originally a privilege of the affluent, farmers came to use it extensively. No direct finance charges were imposed; instead, the cost of credit was added to the prices of goods. With the advent of the automobile in the early 1900s, installment credit, in which the debt is repaid in equal installments over a specified period of time, exploded on the American scene.
All economists now recognize consumer credit as a major force in the American economy. Any forecast or evaluation of the economy includes consumer spending trends and consumer credit as a sustaining force.
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Uses and Misuses of Credit
Using credit to purchase goods and services may allow consumers to be more efficient or more productive, or it may lead to more satisfying lives. Many valid reasons can be found for using credit. A medical emergency may leave a person strapped for funds. A homemaker returning to the workforce may need a car. An item may cost less money now than it will cost later. Borrowing for a college education may be another valid reason. But borrowing for everyday living expenses or financing a Corvette on credit when a Ford Focus is all your budget allows is probably not reasonable.
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. However, many people expect their incomes to increase and therefore expect to be able to make payments on past credit purchases and still make new purchases. This should be carefully considered.
Here are some questions you should consider before you decide how and when to make a major purchase, for example, a car:
Do I have the cash I need for the down payment?
Do I want to use my savings for this purchase?
Does the purchase fit my budget?
Could I use the credit I need for this purchase in some better way?
Could I postpone the purchase?
What are the opportunity costs of postponing the purchase (alternative transportation costs, a possible increase in the price of the car)?
What are the dollar costs and the psychological costs of using credit (interest, other finance charges, being in debt and responsible for making a monthly payment)?
If you decide to use credit, make sure the benefits of purchasing now (increased efficiency or productivity, a more satisfying life, etc.) outweigh the costs (financial and psychological) of using credit. Thus, credit, when effectively used, can help you 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—or it can provide for emergencies, and it can pay for them all through payment plans based on future income.
Credit cards permit the purchase of goods even when funds are low. Customers with previously approved credit may receive other extras, such as advance notice of sales and the right to order by phone or to buy on approval. Many retailers will accept returned merchandise without a receipt because they can look up the purchase made by a credit card. Credit cards also provide shopping convenience and the efficiency of paying for several purchases with one monthly payment.
Credit is more than a substitute for cash. Many of the services it provides are taken for granted. Every time you turn on the water tap, click the light switch, or telephone a friend, you are using credit.
Using credit is safe, since charge accounts and credit cards let you shop and travel without carrying a large amount of cash. It offers convenience, since you need a credit card to make a hotel reservation, rent a car, and shop by phone or internet. You may also use credit cards for identification when cashing checks, and the use of credit provides you with a record of expenses.
The use of credit cards can provide up to a 50-day “float,” the time lag between when you make the purchase and when the lender deducts the balance from your checking page 143account when payment is due. This float, offered by many credit card issuers, includes a grace period of 20 to 25 days. During the grace period, no finance charges are assessed on current purchases if the balance is paid in full each month within 25 days after billing.
In addition, many major credit cards provide the following benefits to their customers at no extra cost:
Accidental death and dismemberment insurance when you travel on a common carrier (train, plane, bus, or ship), up to $250,000.
Auto rental collision damage waiver for damage due to collision or theft for $50,000 or more.
Roadside dispatch referral service for emergency roadside assistance, such as towing, locksmith services, and more.
Redemption of your points or miles for gift cards or cash, or to book travel—from airfare, hotels, and rental cars to vacation packages.
No foreign transaction fees for some cards, such as CapitalOne.
Finally, credit indicates stability. The fact that lenders consider you a good risk usually means you are a responsible individual. However, if you do not repay your debts in a timely manner, you will find that credit has many disadvantages.
Disadvantages of Credit
Perhaps the greatest disadvantage of using credit is the temptation to overspend, especially during periods of inflation. Buying today and paying tomorrow, using cheaper dollars, seems ideal. But continual overspending can lead to serious trouble.
Whether or not credit involves security (or collateral)—something of value to back the loan—failure to repay a loan may result in loss of income, valuable property, and your good reputation. It can even lead to court action and bankruptcy. Misuse of credit can create serious long-term financial problems, cause damage to family relationships, and delay progress toward financial goals. Therefore, you should approach credit with caution and avoid using it more than your budget permits.
Although credit allows immediate satisfaction of needs and desires, it does not increase total purchasing power. Credit purchases must be paid out of future income; therefore, credit ties up the use of future income. Furthermore, if your income does not increase to cover rising costs, your ability to repay credit commitments will diminish. Before buying goods and services on credit, consider whether they will have lasting value, whether they will increase your personal satisfaction during present and future income periods, and whether your current income will continue or increase.
Finally, credit costs money. It is a service for which you must pay. Paying for purchases over a period of time is more costly than paying for them with cash. Purchasing with credit rather than cash involves one obvious trade-off: The items purchased may cost more due to monthly finance charges and the compounding effect of interest on interest.
Summary: Advantages and Disadvantages of Credit
The use of credit provides immediate access to goods and services, flexibility in money management, safety and convenience, a cushion in emergencies, a means of increasing resources, and a good credit rating if you pay back your debts in a timely manner. But remember, the use of credit is a two-sided coin. An intelligent decision as to its use demands careful evaluation of your current debt, your future income, the added cost, and the consequences of overspending.
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LO5.2
Assess the types and sources of consumer credit.
Types of Credit
Two basic types of consumer credit exist: closed-end and open-end credit. With closed-end credit, you pay back one-time loans in a specified period of time and in payments of equal amounts. With open-end credit, loans are made on a continuous basis and you are billed periodically for at least partial payment. Exhibit 5–1 shows examples of closed-end and open-end credit.
Exhibit 5–1 Examples of Closed-End and Open-End Credit
Closed-End Credit
Closed-end credit is used for a specific purpose and involves a specified amount. Mortgage loans, automobile loans, and installment loans for purchasing furniture or appliances are examples of closed-end credit. Generally, the seller holds title to the merchandise until the payments have been completed and can take possession of the item if the bill is unpaid.
The three most common types of closed-end credit are installment sales credit, installment cash credit, and single lump-sum credit. Installment sales credit is a loan that allows you to receive merchandise, usually high-priced items such as large appliances or furniture. You make a down payment and usually sign a contract to repay the balance, plus interest and service charges, in equal installments over a specified period.
Installment cash credit is a direct loan of money for personal purposes, home improvements, or vacation expenses. You make no down payment and make payments in specified amounts over a set period.
Single lump-sum credit is a loan that must be repaid in total on a specified day, usually within 30 to 90 days. Lump-sum credit is generally, but not always, used to purchase a single item. As Exhibit 5–2 shows, consumer installment credit reached a peak of over $3.7 trillion in 2017.
Exhibit 5–2% Volume of Consumer Credit
All economists now recognize consumer credit as a major force in the American economy.
Source: https://fred.stlouisfed.org/series/TOTALST, accessed April 1, 2017
Open-End Credit
Using a credit card issued by a department store, using a bank credit card (Visa, MasterCard) to make purchases at different stores, charging a meal at a restaurant, and using overdraft protection are examples of open-end credit. As you will soon see, you do not apply for open-end credit to make a single purchase, as you do with closed-end credit. Rather, you can use open-end credit to make any purchases you wish if you do not exceed your line of credit, the maximum dollar amount of credit the lender has made available to page 145you. You may have to pay interest, a periodic charge for the use of credit, or other finance charges. Usually, you have the option to pay the bill in full within 30 days without interest charges or to make set monthly installments based on the account balance plus interest. Some creditors allow you a grace period of 20 to 25 days to pay a bill in full before you incur any interest charges.
Many banks extend revolving check credit. Also called a bank line of credit, this is a prearranged loan for a specified amount that you can use by writing a special check. Repayment is made in installments 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
Credit cards are extremely popular. The average cardholder has more than nine credit cards, including bank, retail, and gasoline cards. Cardholders who pay off their balances in full each month are often known as convenience users. Cardholders who do not pay off their balances every month are known as borrowers.
Most credit card companies offer a grace period, a time period during which no finance charges will be added to your account. A finance charge is the total dollar amount you page 146pay to use credit. Usually, if you pay your entire balance before the due date stated on your monthly bill, you will not have to pay a finance charge. Borrowers carry balances beyond the grace period and pay finance charges. Many credit cards offer “teaser rates.” These introductory rates are good for a short period of time, typically 6 to 12 months. The rates may rise significantly after the introductory period. These should be carefully considered before transferring a balance or making significant purchases that you may not be able to repay during the introductory period.
Many credit card companies now offer reward programs that provide cash, rebates, or airline tickets. These types of cards usually have higher finance charges, and the value of the reward should be compared to the cost of the card if you do not intend to pay off the balance monthly.
The cost of a credit card depends on the type of credit card you have and the terms set forth by the lender. As a cardholder, you may have to pay interest or other finance charges. Some credit card companies charge cardholders an annual fee, usually page 147about $40. However, many companies have eliminated annual fees in order to attract more customers. If you are looking for a credit card, be sure to shop around for one with no annual fee. The nearby Financial Literacy in Practice feature offers some other helpful hints for choosing a credit card.
DEBIT CARDSߒDon’t confuse credit cards with debit cards. Although they may look alike, they’re very different. A debit card electronically subtracts money from your savings or checking account to pay for goods and services. A credit card extends credit and delays your payment. Debit cards are most frequently used at automatic teller machines (ATMs). More and more, however, they are also used to purchase goods in stores and to make other types of payments.
Raquel Garcia is serious about avoiding debt. The 18-year-old customer representative for U-Haul recently canceled her credit card. Now she gets her entire paycheck deposited onto a prepaid debit card, which she uses for all her purchases. Since she can access only what’s in the account, Garcia no longer worries about breaking her budget: “I’m spending just what I need.”
STORED VALUE (OR GIFT) CARDSߒStored-value cards, gift cards, or prepaid cards resemble a typical debit card, using magnetic stripe technology to store information and track funds. However, unlike traditional debit cards, stored value cards are prepaid, providing you with immediate money. Gift card sales have exploded over the last few years. The convenience factor for the gift giver is huge. It is estimated that sales of gift cards reached over $149 billion at the beginning of 2017. Substantial growth has also occurred in the area of digital gift cards. These cards are sent via e-mail to recipients, who will receive an access code to activate and use their e-cards online to make purchases.
Bankruptcy courts treat gift cards the same way they handle unsecured debt: If a retailer goes bankrupt, holders get pennies on the dollar at most—and in many cases nothing. One market research firm estimates that holders of gift cards recently lost more than $75 million when the number of retailer bankruptcies increased sharply.
SMART CARDSߒA smart card is a plastic card equipped with a computer chip that can store 500 times as much data as a normal credit card. Smart cards can combine credit card balances, a driver’s license, health care identification, medical history, and other information all in one place. A smart card, for example, can be used to buy an airline ticket, store it digitally, and track frequent flyer miles.
TRAVEL AND ENTERTAINMENT CARDSߒTravel and entertainment (T&E) cards are really not credit cards because the balance is due in full each month. However, most people think of T&E cards—such as Diners Club or American Express cards—as credit cards because they don’t pay for goods or services when they purchase them.
SMARTPHONESߒSome phones are now equipped to make purchases. This concept, called mobile commerce, has seen a significant increase in interest from consumers, retailers, and finance companies. For example, some credit card companies, instead of providing a physical credit card, provide stickers that attach to a phone that will allow the customer to scan the code. In addition, retailers such as Starbucks have apps that are scannable barcodes to allow quick payment using a mobile phone.
Sources of Consumer Credit
Many sources of consumer credit are available, including commercial banks and credit unions. Exhibit 5–3 summarizes the major sources of consumer credit. Study and compare the differences to determine which source might best meet your needs and requirements.
Exhibit 5–3 Sources of Consumer Credit
Credit Source |
Type of Loan |
Lending Policies |
Commercial banks |
Single-payment loan Personal installment loans Passbook loans Check-credit loans Credit card loans Primary mortgages Second mortgages |
|
Consumer finance companies |
Personal installment loans Primary mortgages Second mortgages |
|
Credit unions |
Personal installment loans Share draft-credit plans Credit card loans Primary mortgages Second mortgages |
|
Life insurance companies |
Single-payment or partial-payment loans |
|
Federal savings banks (savings and loan associations) |
Personal installment loans (generally permitted by state-chartered savings associations) Home improvement loans Education loans Savings account loans Primary mortgages Second mortgages |
|
Consumer credit is available from several types of sources. Which sources seem to offer the widest variety of loans? |
||
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Loans
Loans involve borrowing money with an agreement to repay it, as well as interest, within a certain amount of time. If you were considering taking out a loan, your immediate thought might be to go to your local bank. However, you might want to explore some other options first.
INEXPENSIVE LOANSߒParents or other family members are often the source of the least expensive loans—loans with low interest. They may charge only interest they would page 149have earned on the money if they had deposited it in a savings account. They may even give you a loan without interest. Be aware, however, that loans can complicate family relationships. You can borrow (or invest) money with microlending organizations, such as kiva.org. Borrowers with good credit can borrow at interest rates lower than those charged by banks and credit unions.
MEDIUM-PRICED LOANSߒOften you can obtain medium-priced loans—loans with moderate interest—from commercial banks, savings and loan associations, and credit unions. Borrowing from credit unions has several advantages. They provide personalized service, and usually they’re willing to be patient with borrowers who can provide good reasons for late or missed payments. However, you must be a member of a credit union in order to get a loan.
EXPENSIVE LOANSߒThe easiest loans to obtain are also the most expensive. Finance companies and retail stores that lend to consumers will frequently charge high interest rates, ranging from 12 to 25 percent. Banks also lend money to their credit card holders through cash advances—loans that are billed to the customer’s credit card account. Most cards charge higher interest for a cash advance and charge interest from the day the cash advance is made. As a result, taking out a cash advance is much more expensive than charging a purchase to a credit card. Read the nearby Figure It Out! box to learn why you should avoid such cash advances.
HOME EQUITY LOANSߒA home equity loan is a loan based on your home equity—the difference between the current market value of your home and the amount you still owe on the mortgage.
Unlike interest on most other types of credit, the interest you pay on a home equity loan is tax-deductible. You should use these loans only for major items such as education, home improvements, or medical bills, and you must use them with care. If you miss payments on a home equity loan, the lender can take your home.
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LO5.3
Determine whether you can afford a loan and how to apply for credit.
Applying for Credit
Can You Afford a Loan?
The only way to determine how much credit you can assume is to first learn how to make an accurate and sensible personal or family budget (see Chapter 2).
Before you take out a loan, ask yourself whether you can meet all of your essential expenses and still afford the monthly loan payments. You can make this calculation 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 payment and still leave funds for other expenses, you cannot afford the loan.
A second and 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. But if you do not, you will have to forgo spending on entertainment, new appliances, or perhaps even necessities. Are you prepared to make this trade-off? Although precisely measuring your credit capacity is difficult, you can follow certain rules of thumb.
General Rules of Credit Capacity
DEBT PAYMENTS-TO-INCOME RATIO The debt payments-to-income ratio 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. Thus, as Exhibit 5–4 shows, a person making $1,250 per month after taxes should spend no more than $250 on credit payments per month.
Exhibit 5–4 How to Calculate Debt Payments-to-Income Ratio
Spend no more than 20 percent of your net (after-tax) income on credit payments.
Monthly gross income |
$1,682 |
Less: |
|
All taxes |
270 |
Social Security |
112 |
Monthly IRA contribution |
50 |
Monthly net income |
$1,250 |
Monthly installment credit payments: |
|
Visa |
25 |
MasterCard |
35 |
Discover card |
15 |
Education loan |
— |
Personal bank loan |
— |
Auto loan |
175 |
Total monthly payments |
$ 250 |
Debt payments-to-income ratio ($250/$1,250) |
20.00% |
The 20 percent is the maximum; however, 15 percent or less is much better. The 20 percent
estimate is based on the average family, with average expenses; it does not take major emergencies into account. If you are just beginning to use credit, you should not consider yourself safe if you are spending 20 percent of your net income on credit payments.
page 152DEBT-TO-EQUITY RATIO The debt-to-equity ratio is calculated by dividing your total liabilities by your net worth. In calculating this ratio, do not include the value of your home and the amount of its mortgage. If your debt-to-equity ratio is about 1—that is, if your consumer installment debt roughly equals your net worth (not including your home or the mortgage)—you have probably reached the upper limit of debt obligations.
None of the above methods is perfect for everyone; the limits given are only guidelines. Only you, based on the money you earn, your obligations, and your financial plans for the future, can determine the exact amount of credit you need and can afford. You must be your own credit manager.
The Five Cs of Credit
When you’re ready to apply for a loan or a credit card, you should understand the factors that determine whether a lender will extend credit to you.
When a lender extends credit to consumers, it takes for granted that some people will be unable or unwilling to pay their debts. Therefore, lenders establish policies for determining who will receive credit. Most lenders build such policies around the “five Cs of credit”: character, capacity, capital, collateral, and conditions.
CHARACTER: WILL YOU REPAY THE LOAN?ߒCreditors want to know your character—what kind of person they are lending money to. They want to know that you’re trustworthy and stable. They may ask for personal or professional references, and they may check to see whether you have a history of trouble with the law. Some questions a lender might ask to determine your character are:
Have you used credit before?
How long have you lived at your present address?
How long have you held your current job?
CAPACITY: CAN YOU REPAY THE LOAN?ߒYour income and the debts you already have will affect your capacity—your ability to pay additional debts. If you already have a large amount of debt in proportion to your income, lenders probably won’t extend more credit to you. Some questions a creditor may ask about your income and expenses are:
What is your job, and how much is your salary?
Do you have other sources of income?
What are your current debts?
CAPITAL: WHAT ARE YOUR ASSETS AND NET WORTH?ߒAssets are any items of value that you own, including cash, property, personal possessions, and investments. Your capital is the amount of your assets that exceed your liabilities, or the debts you owe. Lenders want to be sure that you have enough capital to pay back a loan. That way, if you lost your source of income, you could repay your loan from your savings or by selling some of your assets. A lender might ask:
What are your assets?
What are your liabilities?
COLLATERAL: WHAT IF YOU DON’T REPAY THE LOAN?ߒCreditors look at what kinds of property or savings you already have, because these can be offered as collateral to secure the loan. If you fail to repay the loan, the creditor may take whatever you pledged as collateral. A creditor might ask:
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What assets do you have to secure the loan (such as a vehicle, your home, or furniture)?
Do you have any other valuable assets (such as bonds or savings)?
CONDITIONS: WHAT IF YOUR JOB IS INSECURE?ߒGeneral economic conditions, such as unemployment and recession, can affect your ability to repay a loan. The basic question focuses on security—of both your job and the firm that employs you.
The information gathered from your application and the credit bureau establishes your credit rating. A credit rating is a measure of a person’s ability and willingness to make credit payments on time. The factors that determine a person’s credit rating are income, current debt, information about character, and how debts have been repaid in the past. If you always make your payments on time, you will probably have an excellent credit rating. If not, your credit rating will be poor, and a lender probably won’t extend credit to you. A good credit rating is a valuable asset that you should protect.
Creditors use different combinations of the five Cs to reach their decisions. Some creditors set unusually high standards, and others simply do not offer certain types of loans. Creditors also use various rating systems. Some rely strictly on their own instincts and experience. Others use a credit scoring or statistical system to predict whether an applicant is a good credit risk. When you apply for a loan, the lender is likely to evaluate your application by asking questions such as those included in the checklist in the nearby Financial Literacy in Practice feature.
Your Credit Report
When you apply for a loan, the lender will review your credit history very closely. The record of your complete credit history is called your credit report, or credit file. Your credit records are collected and maintained by credit bureaus. Most lenders rely heavily on credit reports when they consider loan applications. Exhibit 5–5 provides a checklist for building and protecting your credit history.
Exhibit 5–5 Checklist for Building and Protecting Your Credit History
It is simple and sensible to build and protect your own credit history. Here are some steps to get you started:
|
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A Creditor Must . . . |
Remember That a Creditor Cannot . . . |
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|
|
|
|
|
|
If you want a good credit rating, you must use credit wisely. Why is it a good idea to apply for a local department store credit card or a small loan from your bank? |
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Source: The Federal Reserve Bank of Minneapolis.
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CREDIT BUREAUSߒA credit bureau is an agency that collects information on how promptly people and businesses pay their bills. The three major credit bureaus are Experian, TransUnion, and Equifax. Each of these bureaus maintains more than 200 million credit files on individuals, based on information they receive from lenders. Several thousand smaller credit bureaus also collect credit information about consumers. These firms make money by selling the information they collect to creditors who are considering loan applications.
Credit bureaus get their information from banks, finance companies, stores, credit card companies, and other lenders. These sources regularly transmit information about the types of credit they extend to customers, the amounts and terms of the loans, and the customers’ payment habits. Credit bureaus also collect some information from other sources, such as court records.
page 155WHAT’S IN YOUR CREDIT FILES? A typical credit bureau file contains your name, address, Social Security number, and birth date. It may also include the following information:
Your employer, position, and income
Your previous address
Your previous employer
Your spouse’s name, Social Security number, employer, and income
Whether you rent or own your home
Checks returned for insufficient funds
In addition, your credit file contains detailed credit information. Each time you use credit to make a purchase or take out a loan of any kind, a credit bureau is informed of your account number and the date, amount, terms, and type of credit. Your file is updated regularly to show how many payments you’ve made, how many payments were late or missed, and how much you owe. Any lawsuits or judgments against you may appear as well. Federal law protects your rights if the information in your credit file is incorrect.
FAIR CREDIT REPORTINGߒFair and accurate credit reporting is vital to both creditors and consumers. In 1971, the U.S. Congress enacted the Fair Credit Reporting Act, which regulates the use of credit reports. This law requires the deletion of out-of-date information and gives consumers access to their files as well as the right to correct any misinformation that the files may include. The act also places limits on who can obtain your credit report.
WHO CAN OBTAIN A CREDIT REPORT?ߒYour credit report may be issued only to properly identified persons for approved purposes. It may be supplied in response to a court order or by your own written request. A credit report may also be provided for use in connection with a credit transaction, underwriting of insurance, or some legitimate business need. Friends, neighbors, and other individuals cannot be given access to credit information about you. In fact, if they even request such information, they may be subject to a fine, imprisonment, or both.
TIME LIMITS ON UNFAVORABLE DATAߒMost of the information in your credit file may be reported for only seven years. However, if you’ve declared personal bankruptcy, that fact may be reported for 10 years. A credit reporting agency can’t disclose information in your credit file that’s more than 7 or 10 years old unless you’re being reviewed for a credit application of $75,000 or more, or unless you apply to purchase life insurance of $150,000 or more.
INCORRECT INFORMATION IN YOUR CREDIT FILEߒCredit bureaus are required to follow reasonable procedures to ensure that the information in their files is correct. Mistakes can and do occur, however. If you think that a credit bureau may be reporting incorrect data from your file, contact the bureau to dispute the information. The credit bureau must check its records and change or remove the incorrect items. If you challenge the accuracy of an item on your credit report, the bureau must remove the item unless the lender can verify that the information is accurate.
page 156If you are denied credit, insurance, employment, or rental housing based on the information in a credit report, you can get a free copy of your report. Remember to request it within 60 days of notification that your application has been denied.
WHAT ARE YOUR LEGAL RIGHTS?ߒYou have legal rights to sue a credit bureau or creditor that has caused you harm by not following the rules established by the Fair Credit Reporting Act.
Credit Scores
A credit score is a number that reflects the information in your credit report. The score summarizes your credit history and helps creditors predict how likely it is that you will repay a loan and make timely payments. Lenders use credit scores in deciding whether to grant you credit, what terms you are offered, or the interest rate you will pay on a loan.
Information used to calculate your credit score usually includes the following:
The number and type of account you have (credit cards, auto loans, mortgages, etc.);
Whether you pay your bills on time;
How much of your available credit you are currently using;
Whether you have any collection actions against you;
The amount of your outstanding debt; and
The age of your accounts.
FICO AND VANTAGESCOREߒTypical questions in a credit application appear in Exhibit 5–6. The information in your credit report is used to calculate your FICO credit score—a number generally between 350 and 850 that rates how risky a borrower is. The higher the score, the less risk you pose to creditors. Your FICO score is available from www.myfico.com for a fee. Free credit reports do not provide your credit score.
Exhibit 5–6 Sample Credit Application Questions
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According to Anthony Sprauve, senior consumer credit specialist at FICO, “The consequences of not maintaining a sound credit score can be very costly. A low score can bar you from page 157getting a new loan, doom you to a higher interest rate, and even cost you a new job or apartment.” Exhibit 5–7 shows a numerical depiction of your creditworthiness and how you can improve your credit score.
Exhibit 5–7 TransUnion Personal Credit Score
The higher your FICO score, the less risk you pose to creditors.
How can I improve my credit score?
A credit score is a snapshot of the contents of your credit report at the time it is calculated. The first step inimproving your score is to review your credit report to ensure it is accurate. Long-term, responsible creditbehavior is the most effective way to improve future scores. Pay all bills, as well as parking, traffic, and even library fines, on time, lower balances, and use credit wisely to improve your score over time.
VantageScore is a new scoring technique, the first to be developed collaboratively by the three credit reporting companies. This model allows for a more predictive score for consumers, even for those with limited credit histories, reducing the need for creditors to manually review credit information. VantageScore features a common score range of 501 to 990 (higher scores represent lower likelihood of risk). A key benefit of VantageScore is that as long as the three major credit bureaus have the same information regarding your credit history, you will receive the same score from each of them. A different score alerts you that there are discrepancies in your report.
Some consumers have very little recorded credit. They may not have credit cards or car or home loans, but they have consistently paid their rent, phone, and utility bills. There is an alternative way to provide a consistent payment record. The Payment Reporting Builds Credit system will check on payment patterns and report to a creditor the history of payments that are typically not included on a traditional credit report.
You should also know what factors a lender cannot consider, according to the law. The Equal Credit Opportunity Act (ECOA) gives all credit applicants the same basic rights. It states that race, nationality, age, sex, marital status, and certain other factors may not be used to discriminate against you in any part of a credit dealing.
Other Factors Considered in Determining Creditworthiness
AGE The Equal Credit Opportunity Act is very specific about how a person’s age may be used as a factor in credit decisions. A creditor may request that you state your age on an application, but if you’re old enough to sign a legal contract (usually 18 to 21 years old, depending on state law), a creditor may not turn you down or decrease your credit because of your age. page 158Creditors may not close your credit account because you reach a certain age or retire.
PUBLIC ASSISTANCEߒYou may not be denied credit because you receive Social Security or public assistance. However, certain information related to this source of income can be considered in determining your creditworthiness.
HOUSING LOANSߒThe ECOA also covers applications for mortgages or home improvement loans. In particular, it bans discrimination against you based on the race or nationality of the people in the neighborhood where you live or want to buy your home, a practice called redlining.
WHAT IS THE BEST INTEREST RATE?ߒEffective January 1, 2011, lenders that provide mortgages, credit cards, auto loans, and most other financial products must disclose important details to their customers if they utilize risk-based pricing. Risk-based pricing seeks to differentiate consumers based on their credit information and charge higher rates for more risky customers. Customers who do not receive the best possible (or preferred rate) must be informed of their current credit score or the fact that risk-based pricing was used and the fact that other customers received better rates. Customers may also be entitled to be told what the negative factors were as well as be provided with a scale of their ranking based upon credit score. This may allow customers an opportunity to review their credit report and ensure accuracy prior to paying an unnecessarily higher interest rate.
What If Your Application Is Denied?
If your credit application is denied, the ECOA gives you the right to know the reasons. If the denial is based on a credit report from the credit bureau, you’re entitled to know the specific information in the report that led to the denial. After you receive this information, you can contact the credit bureau and ask for a copy of your credit report. The bureau cannot charge a fee for this service as long as you ask to see your files within 60 days of notification that your credit application has been denied. You’re entitled to ask the bureau to investigate any inaccurate or incomplete information and correct its records (see Exhibit 5–8).
Exhibit 5–8 What If You Are Denied Credit?
Steps you can take if you are denied credit
Reprinted courtesy of Office of Public Information, Federal Reserve Bank of Minneapolis, Minneapolis, MN 55480.
*If a creditor receives no more than 150 applications during a calendar year, the disclosures may be oral.
What Can You Do to Improve Your Credit Score?
A credit score is a snapshot of the contents of your credit report at the time it is calculated. The first step in improving your score is to review your credit report to ensure it is accurate. Long-term responsible credit behavior is the most effective way to improve future scores. Pay bills on time, lower balances, and use credit wisely to improve your score over time.
Get copies of your credit report—then make sure information is correct. Go to www.annualcreditreport.com. This is the only authorized online source for a free credit report. Under federal law, you can get a free report from each of the three national credit reporting companies every 12 months. You can also call 877-322-8228 or complete the Annual Credit Report Request Form and mail it to Annual Credit Report Request Service, P.O. Box 105281, Atlanta, GA 30348-5281.
page 159Pay your bills on time. One of the most important steps you can take to improve your credit score is to pay your bills by the due date. You can set up automatic payments from your bank account to help you pay on time, but be sure you have enough money in your account to avoid overdraft fees.
Understand how your credit score is determined. Your credit score is usually based on the answers to these questions.
Do you pay your bills on time? The answer to this question is very important. If you have paid bills late, had an account referred to a collection agency, or have ever declared bankruptcy, this history will show up in your credit report.
What is your outstanding debt? Many scoring models compare the amount of debt you have and your credit limits. If the amount you owe is close to your credit limit, it is likely to have a negative effect on your score.
How long is your credit history? A short credit history may have a negative effect on your score, but a short history can be offset by other factors, such as timely payments and low balances.
Have you applied for new credit recently? If you have applied for too many new accounts recently, that may negatively affect your score. However, if you request a copy of your own credit report or if creditors are monitoring your account or looking at credit reports to make prescreened credit offers, these inquiries about your credit history are not counted as applications for credit.
page 160How many and what types of credit accounts do you have? Many credit-scoring models consider the number and type of credit accounts you have. A mix of installment loans and credit cards may improve your score. However, too many finance company accounts or credit cards might hurt your score. To learn more about credit scoring, see the Federal Trade Commission’s website, Facts for Consumers, at www.ftc.gov.
Learn the legal steps to take to improve your credit report. The Federal Trade Commission’s Building a Better Credit Report has information on correcting errors in your report, tips on dealing with debt and avoiding scams—and more.
Beware of credit-repair scams. Sometimes doing it yourself is the best way to repair your credit. The Federal Trade Commission’s Credit Repair: How to Help Yourself explains how you can improve your creditworthiness and lists legitimate resources for low-cost or no-cost help.
LO5.4
Determine the cost of credit by calculating interest using various interest formulas.
The Cost of Credit
If you are thinking of borrowing money or opening a credit account, your first step should be to figure out how much it will cost you and whether you can afford it. Then you should shop for the best terms. Two key concepts that you should remember are the finance charge and the annual percentage rate.
Finance Charge and Annual Percentage Rate
Credit costs vary. If you know the finance charge and the annual percentage rate, you can compare credit prices from different sources. The finance charge is the total dollar amount you pay to use credit. It includes interest costs and sometimes other costs such as service charges, credit-related insurance premiums, or appraisal fees.
page 161For example, borrowing $100 for a year might cost you $10 in interest. If there is also a service charge of $1, the finance charge will be $11. The annual percentage rate (APR) is the percentage cost (or relative cost) of credit on a yearly basis. The APR is your key to comparing costs, regardless of the amount of credit or how much time you have to repay it.
Suppose you borrow $100 for one year and pay a finance charge of $10. If you can keep the entire $100 for one year and then pay it all back at once, you are paying an APR of 10 percent.
On average, you had full use of $100 throughout the year. To calculate the average use, add the loan balance during the first and last month, and then divide by 2:
But if you repay the $100 and the finance charge (a total of $110) in 12 equal monthly payments, you don’t get use of $100 for the whole year. In fact, as shown next, you get use of increasingly less of that $100 each month. In this case, the $10 charge for credit amounts to an APR of 18.5 percent.
Amount Borrowed |
Month Number |
Payment Made |
Loan Balance |
|---|---|---|---|
$100 |
1 |
$ 0 |
$100.00 |
|
2 |
8.33 |
91.67 |
|
3 |
8.33 |
83.34 |
|
4 |
8.33 |
75.01 |
|
5 |
8.33 |
66.68 |
|
6 |
8.33 |
58.35 |
|
7 |
8.33 |
50.02 |
|
8 |
8.33 |
41.69 |
|
9 |
8.33 |
33.36 |
|
10 |
8.33 |
25.03 |
|
11 |
8.33 |
16.70 |
|
12 |
8.33 |
8.37 |
Note that you are paying 10 percent interest even though you had use of only $91.67 during the second month, not $100. During the last month, you owed only $8.37 (and had use of $8.37), but the $10 interest is for the entire $100. As calculated in the previous example, the average use of the money during the year is $100 + $8.37 ÷ 2, or $54.18. The nearby Figure It Out! box shows how to calculate the APR.
Tackling the Trade-Offs
When you choose your financing, there are trade-offs between the features you prefer (term, size of payments, fixed or variable interest, or payment plan) and the cost of your loan. Here are some major trade-offs you should consider.
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TERM VERSUS INTEREST COSTSߒMany 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. Consider the following analysis of the relationship between the term and interest costs.
Suppose you’re buying a $10,000 used car. You put $2,000 down, and you need to borrow $8,000. Compare the following four credit arrangements:
|
APR |
Length of Loan |
Monthly Payment |
Total Finance Charge |
Total Cost |
Creditor A |
5% |
3 years |
$240 |
$ 632 |
$8,632 |
Creditor B |
5 |
4 years |
184 |
843 |
8,843 |
Creditor C |
6 |
4 years |
188 |
1,018 |
9,018 |
Creditor D |
6 |
5 years |
155 |
1,280 |
9,280 |
How do these choices compare? The answer depends partly on what you need. The lowest-cost loan is available from creditor A. If you are looking for lower monthly payments, you could repay the loan over a longer period of time. However, you would have to pay more in total costs. A loan from creditor B—also at a 5 percent APR but for four years—would add about $211 to your finance charge.
If that four-year loan were available only from creditor C, the APR of 6 percent would add another $175 to your finance charges. The lowest payment—but the most costly—would be the five-year loan. Other terms, such as the size of the down payment, will also make a difference. Be sure to look at all the terms before you make your choice.
LENDER RISK VERSUS INTEREST RATEߒYou may prefer financing that requires low fixed payments with a large final payment or only a minimum of up-front cash. But both of these requirements can increase your cost of borrowing because they create more risk for your lender.
page 163If you want to minimize your borrowing costs, you may need to accept conditions that reduce your lender’s risk. Here are a few possibilities:
Variable interest rate. A variable interest rate is based on fluctuating rates in the banking system, such as the prime rate. With this type of loan, you share the interest rate risks with the lender. Therefore, the lender may offer you a lower initial interest rate than it would with a fixed-rate loan.
A secured loan. If you pledge property or other assets as collateral, you’ll probably receive a lower interest rate on your loan.
Up-front cash. Many lenders believe you have a higher stake in repaying a loan if you pay cash for a large portion of what you are financing. Doing so may give you a better chance of getting the other terms you want.
A shorter term. As you have learned, the shorter the period of time for which you borrow, the smaller the chance that something will prevent you from repaying and the lower the risk to the lender. Therefore, you may be able to borrow at a lower interest rate if you accept a shorter-term loan, but your payments will be higher.
Calculating the Cost of Credit
The most common method of calculating interest is the simple interest formula. Other methods, such as simple interest on the declining balance and add-on interest, are variations of this formula.
page 164SIMPLE INTEREST Simple interest is the interest computed on principal only and without compounding; it is the dollar cost of borrowing money. This cost is based on three elements: the amount borrowed, which is called the principal; the rate of interest; and the amount of time for which the principal is borrowed.
You can use the following formula to find simple interest:
SIMPLE INTEREST ON THE DECLINING BALANCEߒWhen simple interest is paid back in more than one payment, the method of computing interest is known as the declining balance method. You pay interest only on the amount of principal that you have not yet repaid. The more often you make payments, the lower the interest you’ll pay. Most credit unions use this method.
ADD-ON INTERESTߒWith the add-on interest method, interest is calculated on the full amount of the original principal, no matter how frequently you make payments. When you pay off the loan with one payment, this method produces the same annual percentage rate as the simple interest method. However, if you pay in installments, your actual rate of interest will be higher than the stated rate. Interest payments on this type of loan do not decrease as the loan is repaid. The longer you take to repay the loan, the more interest you’ll pay.
COST OF OPEN-END CREDITߒThe Truth in Lending Act requires that open-end creditors inform consumers as to how the finance charge and the APR will affect their costs. For example, they must explain how they calculate the finance charge. They must also inform you when finance charges on your credit account begin to accrue, so that you know how much time you have to pay your bills before a finance charge is added.
COST OF CREDIT AND EXPECTED INFLATIONߒInflation reduces the buying power of money. Each percentage point increase in inflation means a decrease of about 1 percent in the quantity of goods and services you can buy with the same amount of money. Because of this, lenders incorporate the expected rate of inflation when deciding how much interest to charge.
Remember the earlier example in which you borrowed $1,000 from your relative at the bargain rate of 5 percent for one year? If the inflation rate was 4 percent that year, your page 165relative’s actual rate of return on the loan would have been only 1 percent (5 percent stated interest minus 4 percent inflation rate). A professional lender who wanted to receive 5 percent interest on your loan might have charged you 9 percent interest (5 percent interest plus 4 percent anticipated inflation rate).
AVOID THE MINIMUM MONTHLY PAYMENT TRAPߒOn credit card bills and with certain other forms of credit, the minimum monthly payment is the smallest amount you can pay and remain a borrower in good standing. Lenders often encourage you to make the minimum payment because it will then take you longer to pay off the loan. However, if you are paying only the minimum amount on your monthly statement, you need to plan your budget more carefully. The longer it takes for you to pay off a bill, the more interest you pay. The finance charges you pay on an item could end up being more than the item is worth.
Original Balance |
Interest Rate |
Years to Repay |
Interest Paid |
Total Interest Paid as Percentage of Original Balance |
$500* |
19.8% |
2.5 years |
$ 150 |
30% |
$500* |
12 |
2.5 years |
78 |
16 |
$2,000** |
19 |
22 years |
4,800 |
240 |
$2,000*** |
19 |
7 years |
1,120 |
56 |
*Minimum payment is 1/36 of the outstanding balance or $20, whichever is greater.
**2% minimum payment.
***4% minimum payment.
Consider the following examples. In each example, the minimum payment is based on 1/36 of the outstanding balance or $20, whichever is greater.
page 166
LO5.5
Develop a plan to protect your credit and manage your debts.
Protecting Your Credit
Have you ever received a bill for merchandise you never bought or that you returned to the store or never received? Have you ever made a payment that was not credited to your account or been charged twice for the same item? If so, you are not alone.
Billing Errors and Disputes
The Fair Credit Billing Act (FCBA), enacted in 1975, sets procedures for promptly correcting billing mistakes, refusing to make credit card or revolving credit payments on defective goods, and promptly crediting your payments. This act is one of the main reasons why it is more advantageous to buy higher dollar value items with a credit card than a debit card. This act provides the consumer recourse against the retailer.
Follow these steps if you think that a bill is wrong or want more information about it. First notify your creditor in writing and include any information that might support your case. (A telephone call is not sufficient and will not protect your rights.) Then pay the portion of the bill that is not in question.
Your creditor must acknowledge your letter within 30 days. Then, within two billing periods (but not longer than 90 days), the creditor must adjust your account or tell you why the bill is correct. If the creditor made a mistake, you don’t have to pay any finance charges on the disputed amount. If no mistake is found, the creditor must promptly send you an explanation of the situation and a statement of what you owe, including any finance charges that may have accumulated and any minimum payments you missed while you were questioning the bill.
PROTECTING YOUR CREDIT RATINGߒAccording to law, a creditor may not threaten your credit rating or do anything to damage your credit reputation while you’re negotiating a billing dispute. In addition, the creditor may not take any action to collect the amount in question until your complaint has been answered.
DEFECTIVE GOODS AND SERVICESߒTheo used his credit card to buy a new mountain bike. When it arrived, he discovered that some of the gears didn’t work properly. He tried to return it, but the store would not accept a return. He asked the store to repair or replace the bike—but still he had no luck. According to the Fair Credit Billing Act, he may tell his credit card company to stop payment for the bike because he has made a sincere attempt to resolve the problem with the store.
Identity Crisis: What to Do If Your Identity Is Stolen
“I don’t remember charging those items. I’ve never been in that 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 use your personal information for their own purposes, they are committing a crime.
The biggest problem? You may not know that your identity has been stolen until you notice that something is wrong: You may get bills for a credit card account you never opened, or you may see charges to your account for things that you didn’t purchase.
If you think that your identity has been stolen and that someone is using it to charge purchases or obtain credit in some other way, the Federal Trade Commission recommends that you take the following three actions immediately:
Contact the 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.
page 167Contact the creditors. Contact the creditors for any accounts that have been tampered with or opened fraudulently. Follow up in writing.
File a police report. Keep a copy of the police report in case your creditors need proof of the crime. If you’re still having identity problems, stay alert to new instances of identity theft. You can also contact the Privacy Rights Clearinghouse at 1-619-298-3396.
Protecting Your Credit from Theft or Loss
Some thieves will pick through your trash in the hope of coming across your personal information. You can prevent this from happening by tearing or shredding any papers that contain personal information before you throw them out. Another tactic that an identity thief may use is skimming. Skimming involves the recording of the data on the magnetic strip of a credit or debit card. Thieves also target ATM machines by adding a device on the machine that will capture your PIN number. This allows them to make fake cards and have access to your account. The best way to avoid falling victim is to carefully look at the machine to see if there are extra wires, strings, or cords that should not be there. Notify the bank immediately if your card is not returned.
According to a 2014 survey by American Consumer Credit Counseling, 64 percent of Americans do not trust retailers with their credit and debit card information. Due to recent data breaches at Target and Neiman Marcus, 42 percent of respondents are more likely to pay with cash or check.
If you believe that an identity thief has accessed your bank accounts, close the accounts immediately. If your checks have been stolen or misused, stop payment on them. If your debit card has been lost or stolen, cancel it and get another with a new personal identification number (PIN).
Lost credit cards are a key element in credit card fraud. To protect your card, you should take the following actions:
Be sure that your card is returned to you after a purchase. Unreturned cards can find their way into the wrong hands.
Keep a record of your credit card number. You should keep this record separate from your card.
Notify the credit card company immediately if your card is lost or stolen. Under the Consumer Credit Protection Act, the maximum amount that you must pay if someone uses your card illegally is $50. However, if you manage to inform the company before the card is used illegally, you have no obligation to pay at all.
Read the accompanying From the Pages of . . . Kiplinger’s Personal Finance feature on how to combat data theft.
Protecting Your Credit Information on the Internet
The internet is becoming almost as important to daily life as the telephone and television. Increasing numbers of consumers use the internet for financial activities, such as investing, banking, and shopping.
When you make purchases online, make sure that your transactions are secure, that your personal information is protected, and that your “fraud sensors” are sharpened. Although you can’t control fraud or deception on the internet, you can take steps to recognize it, avoid it, and report it. Here’s how:
page 168
Gerstner, Lisa, “What To Do About the Target Data Theft” Reprinted by permission from Kiplinger’s Personal Finance January 2014. Copyright ©2014. The Kiplinger Washington Editors, Inc.
In the event of a data breach, why is it wise to request a new card?
What precautions should you take if you decide not to get a new card?
What are the pros and cons of placing a freeze on your credit report as a preventive measure?
page 169
Use a secure browser.
Keep records of your online transactions.
Review your monthly bank and credit card statements.
Read the privacy and security policies of websites you visit.
Keep your personal information private.
Never give your password to anyone online.
Don’t download files sent to you by strangers.
Cosigning a Loan
If a friend or relative ever asks you to cosign a loan, think twice. Cosigning a loan means that you agree to be responsible for loan payments if the other party fails to make them. When you cosign, you’re taking a chance that a professional lender will not take. The lender would not require a cosigner if the borrower were considered a good risk.
If you cosign a loan and the borrower does not pay the debt, you may have to pay up to the full amount of the debt as well as any late fees or collection costs. The creditor can even collect the debt from you without first trying to collect from the borrower. The creditor can use the same collection methods against you that can be used against the borrower. If the debt is not repaid, that fact will appear on your credit record.
Most private student loans today have a cosigner, typically a parent or a grandparent. Your loan may contain provisions that allow the creditor to put you in default, even if you’ve been making your payments on time. According to the Consumer Financial Protection Bureau, “We’ve received complaints that private lenders are placing borrowers into default and making balance due all at once when the cosigner dies or files for bankruptcy.”
Source: Consumer Financial Protection Bureau
Complaining about Consumer Credit
If you believe that a lender is not following the consumer credit protection laws, first try to solve the problem directly with the lender. If that fails, use formal complaint procedures. This section describes how to file a complaint with the federal agencies that administer credit protection laws. Exhibit 5–9 provides contact information for the various federal agencies.
Exhibit 5–9 Federal Government Agencies That Enforce the Consumer Credit Laws
If you think you’ve been discriminated against by: |
You may file a complaint with the following agency: |
Consumer reporting agencies, creditors, and others not listed below |
Federal Trade Commission: Consumer Response Center - FCRA Washington, DC 205801-877-382-4357 |
National banks, federal branches/agencies of foreign banks (word “National” or initials “N.A.” appear in or after bank’s name) |
Office of the Comptroller of the Currency Compliance Management, Mail Stop 6-6Washington, DC 202191-800-613-6743 |
Federal Reserve System member banks (except national banks and federal branches/agencies of foreign banks) |
Federal Reserve BoardDivision of Consumer & Community AffairsWashington, DC 205511-202-452-3693 |
Federal credit unions (words Federal Credit Union appear in institution’s name) |
National Credit Union Administration1775 Duke StreetAlexandria, VA 223141-703-519-4600 |
State-chartered banks that are not members of the Federal Reserve System |
Federal Deposit Insurance CorporationConsumer Response Center, 2345 Grand Avenue, Suite 100Kansas City, MO 64108-26381-877-275-3342 |
The law gives you certain rights as a consumer of credit. What types of complaints about a creditor might you report to these government agencies? |
|
Consumer Credit Protection Laws
If you have a particular problem with a bank in connection with any of the consumer credit protection laws, you can get advice and help from the Federal Reserve System. You don’t need to have an account at the bank to file a complaint. You may also take legal action against a creditor. If you decide to file a lawsuit, you should be aware of the various consumer credit protection laws described below.
TRUTH IN LENDING AND CONSUMER LEASING ACTSߒIf a creditor fails to disclose information as required under the Truth in Lending Act or the Consumer Leasing Act, or gives inaccurate information, you can sue for any money loss you suffer. You can also sue a creditor that does not follow rules regarding credit cards. In addition, the Truth in Lending Act and the Consumer Leasing Act permit class action of all the people who have suffered the same injustice.
FAIR CREDIT AND CHARGE CARD DISCLOSURE ACTߒThis act was initially written as an amendment to the Truth in Lending Act. This act requires that solicitations for credit cards in the mail, over the phone, in print, or online must provide the necessary terms of the account. This includes finance charges as well as cash advance or annual fees. This also includes any changes to the account.
page 170EQUAL CREDIT OPPORTUNITY ACT (ECOA) If you think that you can prove that a creditor has discriminated against you for any reason prohibited by the ECOA, you may sue for actual damages plus punitive damages—a payment used to punish the creditor who has violated the law—up to $10,000.
FAIR CREDIT BILLING ACTߒA creditor that fails to follow the rules that apply to correcting any billing errors will automatically give up the amount owed on the item in question and any finance charges on it, up to a combined total of $50. This is true even if the bill was correct. You may also sue for actual damages plus twice the amount of any finance charges.
FAIR CREDIT REPORTING ACTߒYou may sue any credit bureau or creditor that violates the rules regarding access to your credit records or that fails to correct errors in your credit file. You’re entitled to actual damages plus any punitive damages the court allows if the violation is proven to have been intentional.
CONSUMER CREDIT REPORTING REFORM ACTߒThe Consumer Credit Reporting Reform Act of 1977 places the burden of proof for accurate credit information on the credit bureau, rather than on you. Under this law, the creditor must prove that disputed information is accurate. If a creditor or the credit bureau verifies incorrect data, you can sue for damages.
ELECTRONIC FUND TRANSFER ACTߒIf a financial institution does not follow the provisions of the Electronic Fund Transfer Act, you may sue for actual damages plus punitive damages of not less than $100 or more than $1,000. You are also entitled to court costs and attorney fees in a successful lawsuit. Class-action suits are also permitted.
CREDIT CARD ACCOUNTABILITY RESPONSIBILITY AND DISCLOSURE ACT OF 2009 (CARD ACT)ߒThis act became effective in February 2010. It changed many of the rules by which the credit card companies could provide credit and administer page 171accounts. Credit card companies must now provide 45 days’ notice of rate increases. Also, the time between receiving the statement and the payment due date has been extended to 21 days. Additionally, the credit card companies must apply payments first to the debts that carry the higher interest rates, such as cash advances. They must also provide a more detailed statement that includes the time and total interest amount to pay off the balance if only the minimum payment is made. The rules by which the credit card companies can extend credit to persons under the age of 21 have also changed. Young people must be able to show proof of income or have a signature by a person willing to accept responsibility for the account.
Consumer Financial Protection Bureau
If you are unable to find a resolution to a credit card situation, you may still have one more option. The Consumer Financial Protection Bureau (CFPB) has created a one-stop complaint website for credit card issues. You must visit the website, describe the circumstances of your complaint, and indicate any monies lost due to the issue. You can continue to check back on the website to monitor the progress of your complaint as the CFPB investigates. The website is https://www.consumerfinance.gov/complaint/.
Managing Your Debts
A sudden illness or the loss of your job may prevent you from paying your bills on time. If you find you cannot make your payments, contact your creditors at once and try to work out a modified payment plan with them.
Warning Signs of Debt Problems
Chris is in his late 20s. A college graduate, he has a steady job and earns an annual income of $40,000. With the latest model sports car parked in the driveway of his new home, it would appear that Chris has the ideal life.
However, Chris is deeply in debt. He is drowning in a sea of bills. Almost all his income is tied up in debt payments. The bank has already begun foreclosure proceedings on his home, and several stores have court orders to repossess practically all of his new furniture and electronic gadgets. His current car payment is overdue, and he is behind in payments on all his credit cards. If he doesn’t come up with a plan of action, he’ll lose everything.
Chris’ situation is all too common. Some people who seem to be wealthy are just barely keeping their heads above water financially. Generally, the problem they share is financial immaturity. They lack self-discipline and don’t control their impulses. They use poor judgment or fail to accept responsibility for managing their money.
Chris and others like him aren’t necessarily bad people. They simply haven’t thought about their long-term financial goals. Someday you could find yourself in a situation similar to Chris’. Here are some warning signs that you may be in financial trouble:
You make only the minimum monthly payment on credit cards.
You’re having trouble making even the minimum monthly payment on your credit card bills.
The total balance on your credit cards increases every month.
You miss loan payments or often pay late.
You use savings to pay for necessities such as food and utilities.
You receive second and third payment due notices from creditors.
You borrow money to pay off old debts.
You exceed the credit limits on your credit cards.
You’ve been denied credit because of a bad credit bureau report.
page 172If you are experiencing two or more of these warning signs, it’s time for you to rethink your priorities before it’s too late.
Debt Collection Practices
The Federal Trade Commission enforces the Fair Debt Collection Practices Act. This act prohibits certain practices by debt collectors—businesses that collect debts for creditors. The act does not erase the legitimate debts that consumers owe, but it does control the ways in which debt collection agencies may do business.
Financial Counseling Services
If you’re having trouble paying your bills and need help, you have several options. You can contact your creditors and try to work out an adjusted repayment plan, or you can contact a nonprofit financial counseling program.
CONSUMER CREDIT COUNSELING SERVICESߒThe Consumer Credit Counseling Service (CCCS) is a nonprofit organization affiliated with the National Foundation for Consumer Credit (NFCC). Local branches of the CCCS provide debt counseling services for families and individuals with serious financial problems. The CCCS is not a charity, a lending institution, or a government agency. CCCS counseling is usually free. However, when the organization supervises a debt repayment plan, it sometimes charges a small fee to help pay administrative costs.
According to the NFCC, millions of consumers contact CCCS offices each year for help with their personal financial problems. To find an office near you, call 1-800-388-CCCS or go to www.nfcc.org. All information is kept confidential.
Credit counselors know that most individuals who are overwhelmed with debt are basically honest people who want to clear up their unmanageable indebtedness, the condition of being deeply in debt. Too often, such problems arise from a lack of planning or a miscalculation of earnings. The CCCS is concerned with preventing problems as much as it is with solving them. As a result, its activities are divided into two parts:
Aiding people with serious debt problems by helping them to manage their money better and set up a realistic budget.
Helping people prevent indebtedness by teaching them the importance of budget planning, educating them about the pitfalls of unwise credit buying, and encouraging credit institutions to withhold credit from people who cannot afford it.
See the nearby Financial Literacy in Practice feature for help in choosing a credit counselor.
OTHER COUNSELING SERVICESߒIn addition to the CCCS, universities, credit unions, military bases, and state and federal housing authorities sometimes provide nonprofit credit counseling services. These organizations usually charge little or nothing for their assistance. You can also check with your bank or local consumer protection office to see whether it has a listing of reputable financial counseling services, such as the Debt Counselors of America.
Declaring Personal Bankruptcy
What if a debtor suffers from an extreme case of financial woes? Can there be any relief? The answer is bankruptcy proceedings. 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. Bankruptcy may also include a plan for the debtor to repay creditors on an installment basis. Declaring bankruptcy is a last resort because it severely damages your credit rating.
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Anita Singh illustrates the face of bankruptcy. A 43-year-old freelance photographer from California, she was never in serious financial trouble until she began running up big medical costs. She reached for her credit cards to pay the bills. Because Anita didn’t have health insurance, her debt quickly mounted and soon reached $17,000—too much to pay off with her $25,000-a-year income. Her solution was to declare personal bankruptcy to get relief from creditors’ demands. Medical bills are the leading cause of bankruptcy.
THE U.S. BANKRUPTCY ACT OF 1978ߒExhibit 5–10 illustrates the rate of personal bankruptcy in the United States. The vast majority of bankruptcies in the United States, like Anita Singh’s, are filed under a part of U.S. bankruptcy code known as Chapter 7. You have two choices in declaring personal bankruptcy: Chapter 7 (a straight bankruptcy) and Chapter 13 (a wage earner plan bankruptcy). Both choices are undesirable, and neither should be considered an easy way to get out of debt.
Exhibit 5–10 U.S. Consumer Bankruptcy Filings, 1980–2017
Consumer bankruptcies have increased significantly over the past 30 years. Consumer bankruptcy filings rose from about 287,000 in 1980 to almost 2 million in 2005. Bankruptcies decreased after the Bankruptcy Abuse Prevention and Consumer Protection Act was passed. However, poor economic conditions have caused the numbers to increase yet again, despite the legislation.
*estimated
Source: Administrative Office of the U.S. Courts, http://www.uscourts.gov, and creditslips.org, accessed April 2, 2017.
CHAPTER 7 BANKRUPTCYߒIn a Chapter 7 bankruptcy, an individual is required to draw up a petition listing his or her assets and liabilities. A person who files for relief under the bankruptcy code is called a debtor. The debtor submits the petition to a U.S. district court and pays a filing fee.
Chapter 7 is a straight bankruptcy in which many, but not all, debts are forgiven. Most of the debtor’s assets are sold to pay off creditors. Certain assets, however, receive some protection. Among the assets usually protected are Social Security payments, unemployment page 174compensation, and the net value of your home, vehicle, household goods and appliances, tools used in your work, and books.
The courts must charge a $335 case filing fee; it includes $75 miscellaneous administrative fee, and a $15 trustee fee. If the debtor is unable to pay the fees even in installments, the court may waive the fees.
In filing a petition, a debtor must provide the following information:
A list of all creditors and the amount and nature of their claims.
The source, amount, and frequency of the debtor’s income.
A list of all the debtor’s property.
A detailed list of the debtor’s monthly expenses.
The release from debt does not affect alimony, child support, certain taxes, fines, certain debts arising from educational loans, or debts that you fail to disclose properly to the bankruptcy court. Furthermore, debts arising from fraud, driving while intoxicated, or certain other acts or crimes may also be excluded.
THE BANKRUPTCY ABUSE PREVENTION AND CONSUMER PROTECTION ACT OF 2005ߒOn April 20, 2005, President George W. Bush signed the Bankruptcy Abuse Prevention and Consumer Protection Act, which is perhaps the largest overhaul of the Bankruptcy Code since it was enacted in 1978. Signing the bill, the president declared, “Bankruptcy should always be the last resort in our legal system. In recent years, too many people have abused the bankruptcy laws. Under the new law, Americans who have the ability to pay will be required to pay back at least a portion of their debts. The law will page 175help make credit more affordable, because when bankruptcy is less common, credit can be extended to more people at better rates. Debtors seeking to erase all debts will now have to wait eight years from their last bankruptcy before they can file again. The law will also allow us to clamp down on bankruptcy mills that make their money by advising abusers on how to game the system.”
Among other provisions, the law requires that:
The director of the Executive Office for U.S. Trustees develop a financial management training curriculum to educate individual debtors on how to better manage their finances, and test, evaluate, and report to Congress on the curriculum’s effectiveness.
Debtors complete an approved instructional course in personal financial management.
The clerk of each bankruptcy district maintain a list of credit counseling agencies and instructional courses on personal financial management.
Furthermore, the law may require that states should develop personal finance curricula designed for use in elementary and secondary schools.
The bottom line: The new law made it more difficult for consumers to file a Chapter 7 bankruptcy and forces them into a Chapter 13 repayment plan.
CHAPTER 13 BANKRUPTCYߒIn Chapter 13 bankruptcy, a debtor with a regular income proposes a plan for using future earnings or assets to eliminate his or her debts over a period of time. In such a bankruptcy, the debtor normally keeps all or most of his or her property. A debtor must provide the same information that is required to file a Chapter 7 bankruptcy.
During the period when the plan is in effect, which can be as long as five years, the debtor makes regular payments to a Chapter 13 trustee, or representative, who then distributes the money to the creditors. Under certain circumstances, the bankruptcy court may approve a plan that permits the debtor to keep all property, even though he or she repays less than the full amount of the debts.
EFFECTS OF BANKRUPTCYߒPeople have varying experiences in obtaining credit after they file for bankruptcy. Some find the process more difficult, whereas others find it easier because they have removed the burden of prior debts or because creditors know that they cannot file another bankruptcy case for a certain period of time. Obtaining credit may be easier for people who file a Chapter 13 bankruptcy and repay some of their debts than for those who file a Chapter 7 bankruptcy and make no effort to repay any of their debts.
