National Association of Black Accountants, Inc. M ney $ense Managing Credit and Debt Managing Credit Buy Now, Pay Later Financial Aptitude Test 1. 2. 3. 4. It’s always smart to send in the minimum payment due on a credit card bill each month and stretch out the card payments as long as possible instead of paying the bill in full. T/F Your credit record can be a factor when you apply for a loan or credit card, but cannot affect non-credit decisions, such as applications for insurance for an apartment. T/F While one or two late payments on bills may not damage your credit record, making a habit of it will count against you. T/F There’s no harm in having many different credit cards, especially when the card companies offer free T-shirts and other special giveaways as incentives. The number of cards you carry won’t affect your ability to get a loan; what matters is that you use the cards responsibly. T/F Financial Aptitude Test 5. 6. A debit card may be a good alternative to a credit card for a young person because the money to pay for purchases is automatically deducted from a bank account, thus avoiding interest charges or debt problems. T/F It makes no sense for young adults to put money aside for their retirement many years away. People in their 20s should focus entirely on meeting monthly expenses and saving for short-term goals. T/F Financial Aptitude Test Answers 1. 2. 3. 4. 5. 6. False False True False True False Credit and Debt Terms You Should Know Credit is time given for payment for goods sold on trust Debt is a condition of owing Credit Terms APR: the amount it costs annually when you decide to carry a balance (not pay off your credit card in full) each month. Can range from 0 to as high as 25% annually Finance Charge: Actual dollar cost of using credit Credit Terms Grace Period: the number of days you have to pay your bill in full before incurring finance charges (typically 25 days). Beware of cards with no grace period! Interest accrues from the moment you charge an item. You don’t get a grace period when you carry a balance. Annual Fee: the amount you pay annually as a credit cardholder for the privilege of using credit If you pay your balance each month, you should avoid cards with an annual fee. Some annual fee cards have lower interest rates, so if you carry a balance each month you may actually save money with an annual fee card. Credit Terms Transaction Fees: You may be charged additional fees for ATM cash advances, balance transfers, late charges and exceeding your credit limit. Some cards also charge a monthly fee for not using the card! Late Fee: If your payment is not processed by the due date, you may be assessed a late fee of up to $35. Avoid this expense by mailing timely payments. Remember, creditors must receive a payment at least every 30 days. Credit Terms Minimum Payment: the least amount you must pay each month to avoid additional transaction fees (typically 2% of the balance). Credit Limit: The maximum amount you can charge Type of Credit Lender Advantages Disadvantages HOME MORTGAGE • Commercial bank • Savings and loan • Credit union • Homes often increase in value. • Interest rates for mortgages are relatively low • The interest paid is taxdeductible. • Mortgages are long-term commitments. • Obtaining a home loan involves extensive credit checks. CAR LOANS • Commercial bank • Savings and loan • Credit union • Consumer finance company • Cars can make it easier to work and earn an income. • Cars lose their value relatively quickly. The car you purchase may have little value when the last payment is made. COLLEGE LOANS • Commercial bank • Savings and loan • Credit union Federal government • A college education is a good borrow investment. necessary. • Interest rates can be relatively low. • Students sometimes borrow more than necessary. • New graduates can face difficulty in repaying large loans. PERSONAL LOANS • Commercial bank • Savings and loan • Credit union • Consumer finance company • Personal loans allow individuals to purchase today that boat or vacation they want. • Personal loans have relatively high interest rates. • Some young people may borrow more than their income should allow. CREDIT CARDS • Commercial bank • Savings and loan • Department store • Oil companies • Other financial institutions, e.g., American Express • Credit cards are convenient to use and useful in an emergency. • Credit cards provide a record of charges. • Credit cards have relatively high interest rates. • Some young people may borrow more than their income should allow. Managing Credit Cards Teaser rates When you receive a credit card offer in the mail, examine the fine print that comes with the solicitation. Many cards will offer great introductory rates, such as 3.9% APR. Often these rates will rise after a limited period of time (usually six months). After the introductory time period, your APR could go up significantly. Not a good deal if you’re carrying a balance! Managing Credit Cards Stick with one or two Pay in full every month Pay on time Avoid cash advances Managing Credit Cards Stay within the limit Review your statements Report a lost or stolen card immediately Protect your history Protect personal information Managing Credit Cards Read your credit card contract carefully and be sure to examine any letters that subsequently arrive announcing changes to the terms of your contract. Many cards are eliminating grace periods and adding annual fees for customers who pay in full each month. Contact your creditors if you can’t make your payment on time or at all. They may be willing to work out a deal for you if you’re in good standing. Ask your creditor to reduce your APR if you’re being charged a high interest rate and carrying a balance. Many creditors may be willing to do this. Managing Credit Cards Think before you buy an item on sale with your credit card. Will you really save money? Probably not. Remember that offers to reduce your minimum monthly payment will only cost you more in interest during the long run. Develop a sound spending plan for yourself. This will help you avoid using credit cards to make up for any shortfalls in your cash flow. Shop carefully for a credit card! The offer you get in the mail may not be the best deal. Check www.bankrate.com to compare credit cards and their rates. So Many Credit Card Offers: What’s the Difference? Credit Card A (Providian) Credit Card B Annual fee $0 $110 annual fee $129 set-up fee (one-time) Interest rate (APR) 4.99% 9.9% (initially) Grace period 25 days if the new balance is paid in full by the payment due date 25 days Minimum payment 2.5% of the new balance, minimum of $15 $0 Late fee $15 if balance is less than $200 $35 if balance is greater than $200 $25 and an increased APR Other fees 3% of advance, $10 minimum 3% of balance, $5 to $50, Late $35 if over 2% over limit LOTS OF FEES •If you were to choose one of these credit cards, which one would it be? •What are the benefits of the card you chose? •What are some of the costs of the card you chose? Common Lenders of Credit 1. Commercial banks and savings and loans Very similar in the types of financial services they provide their customers, but regulated by different agencies Include loans, savings accounts, and checking accounts. 2. Credit unions Not-for-profit cooperatives— enterprises owned by their members Provide many of the same financial services as commercial banks and savings and loans. 3. Consumer finance companies Lend money to individuals usually for things such as automobiles or household appliances Often their customers do not qualify for bank credit and therefore pay a higher rate of interest. What Are Lenders Looking For? Lenders look for certain qualities in loan applicants. These qualities are called the Four Cs of Credit: capacity, character, capital and collateral. Capacity: the ability of the consumer to repay the debt. The basic question is: “Have you been working regularly in an occupation that is likely to provide enough income to support your use of credit?” ✔Do you have a steady job? ✔What is your salary? ✔How reliable is your income? ✔Do you have other sources of income? ✔How many other loan payments do you have? ✔What are your current living expenses? ✔What are your current debts? ✔How many dependents do you have? ✔Do you pay alimony or child support? ✔Can you afford your lifestyle? What Are Lenders Looking For? Character: whether you possess the honesty and reliability to pay credit debts ✔Have you used credit before? ✔Do you pay your bills on time? ✔Do you have a good credit report? ✔Can you provide character references? ✔How long have you lived at your present address? ✔How long have you been at your present job? Collateral: serves as a type of insurance for the creditor The creditor is interested in determining whether you have any assets that could be sold to pay off your loan in the event that you are unable to do so. ✔Do you have a checking account? ✔Do you have a savings account? ✔Do you own any stocks or bonds? ✔Do you have any valuable collections or jewelry? ✔Do you own your own home? ✔Do you own a car? ✔Do you own a boat? What Are Lenders Looking For? Capital: having personal items of value. ✔Do you have a car? ✔Do you have a home? Credit Credit Reports and Scores Credit How Credit Works For and Against You Maintaining Good Credit A good rating on a credit report means that in the past bills have been paid on time. How Bad is Bad Credit? A poor rating indicates overdue or unpaid items. Your Credit Report Your ability to qualify for a loan depends on a credit report. A credit report is a record of an individual’s personal credit history. When a person applies for a loan, the lender will order a credit report to see how well the applicant has managed credit in the past. A credit report will tell, in detail, how much the person has borrowed, from whom, and whether the bills have been paid on time. Credit reports are compiled by credit bureaus, which regularly collect information on millions of consumers. Credit bureaus get information from a variety of sources, including stores, credit card companies, banks, mortgage companies, and medical providers. Credit Reporting Agencies Mistakes can and do occur on credit reports. For example, a credit report may contain information about someone with the same name, or paid accounts may be listed as unpaid. The law provides individuals with a means of requesting and reviewing their credit report and having mistakes corrected. Under the Fair Credit Reporting Act you have the right to get a copy of your credit report from a credit bureau. The three largest credit bureaus are: Equifax P.O. Box 105496 Atlanta, GA 303485496 www.equifax.com 800.997.2493 Experian P.O. Box 2104 Allen, TX 75013-2104 www.experian.com 888.397.3742 Trans Union P.O. Box 1000 Chester, PA 19022 www.transunion.com Free annual credit report: www.annualcreditreport.com (only authorized source) Information on FICO Scores & Credit What’s In Your FICO Score http://www.myfico.com/CreditEducation/WhatsInYourScore.aspx The Federal Trade Commission http://www.ftc.gov/bcp/conline/edcams/credit/index.html\ Other Credit Items Credit Traps and Predatory Lending Credit Counseling Identity Theft “The Golden Rule” Credit Advantages Access to cash in an emergency Ability to use it now Safety and convenience Debt Debt is the entire amount of money you owe to lenders TYPES OF DEBT Secured debt: the creditor has given you credit to buy an item that they can take back (repossess) if you don’t make your payments. Generally secured debt involves major purchases. Examples of include: House or condominium, Land, Time share, Automobile, Boat If you allow a secured debt to be repossessed for nonpayment, you’ll damage your credit rating. Unsecured debt: credit granted to you where property can’t be repossessed. Examples include: Credit cards, Student loans, Payday loans, Medical bills not covered by insurance GOOD VERSUS BAD DEBT Good debt: Example: borrowing to pay for a home--considered good debt because you’re purchasing a tangible asset that will generally be worth more over time. Most secured debts are usually considered good debt but there are some exceptions. For instance, new cars lose as much as 20% of their value as soon as they are driven off the lot. Bad debt: Most unsecured debts are considered to be bad debt with the exception of student loans. If you complete your degree, the money you borrowed to pay for your education will be returned to you throughout your lifetime by the type of job. You’ll obtain and the higher wages you’ll earn. It’s never good to carry credit card debt. Interest rates can be staggering, and balances and interest costs will grow when you make irregular or minimum payments. A Word About Debt What is a “debt load?” What is a safe amount of credit for you to carry? How do creditors find out what a person’s debt load is? How do I know my own debt load? DEBT/INCOME RATIO This debt/income ratio is figured with monthly amounts To figure this ratio: add all of your non-housing monthly payments except for your utilities or taxes. Then compare that total with your total gross annual wages divided by 12. If you don’t have fixed monthly payments on revolving debts such as credit cards, estimate your monthly payments at 4% of the total amount you owe. Monthly debt payments/Total monthly income = monthly non-housing debt/income ratio. It’s usually expressed as a percentage so move the decimal point 2 places to the right and add the “%” sign. Rule of Thumb A conservative rule of thumb: the “20-10 Rule.” Total household debt including your housing payments shouldn’t exceed 20% of your net household income. Remember your net income is how much you “bring home” in your paycheck and monthly payments on the debt shouldn’t exceed 10% of net monthly income. Another conservative rule of thumb for mortgage debt is the “28/36” rule. Your non-housing debt shouldn’t exceed 28% of your gross (your total) income, and your total debt — consumer debt plus housing debt — shouldn’t exceed 36% of your gross income. How Much Debt Can You Afford? Example: Yearly income after taxes and deductions: $28,000 Monthly income: $2,333 ($28,000/12) Amt. of consumer pmts. per month you can afford: (15-20% of your after tax income) : $2,333 * .15 = $355 to $2,333 * .20 = $467 HOW TO REDUCE YOUR DEBT So you’ve got a bunch of debt. What do you do? Add up your debts and find out where you stand. You can’t make payoff decisions without a clear picture of what you owe. Look at the amounts owed and determine how much you are paying to all of your creditors. Amt. Owed VISA APR Monthly Pmt. Payoff Goal $2,500 Dentist $150 Student Loan $25,000 18.0% 5.0% 8.2% $40 $25 $340 5 years 6 months 10 years Car $10,000 9.0% $200 5 years Total $37,650 $605 Manage Your Debt Paying $605 every month is going to pay off your debt. The secret to getting rid of debt is to keep paying at least $605 a month until the debt is gone. In six months when the dentist is paid off, take the extra $25 and apply it to the Visa card since it has the highest interest rate. Keep the payments at $605. To quickly reduce your debt, apply any extra cash to high interest debt. Using this payment strategy, the debt in this example would be paid off in less than 10 years. Managing Debt Negotiating with Creditors The Perils of Credit Card and other Consumer Debt Debt Consolidation Options The IRS Tips: How to Get Out of Debt Don’t wait to act Create a plan to get out of debt Cut expenses Honestly assess your ability to pay and take appropriate action Try to increase income Keep making payments when debt is paid off Consolidate loans Limit the number of credit cards you own Try to stop most credit card offers from arriving in the mail (call (888) 5OPT-OUT Debt Counseling Financial literacy isn’t just a matter of knowing what you have and knowing your options. It is a matter of planning for life’s milestones. Thank You! National Association of Black Accountants, Inc. M ney $ense For more information visit www.nabainc.org 360 Degrees of Financial Literacy 360 Degrees of Financial Literacy is a national effort of the CPA profession to improve the financial understanding of Americans. It provides a comprehensive approach to financial education, focusing on the information Americans need at every life stage, from childhood to retirement. CPAs volunteer their time and expertise to educate members of their communities about financial issues. Visit www.360financialliteracy.org for tools to help you make sound financial decisions.