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1. This document is FCS5206, one of a series of the Department of Family, Youth and Community Sciences, Florida Cooperative Extension Service, Institute of Food and Agriculture Sciences, University of Florida. This material was adapted for use in Florida with permission of the University of Idaho Cooperative Extension System. Publication: July, 2001. Please visit the EDIS Web site at http://edis.ifas.ufl.edu.The Institute of Food and Agricultural Sciences is an equal opportunity/affirmative action employer authorized to provide resea rch, educational information and other services only to individuals and in stitutions that function without regard to race, color, se x, age, handicap, or national origin. For information on obtaining other extensi on publications, contact your county Cooperative Extension Servic e office. Florida Cooperative Extension Service / Institute of Food and Agricultural Sciences / University of Florida / Christine Taylor Waddill, Dean 2. Josephine Turner, Ph.D., CFP, professor, Family and Consumer Economics, and reviewed by Nayda I. Torres, Ph.D., professor and c hair, Department of Family, Youth and Community Sciences, Cooperative Extension Service, Institute of Food and Agricultural Sciences, University of Florida, Gainesville, 32611, and Patricia Goodgame, extension agent II, Volusia County. FCS5206Show Me the Money Lesson 3: Using Credit Wisely1Adapted by Josephine Turner2OverviewCredit can be a valuable resource when it is used in a responsible and limite d way. If abused, it can tie up income and even lead to future credit problems. This lesson provides you w ith some guidelines for determining how much debt you can safely afford. With careful planni ng, you can manage to stay within your budget when you borrow. As with most financial matters, there are several factors to consider before assuming further debt responsibilities. These factors are outlin ed in detail, beginning with a ta ble that will help you determine how much credit you can afford. The lesson provides insight into credit qualification process, tips on how to "comparison shop for credit, and how to determine the real cost of buying on time. A timetable will show various options for loan repayment schedules, and you will discover the methods for calculating loan interest. Before you purchase on credit, you will want to know the most commonly used forms available and understand how they work. The le sson will show you this, and some of the possible danger signals of credit abuse. Finally, once you have discovered wh at is involved in obtaining credit, you will want to look at the section entitled What Else You Shoul d Know About Credit. It includes information on establishing a credit history, obtaining copies of your credit report, credit rights, wo men and credit, and some additional tips for using credit wisely.The Credit DecisionIt is important to think carefully before you purch ase something on credit. Do you need it? Is it worth the extra cost? And most importantly, can you pay back the money?
Show Me the Money Lesson 3: Using Credit Wisely Page 2 July 2001 No matter which form of credit you are consideringdepartment store ch arge account, credit card, car loan, or mortgagenever borrow unless you realistically can meet th e pay-back requirements. If the repayment schedule is not fixed, such as with a department store revolving charge, plan to pay off the debt in six months or sooner. In many cases, it is to your advantage to repay within the same billing period to avoid finance charges. How you use cred it is a personal decision. Analyze your family needs realistically. Set prio rities. Look at credit use as part of your total spending plan (refer to Lesson 1). Remember, credit is not extra income. It is obligating future income now. When determining how much credit you can safely assume, consider these factors: The size and stability of your income Whether additional credit payments will cut into money needed for emergencies or unexpected jumps in the price of necessitates The amount of debt you already haveHow Much CreditA common consumer rule-of-thumb is to limit non-mort gage credit payments to 15 to 20 percent of your take-home pay. While this ma y serve as a rough guideline for some, it may not apply to others. Personal values and economic situation also should influence y our credit decisions. Plan credit use according to you needs, goals, and financial limits. With that in mind, make sure the amounts you borro w can be paid safely out of current and future income. This means analyzing your financial situa tion in terms of the money you earn and the expenses you must meet. Since credit payments usually are made monthly, it is helpful to consider income and expenses monthly when determining how much credit you can afford. Worksheet 1 can help to determine debt commitments for some families. If current credit payments are less than or equal to 10 percent of take-home pay, these families can continue to use credit carefully. If credit payments are between 10 and 20 percent of take-home pay, one must avoid taking on more credit. Calculate here how much credit you can afford with this method. How much credit can you afford? Your monthly take-home pay$ 10% of take-home pay (pay x .1)$ 20% of take-home pay (pay x .2)$ Monthly credit payments owed (not including mortgage) $ For example, lets assume your monthly take -home pay was $2,000. Ten pe rcent of your income would be $200; 20 percent would be $400. If you m onthly credit payments were to reach $350, you should avoid taking on more credit debt. Please remember that some families have little or no discretionary income and th erefore cannot afford credit.
Show Me the Money Lesson 3: Using Credit Wisely Page 3 July 2001Qualifying for CreditYour chances of qualifying for a credit card or loan increase if you haveNo major blemishes on your credit report such as bankruptcy, bills turned over to a collection agency for nonpayment, repossession, or a 90-day delinquency;Active accounts to show that the information you ha ve provided is valid; creditors prefer that you have at least two active open accounts including one that has been active for at least 2 years;No recent late payments (late payments sometime, but not always, can disqualify an applicant);A verifiable address; some issuers do not give cards to an applicant using a post office box or General deliv ery address;Consistent payment to all of your acc ounts of at least the minimum amount owed;No more than 90 percent of your available credit lines used up; andNo more than two or three credit card applications pending at one time.Shopping for CreditHow much you pay for credit is influenced by se veral factors, including how much you borrow with or without collateral, and the status of your credit record. To keep costs down, shop for credit just as you would shop for products. Credit costs vary from one financial institution to another, so its is important to compare prices. Never assume all creditors charge the same rates. Before assuming a debt, learn the interest rate, the finances charges, the monthly pa yment amount, and the time you have to repay ( also known as the life of the loan.) In addition to this information, determine the total cost of the loan. Your lender should be able to help in this mater. The Truth in Lending Act (TILA or Regulation Z), a federal law, requires th at you be told exactly what credit costs. Both the finance charge and the annual percentage rate (APR) should be marked clearly on the written disclosure stat ement. The finance charge is th e total dollar amount you must pay for credit. It includes interest, service charges, a nd, if purchased, credit life in surance premiums. (Credit life insurance covers the borrower by repaying the loan if it is still outstanding at the time of death.) The APR is the yearly charge for credit stated as a percentage. It is the rate you pay per dollar of credit you use. The lowest APR is usually the best credit choice. However, other terms, such as the amount of the payments, whether there is a 20 to 30-day grace period, and the total cost of the loan also should be considered. A couple of other options to consider when loan shopping include a passbook saving loan (if you have a savings account), or borrowing against an insu rance policy with a cash value. In either case, you will want to investigate the cost, and determine the advantages and disadvantages of assuming these types of credit. In addition to the source of the loan and the APR, another factor to consider when loan shopping it is how much time you have to repay the loan. The table below shows the difference in monthly payments and total dollar cost for contracts with repayment periods of 12, 18, and 24 months. The amount borrowed ($300) and the annual percentage rate (18 percent on the declining balance) are the same for all three plans. As you can see, the total finance charge at the 12-month rate ($30.00) is almost doubled ($59.28) when the same amount is borrowed for 24 months.
Show Me the Money Lesson 3: Using Credit Wisely Page 4 July 2001 How Credit Costs Increase Over Time Repayment period12 mo. 18 mo. 24 mo. Amount financed$300.00$300.00$300.00 Annual Percentage rate18.0%18.0%18.0% Monthly payment$27.50$19.14$14.97 Finance charge$30.00$44.52$59.28 Total amount to be repaid over the life of the loan $330.00$344.52$359.28Balance Calculation MethodsHow much your credit cards cost you also depends on the method the card issuer used to calculate the finance charge. Because balances on credit cards are constantly changing, once new purchase are made and part or all of the balance is repaid, it is not a simple matter to determine how to charge interest. Among the four main ways that credit card balances are calculated, the most common are the Average Daily Balance method (including new purchases) and the Two-cycle Average Daily Balance (excluding new purchases). Cost to consumers varies. Average daily balance, excluding new purchases. This balance is figured by adding the outstanding balance for each day in the billing cy cle, and then dividing by the number of days in the cycle.Average daily balance, including new purchases. This balance is calculated by adding the outstanding balance (including new purchases and deducting payments) for each day in the billing cycle, then dividing by the number of days.Two-cycle average daily balance, excluding new purchases. This balance is the sum of the average daily balances for two billing cycles. It is calculated by adding the outstanding balance from the previous month, excluding ne w purchases and deducting payments made for each day of the billing cycle, then dividing by the number of days. A second balance is extrapolated for the current billing cycle.Two-cycle average daily balance, including new purchases. Several issuers use the two-cycle average daily balance method. It is used prima rily to back-charge interest on a balance on which no finance charges were paid (because the previous balance was zero). This method only affects consumers who sometimes pay their balance in full, and sometimes carry over a balance.
Show Me the Money Lesson 3: Using Credit Wisely Page 5 July 2001 Credit Card Tip: Shopping wisely for a credit card can make a difference. For example, you save $57 in the first year when you switch a $1,000 balance from a 19.8 percent interest rate card to a 14 percent interest rate card, and you are out of debt a year and a half sooner. The Bottom Line: Know how your creditor/s calculate finance charges. When comparing credit cards be sure to read th rough the balance calculati on method used. That will help you to determine which credit card is best for you. Heres an example of the four met hods applied to consider a consumer who starts the first month with a zero balance and charges $1,000, of which she pay off only the minimum amount due. The next month, she charges another $1,000. In the third mont h, she pays off the entire balance due. This next table shows the finance charges at the end of the year for the different balance calculation methods Balance calculation methods Total finance charge Average daily balance (excluding new purchases) $66 Average daily balance (including new purchases) $132 Two-cycle average daily balance (excluding new purchase) $131 Two-cycle average daily balance (including new purchases) $196 Types of Credit The two most commonly used forms of consumer credit are installment credit and credit cards.
Show Me the Money Lesson 3: Using Credit Wisely Page 6 July 2001Installment Credit. The buyer signs a conditional sales contract for the amount of the item being purchased. Installment payments are predetermined and stated in the contract. Read the contract carefully before signing. Payments usually are made on a monthly basis. A finance charge is added to the purchase price and included as part of each installment payment. The seller retains title to or a security interest in the goods purchased. Failure to make payments can result in repossession.Credit Cards. These are available for use at individual stores or companies or for use at a variety of sellers. A credit line usually is given that limits the total amount of debt at any one time. Credit cards are a popular form of credit because pa yment schedules are flexible. Usually there is a minimum monthly payment, but there is no penalty for early payment of the entire balance. In fact, it is wise to pay the total balance each month to avoid interest payment. If conditions for using credit do not appear on the application, you will receive them when you get the credit card. Carefully study and be prepared to follow the conditions. Credit card conditions tell how to correct billing errors, where and how to report lo st or stolen credit cards, and your liability should such misfortune occur. If you are not willing to comply with the restrictions regarding the use of the card, destroy or return the card to the company. If you decide to keep the card, sign it immediately. This decreases the chance of it becoming a shopping tool for a dishonest person. Treat your card as carefully as you would cash. Be sure you get it back after each use. While charging, make sure the amounts charged are correct, and the total shows clearly before you sign the sales receipt. Keep your records so that you can compare them to your credit statement. If errors, occur, have them corrected immediately. Be prepared for credit card theft. Keep a list of your credit card numbers in a secure place. The list should include the name and phone number of each card issuer (see Worksheet 2). Report lost or stolen cards immediately. By doing so you will limit your liability to a maximum of $50 per card.Danger SignalsThe following situations may indicate you ar e headed for excess debt and credit problems:You pay only the minimum bala nce due on credit accounts. You cant pay all the bill due each month, so you pay some and ignore others.You draw from savings to pay everyday expenses.You are always out of cash and tend to char ge items you used to pay for on the spot.Your are embarrassed to shop at stores where you are behind in payments.You use cash advances regularly to pay bills.You get payday loans on a regularly basis.What You can do to Make it RightIf you cant pay a debt, let the creditor know. The worst thing you can do is to ignore a bill. Give specific reasons why you cant pay. Suggest an alte rnative payment plan that you can handle. Almost every creditor will be receptive to such an offer, si nce it provides some hope that the money will be paid back. The creditors remediesre possession, hiring a collection agen t, or garnishing wagesare
Show Me the Money Lesson 3: Using Credit Wisely Page 7 July 2001unpleasant and costly. Be realistic about your long-term repayment plan. If you dont meet these new commitments, many creditors will take immediate legal action.Credit History and Credit BureausCredit bureaus are reporting agencies that receive and file records of credit transactions. If you have credit, you probably have a file at a credit bureau. In addition to credit transactions, specific information (from public records) is recorded in your file. Th is information can include, but is not limited to, any contract suit, judgment, tax lien, or bankruptcy that has been claimed. When you apply for credit, the creditor usually asks the credit bureau for a report on y ou. Your credit file will i ndicate if you might be a good credit risk. Credit bureaus do not make decisions about granting credit; they only provide the report. Increasingly, credit bureaus use a credit scoring system in which a statistical measure is used to rate applicants on the basis of va rious factors relevant to creditwor thiness. Factors include: length of residence, home ownership, telephone years at current job, annual family income, age, bank accounts, loans, credit cards, payment history. Lending decisi ons, however, are made solely by the creditor and standards vary from one creditor to the next.Obtaining Your Credit ReportsIt is a good idea to periodically check the accuracy of information in your file at the credit bureau. If you are denied credit, you can find out whats in your file at no costif the inquiry is made within 60 days from the date credit is denied. The credit bureau is allowed to charge you a fee if you ask for a copy of your report in most other instances. To order a copy of your credit report, contact: Equifax (credit report for a fee) 1-800-685-1111 Experian (credit report for a fee) 1-888-397-3742 Trans Union (credit report for a fee) 1-800-851-2674 If you find what you think to be incorrect information in your file, ask the credit bureau to check it out. Wrong information must be removed from your record. If you and the creditor disagree about the accuracy of the information, you can file a 100-word statement telling your version of the facts. This statement must be added to your file and shared with other creditors requesting your credit report.Credit RightsConsumer credit laws can help you shop for credit, apply for it, keep up your credit standing, and resolve credit-related problems. When shopping for credit, the creditor must tell you in writing, and before you sign any agreement, th e finance charge and the annual per centage rate. Creditors also must tell you the method of calculating the finance charge. When applying for credit your race, color, age, gender, marital status, and certain other factors may not be used to discriminate against you. The la w does not guarantee that you will be granted credit (you still must pass the creditors tests of credit worthiness). Creditors also may not ask your gender on an application form (unless you are applying for a loan to buy or build a home), and they may not ask about your birth control practices or whether you plan to have children. The creditor must count all of your income, even from a part-time job. You do not ha ve to disclose income from child support or your
Show Me the Money Lesson 3: Using Credit Wisely Page 8 July 2001income, even from a part-time job. You do not have to disclose in come from child support or alimony payments, but if you do, creditors must count them if you can prove they are steady and reliable. In cases of billing errors the law sets out a procedure to corr ect them. First, you must notify the creditor in writing within 60 days after the bill was mailed. Identify the error and explain why you believe the bill is wrong. Pay all parts of the bill that are not in dispute. While waiting for an answer, you do not have to pay the disputed amount or any fi nance changes that apply to it. The creditor must acknowledge your letter within 30 da ys. Within two billing periods, the creditor must either correct your account or explain why the bill is correct. If no error is found, the creditor may bill you for the finance charges that have accumulated while you were disputing the bill. Women and CreditBy law, women have equal cred it opportunity and may not be di scriminated against because of gender or marital status. However, this does not give an automatic right to credita woman must also be credit worthy. Typically, a woman needs to have an income of her own in her own name. Sometimes it is difficult for women to establish financial identify because they are in and out of paid employment due to the varied nature of the roles they perform. For instan ce, if a woman marries, she can lose her financial identity by using only her hus bands name on credit accounts. A woman should maintain her cr edit and financial identity by:Keeping at least one credit card or charge account in her own name;Having her own savings account in addition to a joint one;Making sure she uses, and is co -responsible for, the accounts; andMaking sure joint charge accounts are in both name (thus building up credit history in each separate name). If you recently married and wish to retain a separate credit file, write to your creditors and indicate your name change (if any) and indicate your pr eference to keep the account in your name only.What Else You Should Know About CreditPast credit patterns will affect whether you can get a future loan and how much it will cost you. Your habits establish your credit history, which is determined by: How promptly you pay your bills. How much income your have. How long you have lived or worked in the same place. How much you owe. How much wealth you have accumulated (i.e., items you own that could be considered collateral).Summary of Suggested Activities for Using Credit WiselyExamine your current debt commitments (use Worksheet 1). Make a list of your credit cards and store it in a safe place (use Worksheet 2). Get a recent copy of your credit report and review it for accuracy. Establish credit in your own na me, if you have not already.
Show Me the Money Lesson 3: Using Credit Wisely Page 9 July 2001 Your Credit Status Worksheet This worksheet will help you analyze your current debt commitments (excluding any home mortgage loan). The average consumer probably will not wa nt to commit more than 15 to 20 percent (or about one-sixth) of income after taxes to installment payments.LoanAmount still owed Source of loan Annual percentage rate Months left to pay Monthly payment Vehicle 1 Vehicle 2 Education debt Automatic overdraft on checking Installment loans: Credit Card debt: Other debts: A. Monthly take-home income B. Total monthly payments (total last column) C. Monthly take-home income divided by 6 (about 17 percent) $______________________ $______________________ $______________________ If B is greater than C, you have about as much debt as you can easily carry with your income. Before using more credit, pay off some of your debts, especially those with the highest interest.Worksheet 1
Show Me the Money Lesson 3: Using Credit Wisely Page 10 July 2001 Worksheet 2Your Credit CardsMake a list of your credit cards and keep it in a safe place at home. If your credit cards are lost or stolen, you will need this information. Card account number Address of company to notify if lost Phone number to call if lost or stolen Name(s) on card Credit limit, expiration date, etc.