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Finance: Chapter 8

by: Lindsay Fialli

Finance: Chapter 8 FIN 100

Lindsay Fialli

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About this Document

These are my notes for Chapter 8 of Personal Finance by Jeff Madura.
Personal Finance
Terrance Doyle
Class Notes
Personal, finance
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This 5 page Class Notes was uploaded by Lindsay Fialli on Saturday October 8, 2016. The Class Notes belongs to FIN 100 at Salem State University taught by Terrance Doyle in Fall 2016. Since its upload, it has received 3 views. For similar materials see Personal Finance in Finance at Salem State University.


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Date Created: 10/08/16
Chapter 8: Managing Your Credit  The easiest way to establish credit is to obtain a credit card Advantages of Credit Cards  You can purchase products and services without carrying a large amount of cash or a checkbook  As long as you pay off your balance each month, you receive free financing until the due date on your credit card statement  You receive a monthly statement that contains a consolidated list of the purchases you made with the credit card, which enables you to keep track of your spending  Sometimes receive annual statement as well Disadvantages of Credit Cards  Allows you to make purchase that you cannot afford and should not make o Gives you the opportunity to spend beyond your means  As long as you make the minimum monthly payment, excessive spending can continue over time  Accumulate a lot of debt Applying for a Credit Card  When you apply for a credit card, potential creditors obtain information from you, and from credit bureaus, so that they can assess your ability to repay credit  Personal Information o Cash inflows: What is your monthly income? o Cash outflows: How much do you spend per month? o Credit history: Have you borrowed funds in the past? Did repay any previous loans in a timely manner? o Capital: Do you have any funds in the form of savings or stocks that can be used if necessary to cover future debt payments? o Collateral: Do you have any assets that can be used as collateral to secure the borrowed funds?  Credit Check  Creditors also often ask an applicant to disclose their income and any existing debt so that they can assess the existing debt level as a percentage of income  Creditors may also consider economic conditions Types of Credit Cards  Most popular credit cards are MasterCard, Visa, and American Express o Accepted by most merchants  Credit card company receives a receives a percentage of the payments made to merchants with its credit cards  Retail (or Proprietary) Credit Card: a credit card that is honored only by a specific retail establishment o Interest rate for these cards is usually 18% or higher o Most retailers have established partnerships with credit card companies o Limits your purchases to a single merchant o Individual credit card bill  Secured or Prepaid Cards o If you have poor credit and difficulty obtaining a standard credit card, you may be able to improve your credit record by obtaining a secured credit card, which is "secured" or backed by the funds you deposit  Can apply for at financial institutions  The amount of funds you deposit will be your credit limit o Prepaid cards do not improve your credit  Can be purchased at retail stores and gas stations  No application process  Can reload your balance  Can track your transactions online for some cards  Convenient for people who do not have bank accounts  Many fees involved  Activation fee, reloading fee, fee for withdrawing cash at an ATM, inactivity fee, and fees for checking your balance online  If stolen, you don't have as much protection as a credit card  Some employers pay employees in prepaid cards Credit Limit  The credit limit can usually be increased for individuals who prove they are creditworthy by paying their credit card bills on time  Can cancel your card due to inactivity Overlimit Protection  A few credit cards provide overlimit protection, which allows you to make purchases beyond your stated credit limit o Similar to overdraft protection Annual Fee  Annual fees range from $40-$500 for cards with extensive rewards programs  Can sometimes be waived Incentives to Use the Card  Some credit card companies offer rewards for pending with your card o May be a cash reward o Some use point systems  Prestige Cards: credit cards issued by a financial institution to individuals who have an exceptional credit standing o Offer more benefits Grace Period  Credit cards typically allow a grace period in which you are not charged any interest on your purchases o Essentially free credit  Late Fees o Credit card bills must be due on the same date each month until 5 PM o Late fees must be "reasonable" Interest Rate  When you are granted a credit card and do not pay it off before the started deadline, you will have to pay interest on that credit based on the interest rate imposed by the credit card company  Commonly between 15%-20%  A fixed rate does not change even if the market interest rates are increasing  Variable rates adjust in response to a specified market interest rate  Financial institutions may offer tiered rates, such as a relatively low rate for balances below a specified balance and a higher rate above that balance  Must be informed if rates change  Credit card companies cannot raise your interest rate if you are late on a payment Cash Advances  Many credit cards allow cash advances at ATMs  Higher interest is charged o Applied at the time of the cash advance  Transaction fee may also be charged  Credit cards also sometimes provide "convenience checks" that you can use to make purchases you cannot make with a credit card Repaying Credit  Finance Charge: the interest that you must pay as a result of using credit o Applies only to balances that were not paid in full before their due date in the current billing period o Average Daily Balance Method  For each day in the billing period, the credit card company takes your beginning balance at the start of the day and then subtracts any payments made by you on that day to determine the balance at the end of the day  Then determines the average daily balance at the end of each day  Takes into account the time that you pay off any part of the outstanding balance o Previous Balance Method  Interest is charged on the balance at the beginning of the new billing period  Applied even if part of the outstanding balance is aid off in the billing period o Adjusted Balance Method  Interest is charged on the balance at the end of the new billing period  Applies finance charges only to the outstanding balance that was not paid off during the billing period o Estimating Credit Repayment  Simple Interest Rate: the percentage of credit that must be paid as interest on an annual basis  Amount of Interest = Amount Borrowed x Simple Interest Rate  Annual Percentage Rate (APR): the simple interest rate including any fees charged by the creditor  Allows you to easily compare financing costs among various possible creditors  When obtaining credit, it is important to seek out the lowest interest rate possible  The amount of interest paid on a credit card balance depends on the length of the financing period  Pay annual interest for every year  Your credit card statement is required to show you how many months it will take you to pay off your balance when making the minimum payment each month Reviewing Your Credit Card Statement  Your credit card statement includes the following information: o Previous balance. The amount carried over from the previous credit card statement o Purchases. The amount of credit used this month to make purchases o Cash Advances. The amount of credit used this month by writing checks against the credit card account or making ATM withdrawals o Payments. The payments that you made to the sponsoring financial institution this billing cycle o Finance charge. The finance charge that is applied to any credit that exceeds the grace period or to any cash advances o New balance. The amount that you owe the financial institution as of now o Minimum payment. The minimum amount that you must pay o Paying off the balance. The amount of time it will take to pay off the balance if only the minimum payments is made and the monthly payment required to pay off the balance in three years o Interest and fees. The total amount of interest charges so far this year and the total amount of fees assessed  Look for any errors Regulation of Credit Cards  Regulations have been instituted to ensure better treatment of consumers and that requirements in credit card agreements are transparent  Credit CARD Act o Passed by US Congress in 2009 in an effort to ensure that consumers who use credit cards services are treated fairly and have access to complete information about the fees and other provisions of the credit agreement  Protects users o Credit companies must clearly disclose conditions under which fees will be charged to prospective cardholders o If the interest rate changes, it only applies to credit provided for new purchases and does not apply to credit provided in the past o Any promotional interest rates must be offered for a period of at least six months o Cardholders must be given at least 21 days from the day on which the bill is mailed to make payment o Cardholders cannot be charged an overlimit fee for exceeding their credit limit unless they have overlimit protection o The time it will take to pay the balances with minimum payments being made  Financial Reform Act o Passed in 2010 to prevent deceptive practices in the credit granting process Tips on Using Credit Cards  Use a credit card only if you will have the cash to cover the payment when you receive your credit card statement  Imposing a tighter credit limit as part of your budgeting process so that you can save or invest a specific amount each month  Cut up a credit card rather than closing the account so that it doesn't affect your credit  Reduce your reliance on credit so that you are not subjected to increased financial problems if economic conditions deteriorate Pay Credit Card Bills Before Investing Money  The cost of financing will normally be much higher than the return you are receiving on any money market investments that you hold Pay Off Credit Card Debt Before Other Debt  Pay off your balance as soon as possible and cut back your discretionary spending Avoid Credit Repair Services  If you have made late credit payments or defaulted on a loan, a credit repair service does not have the power to remove such credit information from your report Resolving an Excessive Credit Balance  Spend as little as possible in order to pay off your balance  A debt consolidation loan from a financial institution is another option  Sell some of your assets for cash  If all else fails, file for personal bankruptcy  Personal Bankruptcy: a plan proposed to the court in which you repay at least a portion of your debt and pay attorney and filing fees o Chapter 7 or Chapter 13 o Chapter 7 allows the discharge of almost all debts, but you may also have to surrender assets to help satisfy the debt o Chapter 13 allows you to keep your property, but surrender control of your finances to the bankruptcy court  Court approves a three-to-five-year repayment plan based on your financial resources  No interest charged


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