Chapter 5: Entreprenuership



Chapter 26 How to Get and Keep Credit

Section 26.1: Applying for Credit

Developing a Credit History: credit can have a major impact on your life. If used properly, it can make your life easier. To develop a credit history, you will need to apply for credit, be approved for it, use it, and make payments to the creditor. Most people start to develop a credit history by getting a credit card in their name, however it is important to understand how credit cards work before you obtain one.

Selecting a Credit Card: there are five main factors to consider when choosing a credit card:

• What is the Interest Rate?

• Are there any Extra Fees

• Will the Interest Rate Change?

• Is a cosigner needed?

• Is there a Grace Period?

Other Questions to Consider:

• What will the cost of credit be?

• Who will accept the card?

• What is the Credit Limit?

• Will I be able to use the card to get cash?

The Cost of Credit

Interest Rates: The Annual Percentage Rate (APR) determines the cost of credit on a yearly basis. The formula is: Principle x APR. An example would be that you owe $100 at an annual percentage rate of 18% so $100 x .18 = $18 in interest owed for the year. To find out your monthly interest charge simply divide by 12 so $18/12 = $1.50/month.

In many case a credit card may offer a low introductory rate (i.e. 3%) and after a few months the rate will increase (i.e.20%)

Fees: credit card companies charge different fees for different services. Some charge an annual fee (American Express). Most charge a fee for cash advances. Late or missed payments usually have a fee. Another fee would be associated with going over your credit limit.

Other Considerations:

• You may need a cosigner who agrees to pay the debt if you can not.

• What is the grace period, or time allowed to repay without interest charges?

• There is also a grace period to make a payment before penalties are charged.

Applying for a Credit Card: you must complete and submit a credit application. This form asks for information about where the applicant lives and works, and other credit the applicant has obtained. It also asks questions about your income and savings

Credit Worthiness: The Three Cs of Credit

1) Capacity: the ability to repay the loan based on employment and income. If the applicant already has a lot of credit they may not be able to handle additional credit.

2) Character: based upon your credit report scores that show your history of repaying credit.

3) Capital (Collateral): some loans require you to provide collateral (personal property that has value, i.e. real estate or CDs) which is intended to be used to repay the loan if the debtor can no longer make payments because of loss of a job or becoming disabled.

Credit Limits: the maximum amount a card holder can charge on a credit card. If a debtor repays their bills on time most credit card companies will raise the person’s credit limit.

Making the Minimum Payment: credit card companies provide monthly billing statements based on the charges made, the balance they owe, and the minimum payment due. Many people make the minimum payment every month. However, people who make more than the minimum payment every month wind up paying less interest for the credit. The credit card application is a legally binding contract and the minimum payment is in that contract. Failure to make the minimum payment means the consumer is not meeting their legal obligation and this can have a negative impact on your credit rating.

Section 26.2 Maintaining Credit

Understanding Loans and Mortgages: similar to credit cards however there are some differences

How Installment Loans and Mortgages Work

A loan is money lent by one party to another with interest. Most loans require collateral and are paid back in installments. For example if you purchase a car and acquire a loan to make the purchase the title to the car is usually held by the lender as collateral. Another example would be obtaining a mortgage to buy a home. The lender holds a lien on the deed as collateral.

Installment loans (i.e. car loans can be anywhere from 1 – 3 years for a used car and up to 6 years for a new car)

Mortgage loans usually range from 10 to 30 years

With both types of loans the interest rate is usually fixed for the duration of the loan, however some lenders do offer variable rate mortgages which fluctuate with the market. These variable rate loans usually start out at a low rate but can escalate quite quickly thus increasing the amount of interest you must pay.

The Three Parts of a Loan

• Down Payment: the percentage of the purchase price required to be paid by the borrower when the item is purchased.

• Principal: the remainder of the purchase price financed by the lender (i.e. the amount you borrow). This is what the interest rate is multiplied by to figure out your interest payment.

• Finance Charge (aka APR): The total amount of interest cost associated with the loan.

Principal x APR x loan length = Finance Charge

$100,000 x 5%(0.05) x 30 years = $150,000

You must also pay back the principal amount of $100,000 so your total payment would be $250,000.

Secured Loans (i.e. car loans and mortgages): backed by collateral which may be sold by the lender to pay off the debt if you do not. These loans usually have a lower interest rate than unsecured loans because they are considered less risky.

Unsecured Loans (i.e. credit cards): can not take your property to pay off the debt.

Keeping a Healthy Credit Record (Figure 26.1, p.468)

• It’s as simple a paying your bills on time every time. The higher your credit score means you are less risky to the lender and this results in a lower interest rate then someone without a high score.

and

• Staying within your income limits: don’t buy what you don’t need or can’t afford to pay for. Credit companies usually look for credit payments to be within 20% of a person’s income.

Signs of Credit Trouble

• You cannot make monthly loan payments and minimum credit card payments

• You receive second and third payment notices from creditors for missed payments

• You get calls from bill collectors

• Your wages are being garnished (i.e. creditors are allowed to take directly from your paycheck before you are paid)

• The creditor repossesses an item offered as collateral (i.e. your car or house)

There are businesses that help you resolve credit troubles but they usually charge a fee.

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