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Credit

Lesson Description

Explore the types of credit, its advantages, disadvantages, and some of the most common identity theft concerns when using credit. This lesson provides the basic information that will help students understand both the obligations and concerns that using credit entails.

 

Lesson Objectives

  • Distinguish between the use and abuse of credit.
  • Compare and contrast open- and closed-end credit.

 

Credit Pre-Quiz

Credit is a tool. Put simply, you can use it wisely, or you can abuse it. Here is one cautionary tale:

 

Gena, a college freshman, attends a top university out-of-state. As she leaves for college, her parents hand her a credit card, telling her that it is for “emergencies.” She is soon using the card to purchase everything from clothes to movies to dinners out, accumulating thousands of dollars in debt by the end of her freshman year. The family decides she needs to move home, work for a year to pay off her credit card debt, and then enroll at a local school near home to finish her college degree.

 

Think that can’t happen to you? Unfortunately it’s more common than you think – 56% of undergraduates get their first card at age 18, and 91% of college students have a credit card by their senior year, with more than half of those students carrying four cards or more, according to student-loan provider Nellie Mae. A recent survey by Sallie Mae found that more than half of college students accumulated more than $5,000 in credit card debt while in school. One-third had more than $10,000 in credit card debt.

 

Credit card debt can really add up for college students:

  • most college students don’t have the resources to pay off their debts – most don’t work full-time and many work at jobs that pay them the minimum wage
  • minimum payments may be only $15 or $20 per card per month, but by paying this amount each month you will pay a lot more in finance charges, and it will take years to pay off your credit card debt

 

Put Yourself in the Driver’s Seat

When you are considering whether or not to take on the obligation of a credit card, compare these terms:

  • Annual fee. Some credit cards charge this, but many do not.
  • Annual Percentage Rate or APR. This is the annual rate of interest you will pay to use credit. In addition, you must be told:
    • How long a promotional (lower) rate will stay in effect
    • If the rate is variable
    • The varying rates for balance transfers, purchases, and cash advances
    • Penalty rates and what actions triggers them
  • Minimum Payment. Credit cards generally require a minimum payment which may be only 1-2% of your outstanding balance. If you choose to pay only the minimum payment you will pay a lot in interest over the life of your debt, and you will be paying off your debt for a long time.
  • Grace period. Most credit cards allow a free period during which you can avoid finance charges if you pay your balance in full. Remember that you usually lose the benefits of a grace period when you carry a balance forward from the previous month.
  • Computation method. Different methods result in varying costs for you.
  • Minimum finance charge.
  • Other fees.

 

Other costs of credit include:

  • Increased cost of merchandise (it will take you more than 7 years to pay off a $1,000 debt on a credit card with an 18% interest rate if you pay just $20 per month. And the $1,000 will have grown to $1,862.22 – the extra $862.22 is interest)
  • Opportunity cost (if you put $1,000 of debt on a credit card, you are pledging to spend future earnings to pay off that debt, and you are giving up the use of the $1,000 when you actually earn it)

 

How to Use Credit Cards Wisely

If you choose to get a credit card, follow these tips to use it wisely:

  1. Remember that your credit limit is a maximum set by the card issuer. Only you can decide what you can afford to spend and repay.
  2. Save your credit card receipts. This will help you stay on top of your spending, and will help you double check the charges you see on your bill at the end of the month.
  3. Pay the balance in full each month to avoid finance charges.
  4. If you can’t pay the full balance, pay as much as you can afford.
  5. Pay on time to avoid late fees, penalty triggers, and to guard your credit history.

 

Credit helps expand our purchasing power today, by allowing us to buy items we might not be able to afford if we had to pay cash. But with this right come responsibilities.

Credit Game

FAQs

What are some advantages of using credit?

Credit allows you to:

  1. Buy needed items now
  2. Carry less cash
  3. Create a record of purchases
  4. Gain convenience (compared to writing checks)
  5. Consolidate bills into one payment

 

What are Some of the Disadvantages of Using Credit?

Disadvantages of credit include:

  1. Interest charges mean an item costs more
  2. You may pay additional fees to use credit
  3. Financial difficulties may arise if you lose track of your spending each month
  4. Making more impulse purchases

 

What are Some Steps I can Take to Build a Credit History?

  • Establish a steady work record
  • Pay all bills promptly
  • Open a checking account (and don’t bounce checks)
  • Open a savings account and make regular deposits
  • Apply for a local store card and make regular monthly payments
  • Get a small loan (using your savings account as collateral, or asking a co-signer to help you), and pay back the loan as agreed
  • Put bills, such as the phone or cable bills, in your name

 

What is the 20/10 Rule?

The 20/10 rules applies to your debt ratio. As a rule of thumb, never borrow more than 20% of your yearly net income, and monthly loan and credit payments should not exceed more than 10% of your monthly net income. Mortgage loan payments are not included in the 10%, but other debt should be included such as car loans, student loans and credit cards.

 

What is the “Schumer Box”?

The Truth-in-Lending Act (TILA) requires that certain disclosures be made when credit card companies are soliciting your business. This information will be displayed in a format called the “Schumer Box,” which is named after the U.S. Senator from New York who drafted the bill.

 

The Schumer Box includes:

  • the APR or APRs
  • finance charges, including the minimum finance charge
  • the minimum payment required
  • the method used for computing your outstanding balance
  • the actual company offering you credit (sometimes not the company marketing the card)
  • the credit limit
  • the grace period
  • the annual fee, if any
  • the fees for credit insurance, if any

 

What Do Credit Reports Include?

Credit reports include:

  • Identification and employment information: Your name, birth date, Social Security number, employer, and spouse’s name are noted routinely. The consumer reporting company also may provide information about your employment history, home ownership, income, and previous address, if a creditor asks.
  • Payment history: Your accounts with different creditors are listed, showing how much credit has been extended and whether you’ve paid on time. Related events, such as the referral of an overdue account to a collection agency, also may be noted.
  • Inquiries: Consumer reporting companies must maintain a record of all creditors who have asked for your credit history within the past year, and a record of individuals or businesses that have asked for your credit history for employment purposes for the past two years.
  • Public record information: Events that are a matter of public record, such as bankruptcies, foreclosures, or tax liens, may appear in your report.

Credit Post-Quiz