Credit and Debt Management Flashcards
Disadvantages of Using Credit
Overspending
Associated costs
Less flexibility with budget
Factors that weight on Credit Score
Home Ownership
Residential and Job Stability
Education
Income
Questions to judge credit worthiness
Do you have checking and savings accounts and use them regularly?
Do you use them properly, or are there frequent overdrafts?
Have you used credit properly before by repaying your debts on a timely basis?
Equal Credit Opportunity Act
Individuals cannot be discriminated against because of race, color, age, sex, marital status, or other related factors. This does not mean that someone is automatically given a loan because of one or several of these characteristics. It means that lenders may not deny him a loan because of any one of them.
Lenders do not use such factors in credit-scoring formulas. Age may matter, but if you are 62 or older, you must be given at least as many points as someone under 62, and
You have to receive a response from a creditor within 30 days after your application indicating whether your request has been approved or denied. If it was denied, the response must be in writing, and it must either explain the reasons for the denial or indicate your right to an explanation.
Three Forms of Credit
A regular (or 30-day) account
A revolving account
A retail installment account.
Open End Account
When you establish an open-end account, you will sign an agreement that covers all credit purchases and cash advances made in the account. This agreement is binding as long as the account is open.
Closed End Account
A credit agreement covering a single purchase with a set repayment schedule is a closed-end account. A closed-end account requires a separate retail installment contract for each purchase. These accounts are usually for large amounts and longer periods of time.
Charge Account
A regular charge account is a credit account with a merchant, in which complete payment at the end of the billing cycle usually avoids all interest changes.
Long Term Debt Ratio
The long-term debt ratio relates the amount of funds available for debt repayment to the size of the debt payments. In effect, this ratio is the number of times you could make your debt payments with your current income. It focuses on long-term obligations such as home mortgage payments, auto loan payments, and any other long-term credit obligations. A long-term debt coverage ratio below 2.5 is not financially desirable.
Debt Resolution Rule
Financial planners use the debt resolution rule to help control debt obligations. These exclude borrowing associated with education and home financing. The debt resolution rule forces you to repay all your outstanding debt obligations every 4 years.
The logic behind this rule is that consumer credit should be short-term in nature. If it lasts over 4 years, it’s not short-term. Unfortunately, it’s all too easy to rely on consumer credit as a long-term source of funding. Given its relative costs, this type of funding should be used sparingly.
Debt Limit Ratio
The debt limit ratio is simply a measure of the percentage of your take-home pay or income taken up by non-mortgage debt payments. The recommended maximum debt limit ratio should not exceed 20%.
Fixed Rate Loan
A fixed-rate loan is not tied to market interest rates and maintains a single interest rate for the entire duration of the loan. Regardless of whether market interest rates swing up or down, the interest rate you pay remains fixed. The vast majority of consumer loans have fixed rates.
Variable Rate Loans
A variable- or adjustable-rate loan is tied to a market interest rate, such as the prime rate or the six-month Treasury bill rate. The interest rate you pay varies as that market rate changes.
Prime Rate
The prime rate is the interest rate banks charge to their most creditworthy customers. Most consumer loans are set above the prime rate or the Treasury bill rate. For example, your loan might be set at 4 percent over prime. In this case, if the prime rate is 9 percent at the moment, the rate you pay on your variable-rate loan would be 13 percent. If the prime rate drops to 8 percent, your rate would change to 12 percent.
Not all variable-rate loans are the same. For example, rates may be adjusted at different, but fixed, intervals. Some loans adjust every month, others every year. The less frequently the loan adjusts, the less you have to worry about rate changes.
Convertible Loan
A convertible loan is a variable-rate loan that can be converted into a fixed-rate loan at the borrower’s option at specified dates in the future. Although convertible loans are much less common than variable or fixed-rate loans, they do offer the advantage of the lower cost of a variable-rate loan while still being able to lock into the savings of a fixed-rate loan.
