Managing Credit

M ODU L E - 3
Chapter Objectives
Provide Provide a background on credit cards

Explain Explain credit repayment

Describe Describe how to review the credit card statement

Explain Explain credit card regulations

Offer Offer tips on using credit cards

Explain Explain how managing your credit fits within your financial plan
Background on Credit
Cards (1 of 7)
Advantages
No need to carry large amounts of cash
Free financing if you pay in full each month
Monthly statement for recordkeeping
Disadvantages
Can make purchases that you can’t afford
Allows spending beyond your means
Excessive spending can continue with minimum
payments
Background
on Credit
Cards (2 of
7)
EXHIBIT 8. 1 HOW A LOA N
OF $ 2 , 000 G ROWS OV E R
T I M E ( A S SU ME I N T EREST
R AT E = 1 . 5 % P E R M ON T H)
 Applying for a credit card
◦ Personal information
◦ Cash inflows
◦ Cash outflows
Background on
◦ Credit history
Credit Cards (3 ◦ Capital
of 7) ◦ Collateral
◦ Credit check
◦ Credit card issuer obtains a credit
report
 ◦ Other information that creditors
Background evaluate
on Credit ◦ Income
◦ Existing debt level
Cards (4 of 7) ◦ Current economic conditions
 Types of credit cards
◦ Most popular are MasterCard, Visa and
American Express
◦ MasterCard and Visa allow financing
Background on ◦ Most American Express cards
require payment in full
Credit Cards (5 ◦ Retail (or proprietary) credit card: a
of 7) credit card that is honored by a specific
retail establishment
◦ Retail stores and gas stations
◦ Limits purchases to a single
merchant
 Credit limit—maximum amount of credit
allowed
Overdraft protection—allows purchases
Background beyond credit limit

on Credit Annual fee

Incentives to use the card
Cards (6 of 7) ◦ Prestige cards: credit cards, such as gold or
platinum cards, issued by a financial
institution to individuals who have an
exceptional credit standing
 Grace period—period between
time of purchase and when
payment is due

Background on Types of interest rates

charged on credit cards

Credit Cards (7 Interest Rate

•May be fixed, variable or
tiered
Regulations on interest

of 7) rates – new regulations

more favorable to users

High transaction fees

Cash Advances No grace period & high
interest
Go to https://www.bankrate.com/calculators.aspx
This Web site provides
◦ Estimates of when you might be debt free
◦ Estimates of your future credit card payments based on
interest rates, card balance, and the desired payoff time

Financial Planning Online (1 of 4)

 Finance charge: the interest that
you must pay as a result of using
credit

Repaying Credit Average daily

Most frequently used
Interest charged on

(1 of 9) balance method
average daily balance at
the end of every day in
the billing period

Previous Balance Interest charged on the

balance at the beginning
Method of the new billing period
 Adjusted Balance Method
Interest is charged based on the balance
at the end of the new billing period
Repaying Credit
(2 of 9)

Review the following example

using all 3 methods to
compute the interest charges
Assume that as of June 10, you have an outstanding credit card
balance of $700 from purchases made over the last month. The new
billing period begins on June 11. Assume that your outstanding
balance for the first fifteen days of this new billing period (from June
11 to June 25) is $700. Then, on June 25, the financial institution
receives a payment of $200 from you, reducing the balance to $500.
This is the balance for the remaining fifteen days of the billing period.

Repaying Credit (3 of 9)
Repaying Credit (4 of 9)

Average Daily Balance Method. Under this method the monthly

interest rate is applied to the average daily balance. Because your daily
balance was $700 over the first fifteen days and $500 over the last
fifteen days, your average daily balance was $600 over the thirty-day
billing period. Using a monthly interest rate of 1.5%, your finance charge
is
$600  .015 = $9.00
Previous Balance Method. Under this method you will be subject to a
finance charge that is calculated by applying the monthly interest rate
to the $700 outstanding at the beginning of the new billing period.
Using a monthly interest rate of 1.5%, your finance charge is

$700  .015 = $10.50

 Adjusted Balance Method. Under this method you
will be subject to a finance charge that is calculated
by applying the monthly interest rate to the $500
outstanding at the end of the new billing period.
Using a monthly interest rate of 1.5%, your finance
charge is
Repaying Credit
(5 of 9)
$500 x .015 = $7.50
 Go to the Credit cards section of
http://www.consumerfinance.gov
Financial This Web site provides tips on selecting a
Planning Online credit card.
(2 of 4)
 You can estimate repayment on credit
cards
◦ Simple interest rate: the percentage of
credit that must be paid as interest on
Repaying Credit an annual basis
(6 of 9) ◦ Annual percentage rate (A P R): the
simple interest rate including any fees
charged by the creditor
◦ Allows comparison among potential
lenders
 Impact of interest rate on
the amount you owe
• The larger the interest rate, the
Repaying Credit higher the interest payments
(7 of 9)
Impact of financing period
on credit payments
• Total interest paid depends on
the length of the financing period
 Simple Interest Total Simple Interest
Simple Interest Rate Payment per Year Payments over Four Years
6 $ 600 $2,400
8 800 3,200
10 1,000 4,000
12 1,200 4,800
14 1,400 5,600
16 1,600 6,400
18 1,800 7,200
20 2,000 8,000

Repaying Credit (8 of 9)
E X H I B I T 8 . 2 H O W I N T E R E S T PAY M E N T S A R E I N F L U E N C E D B Y I N T E R E S T R AT E S ( A S S U M E L O A N
AMOUNT OF $10,000)
Repaying Credit (9 of 9)
Statements typically sent at the end of the billing cycle
Lists:
◦ Previous balance
◦ Purchases
◦ Cash advances
◦ Payments
◦ Finance charge
◦ New balance
◦ Minimum payment

Reviewing Your Credit Card Statement (1 of 2)

 ❑ Always scrutinize statement for
errors
Reviewing Your
❑ Dispute any errors, but pay correct
Credit Card
charges in a timely manner
Statement (2 of
2) ❑ Customer service number and/or
dispute instructions included on
statement
Credit Card Act
◦ Passed in 2009; contains provisions to protect consumers
◦ Conditions for fees
◦ Advance notice to change interest rate
◦ Promotional interest rate guidelines
◦ Payment period
◦ Credit limit
◦ Disclosure about paying balance due

Regulation of Credit Cards (1 of 2)

 ◦ Restrictions for cardholders less than age 21
◦ Summary of provisions
Consumer Financial Protection Bureau
◦ Created in 2010 as part of Financial Reform Act
◦ Goal is to enforce consumer finance laws
◦ Makes sure consumers receive full disclosure of information to
help them make financial decisions

Regulation of Credit Cards (2 of 2)

 Go to http://www.consumerfinance.gov
Financial Insert the search term “equal credit
opportunity”
Planning Online
(3 of 4) This Web site provides information about
various laws that protect your rights when
using credit
Tips on Using Credit Cards (1 of 5)
Use a credit card Reduce credit
Impose a tight
only if you can limit when the
credit limit
cover the bill economy weakens

Pay credit card Pay off credit card

Avoid credit repair
bills before debt before other
services
investing money debt
Tips on Using Credit Cards (2 of 5)
E X H I B I T 8 . 3 S E L F - I M P O S E D C R E D I T L I M I T B A S E D O N M O N T H LY C A S H I N F L O W S
Tips on Using Credit Cards (3 of 5)
E X H I B I T 8 . 4 S E L F - I M P O S E D C R E D I T L I M I T B A S E D O N M O N T H LY C A S H I N F L O W S A N D A M O N T H LY
S AV I N G S G O A L
Go to the Tips & Advice section of http://www.ftc.gov
and click on Tips & Advice tab then For Consumer then
click on “Money and Credit” tab
This Web site provides information about establishing,
using and protecting credit.

Financial Planning Online (4 of 4)

Resolving an excessive credit balance
◦ Spend as little as possible
◦ Consider ways to increase income
◦ Borrow from a family member
◦ Get a debt consolidation loan
◦ Sell assets for cash
◦ Reduce everyday expenses

Tips on Using Credit Cards (4 of 5)

 ◦ 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
Tips on Using ◦ Chapter 7 allows the discharge of
Credit Cards (5 almost all debts, but also have to
of 5) surrender assets to pay debt
◦ Chapter 13 allows you to keep your
assets, but the court takes control
of your finances and devises a 3-5
year repayment plan
How Credit Key credit management decisions for
Management your financial plan are:
Fits within Your ◦ What limit should you impose on
Financial Plan (1 your credit card?
of 4) ◦ When should you use credit?
How Credit Management Fits within Your Financial
Plan (2 of 4)
Exhibit 8.5 How Credit Management Fits Within Stephanie Spratt’s
Financial Plan
Goals for managing credit
1. Set my own limit on credit card purchases to ensure that I will always be
able to pay o the credit balance in the same month.
2. Set a policy to avoid incurring high interest expenses on credit cards.

Analysis
Liquid Assets Balance Annualized Interest Rate (%)
Cash $100 0
Checking account balance 800 0
Money market fund 400 1.5
One-month CD 1,200 2.5
Credit card balance 600 20.0

How Credit Management Fits within Your Financial Plan (3 of 4)

EXHIBIT 8.5 [CONTINUED]
Exhibit 8.5 [continued]
Decisions
Decision on Credit Limit
Given that I have $500 each month left from my salary after paying typical expenses, I have $500
remaining that can be used for credit card purchases if necessary. I will impose a maximum limit
of $1,000 on my credit card spending, which I could pay off in a period of two months. As my
income rises over time, I may consider increasing my credit limit.
Decision on Paying Off Credit Balances
Given the interest rates that I can earn on deposit accounts versus the interest rate I would pay
on a credit card balance, I will always pay off my credit card balance, even if I must withdraw
funds from my savings account to do so.

How Credit Management Fits within Your Financial Plan (4

of 4)
Fin