Credit is an arrangement to receive cash, goods, or services now and pay for them in the future. Consumer credit refers to the use of credit for personal needs (except a home mortgage) by individuals and families in contrast to credit used for business purposes.
Most consumers have three alternatives in financing current purchases:
they can draw on their savings,
use their present earnings, or
borrow against their expected future income.
Each of these alternatives has trade-offs. If you continually deplete your savings, little will be left for emergencies or retirement income. If you spend your current income on luxuries instead of necessities, your well-being will eventually suffer. And if you pledge your future income to make current credit purchases, you will have little or no spendable income in the future.
Consumer credit is based on trust in people's ability and willingness to pay bills when due. It works because people by and large are honest and responsible. But how does consumer credit affect our economy, and how is it affected by our economy?
The Importance of Consumer Credit in Our Economy
All economists recognize consumer credit as a major force in the American economy. Any forecast or evaluation of the economy includes consumer spending trends and consumer credit as a sustaining force.
Using credit to purchase goods and services may allow consumers to be
more efficient or more productive or to lead more satisfying lives. There
are many valid reasons for using credit. A medical emergency may leave
a person strapped for funds.
Using credit increases the amount of money a person can spend to purchase
goods and services now. But the trade-off is that it decreases the amount
of money that will be available to spend in the future.
Some questions you should consider before you decide how and when to
make a major purchase, for example, a car:
Do I have the cash I need for the down payment?
Do I want to use my savings for this purchase?
Does the purchase fit my budget?
Could I use the credit I need for this purchase in some better way?
Could I postpone the purchase?
What are the opportunity costs of postponing the purchase? (Alternative
transportation costs, a possible increase in the price of the car)
If you decide to use credit, make sure the benefits of making the purchase
now (increased efficiency or productivity, a more satisfying life, etc.)
outweigh the costs (financial and psychological) of using credit. Thus,
credit, when effectively used, can help you have more and enjoy more.
When misused, credit can result in default, bankruptcy, and loss of creditworthiness.
Advantages of Credit
Consumer credit enables people to enjoy goods and services now-a car, a home, an education, help in emergencies-and pay for them through payment plans based on future income.
Credit cards permit the purchase of goods even when funds are low. Customers with previously approved credit may receive other extras, such as advance notice of sales and the right to order by phone or to buy on approval.
Credit cards also provide shopping convenience and the efficiency of paying for several purchases with one monthly payment.
Credit is more than a substitute for cash. Many of the services it provides are taken for granted. Everytime you turn on the water tap, flick the light switch, or telephone a friend, you are using credit.
It is safer to use credit, since charge accounts and credit cards let you shop and travel without carrying a large amount of cash.
The use of credit cards can provide up to a 50-day "float," the time lag between when you make the purchase and when the lender deducts the balance from your checking account when the payment is due.
Some large corporations, such as General Electric Company and General Motors Corporation, issue their own Visa and MasterCard and offer rebates on purchases.
Perhaps the greatest disadvantage of using credit is the temptation to overspend, especially during periods of inflation. It seems easy to buy today and pay tomorrow using cheaper dollars. But continual overspending can lead to serious trouble.
Whether or not credit involves security (something of value to back the loan), failure to repay a loan may result in loss of income, valuable property, and your good reputation. It can even lead to court action and bankruptcy.
Misuse of credit can create serious long-term financial problems, damage to family relationships, and a slowing of progress toward financial goals. Therefore, you should approach credit with caution and avoid using it more extensively than your budget permits.
Although credit allows more immediate satisfaction of needs and desires, it does not increase total purchasing power. Credit purchases must be paid for out of future income; therefore, credit ties up the use of future income.
Two basic types of consumer credit exist: closed-end credit and open-end credit.
Closed-End Credit is used for a specific purpose and involves a specified amount.
Mortgage loans, automobile loans, and installment loans for purchasing furniture or appliances are examples of closed-end credit. An agreement, or contract, lists the repayment terms: the number of payments, the payment amount, and how much the credit will cost.
Closed-end payment plans usually involve a written agreement for each credit purchase. A down payment or trade-in may be required, with the balance to be repaid in equal weekly or monthly payments over a period of time.
The three most common types of closed-end credit are installment sales credit, installment cash credit, and single lump-sum credit. Installment sales credit is a loan that allows you to receive merchandise, usually high-priced items such as large appliances or furniture. You make a down payment and usually sign a contract to repay the balance, plus interest and service charges, in equal installments over a specified period.
Installment cash credit is a direct loan of money for personal purposes, home improvements, or vacation expenses. You make no down payment and make payments in specified amounts over a set period.
Single lump-sum credit is a loan that must be repaid in total on a specified day, usually within 30 to 90 days.
Open-End Credit
Using a credit card issued by a department store, using a bank credit card (Visa, MasterCard) to make purchases at different stores, charging a meal at a restaurant, and using overdraft protection are examples of open-end credit.
You can use open-end credit to make any purchases you wish if you do not exceed your line of credit, the maximum dollar amount of credit the lender has made available to you. You may have to pay interest, a periodic charge for the use of credit, or other finance charges. Some creditors allow you a grace period of 20 to 25 days to pay a bill in full before you incur any interest charges.
You may have had an appointment with a doctor or a dentist that you did not pay for until later. Professionals and small businesses often do not demand immediate payment but will charge interest if you do not pay the bill in full within 30 days. Incidental credit is a credit arrangement that has no extra costs and no specific repayment plan.
Many retailers use open-end credit. Customers can purchase goods or services up to a fixed dollar limit at any time. Usually you have the option to pay the bill in full within 30 days without interest charges or to make set monthly installments based on the account balance plus interest.
Credit cards are extremely popular. Consumers use more than 1.4 billion credit cards to buy clothing, meals, vacations, gasoline, groceries, doctor visits, and other goods and services on credit.
While cash advances on credit cards can look attractive, remember that interest usually accrues from the moment you accept the cash, and you must also pay a transaction fee.
Smart cards combine credit cards, a driver's license, a health care ID with your medical history and insurance information, frequent-flier miles, and telephone cards. A single smart card, for example, can be used to buy an airline ticket, store it digitally, and track frequent-flier miles. In the near future, smart cards will provide a crucial link between the World Wide Web and the physical world.
T&E cards are really not credit cards, because the monthly balance is due in full. However, most people think of Diners Club or American Express cards as credit cards because they don't pay the moment they purchase goods or services.
Home Equity Loans
A home equity loan is based on the difference between the current market value of your home and the amount you still owe on your mortgage. With such a loan, you can borrow up to $100,000 or more on your home. Depending on the value of the home, you can borrow up to 85 percent of its appraised value, less the amount you still owe on your mortgage.
The interest you pay on a home equity loan is tax deductible, unlike interest on other types of loans.
Before you take out a loan, ask yourself whether you can meet
all of your essential expenses and still afford the monthly loan
payments. You can make this calculation in two ways.
One is to add up all of your basic monthly expenses and then
subtract this total from your take-home pay. If the difference
will not cover the monthly payment and still leave funds for other
expenses, you cannot afford the loan.
The debt payments-to-income ratio is calculated by dividing your
monthly debt payments (not including house payment, which is a long-term
liability) by your net monthly income. Experts suggest that you spend
no more than 20 percent of your net (after-tax) income on consumer credit
payments.
What would you do if a friend or a relative asked you to cosign
a loan? Before you give your answer, make sure you understand what
cosigning involves.
Some studies of certain types of lenders show that as many
as three of four cosigners are asked to wholly or partially repay
the loan. That statistic should not surprise you. When you are asked
to cosign, you are being asked to take a risk that a professional
lender will not take. The lender would not require a cosigner if the
borrower met the lender's criteria for making a loan.
Despite the risks, at times you may decide to cosign. Perhaps your
child needs a first loan or a close friend needs help. Here are a
few things to consider before you cosign:
Be sure you can afford to pay the loan. If you are asked to pay
and cannot, you could be sued or your credit rating could be damaged.
Consider that even if you are not asked to repay the debt, your
liability for this loan may keep you from getting other credit you
want.
Before you pledge property such as your automobile or furniture
to secure the loan, make sure you understand the consequences. If
the borrower defaults, you could lose the property you pledge.
Check your state law. Some states have laws giving you additional
rights as a cosigner.
Request that a copy of overdue-payment notices be sent to you
so that you can take action to protect your credit history.
Building and Maintaining Your Credit Rating
If you apply for a charge account, credit card, car loan, personal loan, or mortgage, your credit experience, or lack of it, will be a major consideration for the creditor. Your credit experience may even affect your ability to get a job or buy life insurance.
A good credit rating is a valuable asset that should be nurtured and protected. If you want a good rating, you must use credit with discretion: Limit your borrowing to your capacity to repay, and live up to the terms of your contracts. The quality of your credit rating is entirely up to you.
Fair and accurate credit reporting is vital to both creditors and consumers. In 1971, Congress enacted the Fair Credit Reporting Act, which regulates the use of credit reports, requires the deletion of obsolete information, and gives consumers access to their files and the right to have erroneous data corrected. Furthermore, the act allows only authorized persons to obtain credit reports.
Your credit report may be issued only to properly identified persons
for approved purposes. It may be furnished to prospective employers
in response to a court order or in accordance with your own written
request.
When you are ready to apply for credit, you should know what creditors think is important in deciding whether you are creditworthy. You should also know what they cannot legally consider in their decisions. The Equal Credit Opportunity Act (ECOA) starts all credit applicants off on the same footing. It states that race, color, age, sex, marital status, and certain other factors may not be used to discriminate against you in any part of a credit dealing.
What Creditors Look For: The Five Cs of Credit Management
When a lender extends credit to its customers, it recognizes
that some customers will be unable or unwilling to pay for their
purchases. Therefore, lenders must establish policies for determining
who will receive credit. Most lenders build their credit policies
around the five Cs of credit.
Character is the borrower's attitude toward credit obligations.
Most credit managers consider character the most important factor
in predicting whether you will make timely payments and ultimately
repay your loan.
Capacity is your financial ability to meet credit obligations,
that is, to make regular loan payments as scheduled in the credit
agreement. Therefore, the lender checks your salary statements
and other sources of income, such as dividends and interest. Your
other financial obligations and monthly expenses are also considered
before credit is approved.
Capital refers to your assets or net worth. Generally,
the greater your capital, the greater your ability to repay a
loan. The lender determines your net worth by requiring you to
complete a credit application. You must authorize your employer
and financial institutions to release information to confirm the
claims made in the credit application.
Collateral is an asset that you pledge to a financial
institution to obtain a loan. If you fail to honor the terms of
the credit agreement, the lender can repossess the collateral
and then sell it to satisfy the debt.
Conditions refer to general economic conditions that
can affect your ability to repay a loan. The basic question focuses
on security-of both your job and the firm that employs you.
The ECOA is very specific about how a person's age may be used
in credit decisions. A creditor may ask about your age, but if
you're old enough to sign a binding contract (usually 18 or 21
years old, depending on state law), a creditor may not
Turn you down or decrease your credit because of your age.
Ignore your retirement income in rating your application.
Close your credit account or require you to reapply for it
because you have reached a certain age or retired.
Deny you credit or close your account because credit life
insurance or other credit-related insurance is not available
to people of your age.
Public Assistance You may not be denied credit because
you receive Social Security or public assistance. But, as with
age, certain information related to this source of income could
have a bearing on your creditworthiness.
What If Your Application Is Denied?
Ask Questions If Your Application Is Denied If you receive a notice that your application has been denied, the ECOA gives you the right to know the specific reasons for denial. If the denial is based on a credit report, you are entitled to know the specific information in the credit report that led to it.
The best way to maintain your credit standing is to repay your debts on time. But complications may still occur. To protect your credit and save your time, money, and future credit rating, you should learn how to correct any mistakes and misunderstandings that crop up in your credit accounts. If a snag occurs, first try to deal directly with the creditor. The credit laws can help you settle your complaints.
The Fair Credit Billing Act (FCBA), passed in 1975, sets procedures for promptly correcting billing mistakes, refusing to make credit card or revolving credit payments on defective goods, and promptly crediting your payments.
The act defines a billing error as any charge for something you did not buy or for something bought by a person not authorized to use your account. Also included among billing errors is any charge that is not properly identified on your bill (that is, for an amount different from the actual purchase price) or that was entered on a date other than the purchase date. A billing error may also be a charge for something you did not accept on delivery or was not delivered according to agreement.
If you think your bill is wrong or you want more information about it, follow these steps. First, notify the creditor in writing within 60 days after the bill was mailed. A telephone call will not protect your rights. Be sure to write to the address the creditor lists for billing inquiries.
Give the creditor your name and account number, say that you believe the bill contains an error, and explain what you believe the error to be. State the suspected amount of the error or the item you want explained. Then pay all the parts of the bill that are not in dispute.
While waiting for an answer, you do not have to pay the disputed amount or any minimum payments or finance charges that apply to it.
The creditor must acknowledge your letter within 30 days, unless it can correct your bill sooner. Within two billing periods, but in no case longer than 90 days, either your account must be corrected or you must be told why the creditor believes the bill is correct.
If the creditor made a mistake, you need not pay any finance charges on the disputed amount. Your account must be corrected, and you must be sent an explanation of any amount you still owe.
If no error is found, the creditor must promptly send you an explanation of the reasons for that determination and a statement of what you owe, which may include any finance charges that have accumulated and any minimum payments you missed while you were questioning the bill.
Your Credit Rating during the Dispute
A creditor may not threaten your credit rating while you are resolving a billing dispute.
Once you have written about a possible error, a creditor is prohibited from giving out information that would damage your credit reputation to other creditors or credit bureaus.
After explaining the bill, the creditor may report you as delinquent on the amount in dispute and take action to collect if you do not pay in the time allowed. Even so, you can still disagree in writing. Then the creditor and the credit bureau must report that you have challenged your bill and give you the name and address of each recipient of information about your account.
When the matter has been settled, the creditor must report the outcome to each recipient of the information. Remember, you may also place your version of the dispute in your credit record.
Maybe you never charged those goods and services, but someone
else did-someone who used your name and personal information
to commit fraud. When impostors take your name, Social Security
number, credit card number, or some other piece of your personal
information for their use, they are committing a crime.
The biggest problem is that you may not know your identity
has been stolen until you notice that something is amiss:
You may get bills for a credit card account you never opened,
your credit report may include debts you never knew you had,
a billing cycle may pass without you receiving a statement,
or you may see charges on your bills that you didn't sign
for, didn't authorize, and know nothing about.
If someone has stolen your identity, the Federal Trade Commission
recommends that you take three actions immediately:
Contact the fraud departments of each of the three major
credit bureaus. Tell them to flag your file with a fraud
alert, including a statement that creditors should call
you for permission before they open any new accounts in
your name.
Contact the creditors for any accounts that have been
tampered with or opened fraudulently. Ask to speak with
someone in the security or fraud department, and follow
up in writing.
File a police report. Keep a copy in case your creditors
need proof of the crime.
To prevent an identity thief from picking up your trash
to capture your personal information, tear or shred your charge
receipts, copies of credit applications, insurance forms,
bank checks and statements, expired charge cards, and credit
offers you get in the mail.
If you believe an identity thief has accessed your bank
accounts, checking account, or ATM card, close the accounts
immediately. When you open new accounts, insist on password-only
access. If your checks have been stolen or misused, stop payment.
If your ATM card has been lost, stolen, or otherwise compromised,
cancel the card and get another with a new personal identification
number (PIN).
If, after taking all these steps, you are still having identity
problems, stay alert to new instances of identity theft. Notify
the company or creditor immediately, and follow up in writing.
Also, contact the Privacy Rights Clearinghouse, which provides
information on how to network with other identity theft victims.
Call 619-298-3396 or visit www.privacyrights.org.
The U.S. Secret Service has jurisdiction over financial
fraud cases. Although the service generally investigates cases
where the dollar loss is substantial, your information may
provide evidence of a larger pattern of fraud that requires
its involvement. Contact your local field office.
The Social Security Administration may issue you a new Social
Security number if you still have difficulties after trying
to resolve problems resulting from identity theft. Unfortunately,
however, there is no guarantee that a new Social Security
number will resolve your problems.
If you have a complaint about credit, first try to solve your problem directly with the creditor. Only if that fails should you use more formal complaint procedures.
If you think you can prove that a creditor has discriminated
against you for any reason prohibited by the ECOA, you
may sue for actual damages plus punitive damages (that
is, damages for the fact that the law has been violated)
of up to $10,000.
Fair Credit Billing Act
A creditor that fails to comply with the rules applying
to the correction of billing errors automatically forfeits
the amount owed on the item in question and any finance
charges on it, up to a combined total of $50, even if
the bill was correct. You may also sue for actual damages
plus twice the amount of any finance charges.
Fair Credit Reporting Act
You may sue any credit-reporting agency or creditor
for violating the rules regarding access to your credit
records and correction of errors in your credit file.
You are entitled to actual damages plus any punitive
damages the court allows if the violation is proven
to have been intentional.
Consumer Credit Reporting Reform Act
An unfavorable credit report can force you to pay
a higher interest rate on a loan or cost you a loan,
an insurance policy, an apartment rental, or even a
job offer. The Consumer Credit Reporting Reform Act
of 1997 places the burden of proof for accurate
credit information on the credit reporting agency rather
than on you. Under this law, the creditor must certify
that disputed data are accurate. If a creditor or the
credit bureau verifies incorrect data, you can sue for
damages. The federal government and state attorneys
general can also sue creditors for civil damages.
The Federal Reserve System has set up a separate office,
the Division of Consumer and Community Affairs, in Washington
to handle consumer complaints. Contact the director of
this division in Washington, DC 20551. This division also
writes regulations to carry out the consumer credit laws,
enforces these laws for state-chartered banks that are
members of the Federal Reserve System, and helps banks
comply with these laws.
If you believe you have been refused credit due to discrimination, you can do one or more of the following:
Complain to the creditor. Let the creditor know you
are aware of the law.
File a complaint with the government. You can report
any violations to the appropriate government enforcement
agency.
Although the agencies use complaints to decide which companies
to investigate, they cannot handle private cases. When
you are denied credit, the creditor must give you the
name and address of the appropriate agency to contact.
