Using Credit
Chapter 6
How Will This Affect Me?
The ability to borrow funds to buy goods and services is as convenient as it is seductive. It is
important to understand how to get and maintain access to credit via credit cards, debit cards,
lines of credit, and other means. This chapter reviews the common sources of consumer credit
and provides a framework for choosing among them. It also discusses the importance of
developing a good credit history, achieving and maintaining a good credit score, and protecting
against identity theft and credit fraud. The chapter will help you understand the need to use credit
intentionally, in a way that is consistent with your overall financial objectives.
The student needs to understand that the ability to obtain credit is not an invitation to spend
money. The use of credit must be intentional and done for the right reasons. Of special
importance to the students is the section on credit cards and credit scoring, specifically the FICO,
the largest provider of credit scores by far. The FICO scores are a product of Fair Isaac & Co.
LG1 Describe the reasons for using consumer credit, and identify its benefits and problems.
LG2 Develop a plan to establish a strong credit history.
LG3 Distinguish among the different forms of open account credit.
LG4 Apply for, obtain, and manage open forms of credit.
LG5 Choose the right credit cards and recognize their advantages and disadvantages.
LG6 Avoid credit problems, protect yourself against credit card fraud, protect yourself against
identity theft, and understand the personal bankruptcy process.
Financial Facts or Fantasies?
These may be used as “teasers” to get the students on the right page with you. Also, they may be
used as quizzes after you covered the material or as “pre–test questions” to get their attention.
• It’s a good idea to contact your creditors immediately if, for some reason, you can’t make
payments as agreed.
Fact: Let the lenders know and they’ll often give you a credit
extension. This is one of the smartest things you can do to build a sound
credit history. However, except for those occasional tight spots, it’s
important to make credit payments on time consistently!
• When you apply for credit, most lenders will contact a credit bureau and let them decide
whether or not you should receive the credit.
Fantasy: Credit bureaus collect information and maintain credit files
about individual borrowers. However, they do not make the credit
decision. That’s done by the merchant or financial institution considering
extending the credit.
Financial facts or Fantasies as True/False Questions
1. True False One of the benefits of using credit is that it allows you to purchase
expensive goods and services while spreading the payment for them
overtime.
2. True False It’s a good idea to contact your creditors immediately if, for some reason,
you can’t make payments as agreed.
3. True False Excluding mortgage payments, most families will have little or no credit
problems so long as they limit their monthly credit payments to 25 to 30
percent their monthly take-home pay.
4. True False When you apply for credit, most lenders will contact a credit bureau and
let them decide whether or not you should receive the credit.
5. True False Credit card issuers are required by truth-in-lending laws to use the average
daily balance in your account when computing the amount of finance
charges you’ll have to pay.
6. True False You use a check rather than a credit card to obtain funds from an
unsecured personal line of credit.
YOU CAN DO IT NOW
The “You Can Do It Now” cases may be assigned to the students as short cases or problems.
They will help make the topic more real or relevant to the students. In most cases, it will only
take about ten minutes to do, that is, until the student starts looking around at the web site. But
they will learn by doing so.
Is Your Credit Card a Good Deal?
YOU CAN DO IT NOW
How Does Your Credit Report Look?
Financial Impact of Personal Choices
Carter Has Had It and Files for Bankruptcy
Applying Personal Finance
How’s Your Credit?
Financial Planning Exercises
1. Establish a credit history. After graduating from college last fall, Holly Baker took a job
as a consumer credit analyst at a local bank. From her work reviewing credit applications,
she realizes that she should begin establishing her own credit history. Describe for Holly
several steps that she could take to begin building a strong credit record. Does the fact that
she took out a student loan for her college education help or hurt her credit record?
Here are some things you can do to build a strong credit history:
2. Evaluating debt burden. Ted Phillips has a monthly take-home pay of $1,685; he makes
payments of $410 a month on his outstanding consumer credit (excluding the mortgage on
his home). How would you characterize Isaac’s debt burden? What if his take-home pay
were $850 a month and he had monthly credit payments of $150?
3. Evaluating debt safety ratio. Use Worksheet 6.1. Chloe Young is evaluating her debt
safety ratio. Her monthly take- home pay is $3,320. Each month, she pays $380 for an auto
loan, $120 on a personal line of credit, $60 on a department store charge card, and $85 on
her bank credit card. Complete Worksheet 6.1 by listing Chloe’s outstanding debts, and
then calculate her debt safety ratio. Given her current take-home pay, what is the
maximum amount of monthly debt payments that Chloe can have if she wants her debt
safety ratio to be 12.5 percent? Given her current monthly debt payment load, what would
Chloe’s take-home pay have to be if she wanted a 12.5 percent debt safety ratio?
Dated
•1. $
2.
3.
•1.
2.
•1.
•
•1.
2.
3.
4.
•1.
*Note: List only those loans that require regular monthly payments.
Changes needed to reach a new debt safety ratio
12.5 %
3,320.00$ ,
Total monthly
3,320.00$ ×=415.00
$
total take-home pay must equal:
Bank
Home Equity Line
120.00
60.00
85.00
Education loans
Type of Loan*
Name
Lender
Current
Monthly (or Min.)
Payment
380.00
MONTHLY CONSUMER LOAN PAYMENTS & DEBT SAFETY RATIO
September 7, 2018
Chloe Young
**Note: Enter debt safety ratio as a decimal (e.g., 15%=0.15).
take-home pay × Target debt safety ratio**
0.125
Required take-home pay
1. New (Target) debt safety ratio:
2. At current take-home pay of
total monthly payments must equal:
Auto and Personal loans
Personal line of credit
Credit Cards
Department store
Overdraft Protection Line
4. Comparing credit and debit cards. Samuel Ramirez is trying to decide whether to apply
for a credit card or a debit card. He has $8,500 in a savings account at the bank and spends
his money frugally. What advice would you have for Samuel? Describe the benefits and
drawbacks of each type of card.
If Samuel is willing to keep good records of use, a debit card provides the desired convenience
without the possibility of high interest on balances. However, if he does not keep good records,
use of a debit card may result in overdraft of the related bank account, typically a checking
5. Home equity lines. Kai and Ivy Harris have a home with an appraised value of $180,000
and a mortgage balance of only $90,000. Given that an S&L is willing to lend money at a
loan to-value ratio of 75 percent, how big a home equity credit line can Kai and Ivy obtain?
How much, if any, of this line would qualify as tax deductible interest if their house
originally cost $200,000?
6. Using overdraft protection line. Grace Wang has an overdraft protection line. Assume
that her October 2020 statement showed a latest (new) balance of $862. If the line had a
minimum monthly payment requirement of 5 percent of the latest balance (rounded to the
nearest $5 figure), then what would be the minimum amount that she’d have to pay on her
overdraft protection line?
7. Choosing between credit cards. Gabriel Clark recently graduated from college and is
evaluating two credit cards. Card A has an annual fee of $75 and an interest rate of 9
percent. Card B has no annual fee and an interest rate of 16 percent. Assuming that
Gabriel intends to carry no balance and pay off his charges in full each month, which card
represents the better deal? If Gabriel expected to carry a significant balance from one
month to the next, which card would be better? Explain.
8. Calculating credit card interest. Ruby Wilson, a student at State College, has a balance of
$380 on her retail charge card; if the store levies a finance charge of 21 percent per year,
how much monthly interest will be added to Ruby’s account?
9. Balance transfer credit cards. Zoe Robinson has several credit cards, on which she is
carrying a total current balance of $14,500. She is considering transferring this balance to a
new card issued by a local bank. The bank advertises that, for a 2 percent fee, she can
transfer her balance to a card that charges a 0 percent interest rate on transferred balances
for the first nine months. Calculate the fee that Zoe would pay to transfer the balance, and
describe the benefits and drawbacks of balance transfer cards.
Zoe has a fairly large balance of $14,500 on her credit cards. If her current cards charge her 12%
10. Credit card liability. Luna was reviewing her credit card statement and noticed several
charges that didn’t look familiar to her. Lina is unsure whether she should “make some
noise,” or simply pay the bill in full and forget about the unfamiliar charges. If some of
these charges aren’t hers, is she still liable for the full amount? Is she liable for any part of
these charges—even if they’re fraudulent?
11. Protecting against credit card fraud. Liam O’Sullivan takes pride in managing his
finances carefully with great attention to detail. He recently received a phone call in which
he was asked to confirm his credit card account number and social security number. Wyatt
was pleased he had the information handy and appreciated the caller’s thoroughness. He
gladly provided the information. What advice would you give Liam concerning his
response?
12. How to Improve FICO Score. Caleb Stewart had a FICO score of 620 when he learned
that his neighbor, Bert Collins, has a FICO score of 750. While shopping for a new
mortgage, Caleb learns that a new mortgage will cost him about 1/2 percent higher than
the rate available to Bert. Advise Caleb how he could possibly increase his FICO score.
13. Protecting Against Identity Theft. Sienna Flores lives in a neighborhood where three of
her friends have had their identities stolen in the last six months. She’s worried it will
happen to her. Explain what Sienna should keep in mind to protect herself from identity
theft.